Toll Brothers Inc (TOL): Why Cyclicality Is Less of an Issue for This Home Builder

On the back of a 35% year-on-year increase in revenue for the first quarter of fiscal 2013, it increased its authorized investment in land and development by $200 million each year to build up inventory for the future.

Despite this, I am negative on PulteGroup, Inc. (NYSE:PHM) for two reasons. Firstly, it is more leveraged than Toll Brothers with a gearing of 114%. Secondly, inline with its focus on ROIC, it has been actively reducing its land bank since 2010 to generate more cash; unlike Toll Brothers, which has been increasing land bank over the past few years to prepare for the market recovery.

D.R. Horton, Inc. (NYSE:DHI) adopts a cost leadership strategy and focuses on cost-cutting and sale of new single-family homes at below average prices. As a result of this strategy, it also has a relatively comfortable gearing of 87%. It registered strong revenue growth in the second quarter of fiscal 2013, increasing net sales orders by 34% in units and 52% in dollar terms to 7,879 homes and $2.0 billion, respectively. Its future outlook looks bright with backlog increasing 76% year-on-year to $2.4 billion.

However, I am concerned about D.R. Horton, Inc. (NYSE:DHI)’s high cancellation rates historically. Its cancellation rates were above 25% from 2008 to 2011, but came down to 19% in the most recent quarter. Because of its low-price focus, it is possible that D.R. Horton attracts a significantly higher portion of fringe buyers who do not qualify for mortgages.

Conclusion

Toll Brothers Inc (NYSE:TOL)’ product diversification and strong balance sheet help to reduce customer type concentration and bankruptcy risk, respectively. In addition, its recent investments in distressed real estate and campus living programs will make Toll Brothers less exposed to the cyclicality of the home-building industry. Moreover, Toll Brothers is cheap at 0.6 times PEG, indicating that the strong growth prospects of the company have not been factored into its stock price. This makes it an attractive investment candidate in my opinion.

The article Why Cyclicality Is Less of an Issue for This Home Builder originally appeared on Fool.com and is written by Mark Lin.

Mark Lin has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Mark is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.

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