Description

Toll Brothers is a luxury homebuilder with FY2002 (year ended 10/02) deliveries of 4,430 homes at an average price of approximately $515,000. The company builds in 22 states and 46 markets. TOL's historical performance has been impressive with ten consecutive years of eps growth and ROE (on beginning equity) during this period averaging 22.9%.

and market share gains by the large public homebuilders (see my August 2001 recommendation of Centex), I will keep my TOL summary brief. For those of you who read the recent Barron's article on TOL, much of this write-up will seem repetitive.

Operations: TOL distinguishes itself from the other large homebuilders by focusing exclusively on the luxury market, a niche that should grow -- over the long-term - at a rate greater than the overall housing market. While inventory (both land and "bricks & sticks") turnover is lower than the other public homebuilders, margins are higher as TOL competes mainly with inefficient local builders and captures more land appreciation (especially since turns are slower) than other production builders. Additionally, Toll distinguishes itself from most other public builders by aggressively pursuing a house component assembly and manufacturing operation.

Land: TOL has a very strong land positions; the company controls nearly 41,000 lots (or more than 9 years of supply at the 2002 delivery rate), most of which are in constrained markets (NJ, CA, etc.); about 65% of the company's lots are owned with the remainder controlled through options. It is worth noting that TOL's on-balance sheet land and options to purchase land are worth substantially more than book value (some of the land was purchased ten years ago).

Management: TOL's management -- led by company founder Bob Toll -- is smart, scrappy, and incentivized (insiders own approximately 36% of shares outstanding).

Balance sheet: Net Debt/Capital is 46%, with debt mainly financing pre-sold inventory (net debt = $970MM and construction in progress = $1,491MM). TOL has grown organically and thus does not have goodwill.

Valuation: TOL should earn about $3.25 p/s this year (ending October 2003); since October is only 7 months away and TOL homes are delivered about 9 months after ordering (this is longer than the typical public homebuilder due to the larger size and greater customization of a TOL house), visibility of earnings is quite good. Thus, tangible book value should be about $18.45 in October 2003. Thus, the shares trade at about year-end tangible book and less than 6x this year's earnings. Additionally, due to the appreciation of TOL's controlled land, the shares trade at a significant discount to liquidation value.

Catalyst

Valuation. TOL sells below year-end tangible book value and at a very low p/e. Over the long-term, TOL should be able to achieve above-average growth, and thus deserves a significantly higher valuation.