Toll Bros., long a Northeast and Mid-Atlantic builder, is now bigger out west
Home builders used to sell on average 1.5 million to 2 million units annually, compared to 1.2 million currently, still well below historic norms. So even though its stock has nearly doubled in the last three years, Toll executives contend there is room to run.
From its start as a local builder in the Philadelphia suburbs, Toll Brothers has been known mainly as a Northeast and Mid-Atlantic home builder based out of Horsham. But the company founded by Bruce and Bob Toll today is moving ever westward, with roughly half of its business now derived from states west of the Mississippi.
Douglas Yearley, Toll Brothers chief executive officer, highlighted Toll's westward focus after releasing its most recent fourth-quarter and 2017 earnings.
"Acquisitions of builders in Seattle in 2011, California in 2014, and Boise in 2017, as well as quality land purchases across all our western markets, have led to significant growth," he said. "California and the West region combined for 47 percent of our revenues" in the fourth quarter.
In California, now Toll's largest region, home-building contracts were up 56 percent in dollars and 54 percent in the number of units in the fourth quarter.
Fiscal 2017 ended "with our highest annual contracts and revenues in over a decade," Yearley said. "Contracts and revenues for the full fiscal year were up 21 percent and 12 percent, respectively. We ended 2017 with a $5 billion backlog, up 27 percent in dollars and 25 percent in units from one year ago. This should result in strong revenue and earnings per share growth in fiscal 2018."
In an interview at Horsham headquarters, Toll CFO Marty Connor also noted the company has grown by purchasing firms out west.
"We have made three acquisitions in the last seven years, including CamWest Development in Seattle for a purchase price of $150 million in 2011, Shapell Homes in California in 2014, for $1.6 billion, and Coleman Homes in Boise, Idaho. All have been great, but due to size and innovation of product, the biggest of those stories is Shapell Homes. Coleman and CamWest got us into new markets. Shapell made us bigger in the southern and northern California markets where we were already operating successfully," he added.
CamWest in Seattle gave Toll one of the largest privately held home-building companies in the Pacific Northwest. Even the Coleman purchase involved the takeover of 1,400 owned lots, 350 controlled lots, and 15 selling communities, boosting Toll's footprint mainly in the western U.S., Connor added.
Toll has also grown operations in Las Vegas and Reno, Nev., Denver, and Phoenix during that time. "Most of the growth is organic, but in Denver and Vegas and Reno we have introduced active adult product that is new," he added. Active adult is Toll's category for 55-plus or senior-living homes.
Projections for this year show similar growth: Toll estimates revenues will be $6.24 billion to $7.48 billion, compared with $5.81 billion in fiscal 2017.
Home builders, whose business is notoriously cyclical, have generally benefited from the stock market's record rally. Toll's stock has nearly doubled since January 2016, reaching the low $50s a share last week. And the group dodged a bullet when mortgage deductions were maintained in the tax bill. Even with the two or three interest rate hikes expected this year, "we don't see that impacting demand at all, really in any demographic," Connor said. Normally, interest rate hikes slow down consumer demand for mortgages.
Nor is there softness when it comes to consumers and home prices: Toll expects to deliver from 7,700 to 8,700 houses this year, at an average price of between $810,000 and $860,000.
Toll is taking cues from Wall Street investors, recently instituting a cash dividend of 8 cents a share for the first time, a move that appeals to long-term shareholders. It marks a huge turnaround from the financial crisis for the public company.
Homes sales have yet to recover to pre-2007 boom levels. In prior decades, home builders on average sold 1.5 million to 1.6 million units annually, compared with 1.2 million currently, still well below historic norms. So Toll executives contend there is room to run.
Toll also is focusing on high-rises in larger urban areas such as Manhattan, Washington, and other regions, as well as a millennial-aimed line called T-Select.
So what could crimp the expansion? Higher labor and materials costs top the list.
While the 2018 outlook for the U.S. home-building industry is compelling given higher demand, a favorable job market and solid economic conditions, "we are concerned about the escalating building material and labor costs that are proving to be a drag on margins," said Zacks Investment Research in a January research report on Toll.
Company executives agree that rising building materials and labor costs are an issue.
Land prices are also rising, which could eat into home builders' margins in the next year or two. Rising lumber and timber costs also raise concern, as these and related products are needed to build new houses. President Trump has announced plans to impose a tariff of up to 24 percent on imports from the Canadian softwood lumber industry, making them costlier. And domestic lumber companies may also be able to charge higher prices in the face of less foreign competition.
"Labor costs represent approximately 25 percent of the price of a new home, thus a 5 percent increase in labor means that we would need a price increase of approximately 1.25 percent to keep margins flat, not factoring any other increased costs for land, materials, or land improvements," Connor said. "We forecast margin in the core of our business to be roughly flat, implying that price increases have kept pace with cost increases."
Toll is seeing labor shortages in certain markets and jobs. "It's not everywhere and it's not all trades. When we see these shortages, it impacts the construction cycle time of the home. … In these circumstances we usually get more aggressive in raising the price, which has the impact of reducing demand and bringing supply of labor and demand for homes more in balance. All that being said, this is not a new phenomenon. We have been dealing with it in various trades and markets for the past few years. We believe we can continue to manage through the issue and it will not have a meaningful impact on our growth."
Even with all those pressures, revenue is projected to grow at a compound annual rate of 11.1 percent for the next five years, concludes New Constructs equity research.