Toll Brothers Inc.

Moat: 2/5

Understandability: 2/5

Balance Sheet Health: 4/5

A luxury home builder in the United States, specializing in single-family detached homes, master-planned communities, and high-rise condominiums in metropolitan areas.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview and Analysis

Toll Brothers (TOL) operates as a luxury home builder across several regions in the U.S. They are primarily engaged in designing, building, and selling detached homes, townhouses, and condominiums to affluent customers.

  • Revenue Distribution: Toll Brothers segments their revenue based on geography and business type, primarily through home sales and land sales. For the fiscal year ending October 31, 2022, revenues totaled $10.6 billion, with 97% derived from home sales. Other revenues include joint venture activity and income from financial services.

  • Industry Trends: The homebuilding industry, particularly the luxury segment, is cyclical, affected by macroeconomic factors such as interest rates, inflation, and consumer confidence. There are trends around sustainable housing, design preferences, technology implementation, and urbanization. In recent years, the industry has seen supply chain disruptions and a tightening labor market, while also having a strong demand for properties.

  • Margins: Toll Brothers has struggled lately to maintain high margins. In 2022 they have maintained gross margin to 24% (excluding impairment charges) up from 2021, but in late 2023 it is down to 22%. They are aiming for higher margins, however, it seems like this is a highly fluctuating metric with significant variability.

  • Competitive Landscape: The homebuilding industry is competitive, with regional players, public builders, and private firms all vying for market share. Toll Brothers positions itself as a luxury brand, but has high fixed costs, making it challenging to compete with smaller firms that have more flexibility. Other players in the market, such as Lennar, offer more value-oriented homes, leading to lower average selling prices and a focus on volume.

  • What makes the Company Different: Toll Brothers distinguishes itself through a luxury focus, high quality customization and design, and strong brand recognition in the luxury segment. They operate in the largest markets in the U.S, meaning they have more bargaining power with the suppliers and are able to implement their construction processes efficiently.

  • Other Notable Information: The company operates a financial arm and a land development arm. Additionally, Toll Brothers are trying to increase automation in order to streamline operations.

Financial Analysis

  • Revenues:
    • 2021 to 2022: Revenues increased significantly, with total revenues climbing by 14.8% YoY. This was driven by a large increase in homes delivered and their average selling prices. They sold 9,976 homes for an average price of 1.048 million in 2022, and sold 9,937 homes in 2021 for an average price of 0.87 million. In 2023, that trend continued as units delivered were up and their price was also higher.
    • 2022 to 2023: In 2023, net income from homebuilding was $1.5 billion compared to 1.27 billion in 2022. This revenue increase is due to the fact that their net contracts signed in Q1 and Q2 are up by 20% compared to previous quarters.
  • Earnings:
    • 2021 to 2022: Income before income tax increased from 1.1 billion to 1.78 billion from 2021 to 2022.
    • 2022 to 2023: They improved net income to $1.56 billion in fiscal 2023 compared to $1.27 billion in 2022.

  • Margins: The gross margins for 2023 were above 24% however this includes a significant 400 basis points in writeoffs. Net profit margin has continued to decline in all quarters of fiscal 2023.

  • Capital Resources:
    • Cash and cash equivalents increased from 1.134 billion to $1.451 billion in one year from 2021 to 2022. Then slightly decreased in 2023 to $1.076 billion.

  • Debt: In fiscal year 2023 debt was approximately $3.5 Billion, meaning a relatively high debt load. Their debt is rated BBB- and has a relatively higher effective borrowing rate.

  • Share Repurchases: In the fiscal year of 2022, they have repurchased 3.5 million common stock shares. In 2023 they continued the share buyback program and bought 2.5 million common stock shares.

Moat Analysis

Moat Rating: 2/5

Toll Brothers has a narrow economic moat. Here’s a breakdown:

  • Brand: Toll Brothers leverages its brand as a luxury home builder. This creates a certain allure and customer loyalty, which acts as a moat to some extent. This moat is stronger in the high-end of their price range, where the company faces fewer competitors. However, their middle range homes aren’t considered as differentiated and thus is a weakness.

  • Scale and Distribution: They have a significant network of operations within the country, and that does give them a cost advantage that is very hard for any small- or mid-sized competitor to match. This large footprint helps with the purchase of materials, hiring personnel, and many other operations-related functions. The downside is, this also means that it is more difficult to adopt to any changes that might be needed because of the size.

  • Switching Costs: Switching costs for the end consumer are relatively low, because they are mainly purchasing the home, not the company. However, given the complex process of building the home, the customers are usually tied to the same builder through the home buying process making the switching costs somewhat important and somewhat a moat.

The brand and a small degree of customer retention do provide some barriers, but these are not as durable as what’s seen in companies with wide moats.

Risks to the Moat and Business Resilience

  • Macroeconomic Factors: Fluctuations in interest rates, economic downturns, and changes in government policies directly influence demand for housing, with luxury markets also being highly sensitive to changes in the financial health of high-income earners. In early 2023, they have benefited because of limited availability of housing, however, they remain a cyclical industry so any changes in the markets can significantly affect the revenue in a short period of time.

  • Competition: With the high fixed cost that comes along with it, it makes them much more vulnerable to smaller competitors who are more flexible with the pricing of their homes and operating practices.

  • Geographic concentration: Toll Brothers has a significant portion of their operations in California, New York and Pennsylvania. Any downturn or significant issue in those particular markets will severely hamper the results and profitability of the company.

  • Debt and Leverage: The current debt load is a bit high, that they had to use in order to gain the competitive advantage and they will have to reduce it to become financially stable. High levels of debt can expose the company to interest rate hikes or when the economy goes through a downtrend.

  • Supply Chain and Labor: The housing sector has experienced labor shortages, especially in the skilled trades. This, coupled with ongoing supply chain challenges, impacts the cost and timelines of their projects.
  • Material Cost: The fluctuating nature of the commodity markets has made pricing of their goods quite difficult. For example in 2022, the company saw a price hike on their raw materials.

Business Resilience: Toll Brothers’ strong market position in the luxury segment does give the company a level of resilience. However, the cyclicality of the housing industry and the presence of macroeconomic risks limit the overall resilience of the business.

Understandability Rating

Understandability: 2/5

Toll Brothers has a business model that is easy to understand; building and selling homes. However, their finances are very complex, and there are many non-obvious metrics to look into such as deferred taxes, and also understanding how they use their many joint-ventures are not very easy to understand for a normal retail investor.

Balance Sheet Health

Balance Sheet Health: 4/5

The company has a strong cash position. They also have high liquidity and good current ratios. They use a lot of leverage, but that is typical in this industry, but their ability to handle that leverage is good. The biggest issues are the size of the company, where they are too large for this type of business model, and that there are very few tangible assets on their balance sheet.

Recent Concerns/Controversies

  • Market Downturns: The company is susceptible to changes in market sentiment and economic downturns. Their earnings have been impacted in a major way due to lower demands and a decline in their book value.

  • Housing Slowdown: The housing market has cooled down significantly and will probably continue to cool down given the increase in interest rates. The company is also cutting prices and offering more incentives for customers to buy the homes. This impacts the profitability of the firm for the coming quarters.

  • Management View: Management is taking measures by controlling costs and focusing their investments in the best geographical locations. They expect margins to bounce back given the increased prices of homes and their cost-cutting measures. They are also taking advantage of a slowdown by acquiring valuable land for the future.