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In my previous post, I wondered about the sanctity of the government’s economic data releases. I expressed my dismay and even criticized the government and its agencies. It didn’t take long for the criticism to be proven correct, and how. On the 21st, the BLS (Bureau of Labor Statistics) released its revisions for all the jobs data for the one year released till the end of March 2024. It was a big whopper of a release.
The BLS reported that it had overstated the number of jobs by 818,000 than previously estimated - with all the job losses coming from the private sector. That is a huge number. When was such a large revision made previously? 2009.
I appreciate that estimating the jobs is hard due to all the statistical vagaries. However, were there telltale signs? Yes. The headline BLS employment numbers reported monthly are based on the establishment survey. The household survey is also included in the report. See for yourself the huge gap between the two.
BLS - Employment Surveys
This has been discussed ad nauseam on fintwit. The consensus was the household survey is probably closer to reality. The debate rages on, but this release did quite a lot of harm to BLS’s reputation. If that were not enough, here are two factoids:
The report was delayed by approximately 45 minutes. However, as Bloomberg reported, some banks got hold of the data before it was publicly disclosed.
Reuters Headline
Now if the following statements from Commerce Secretary Gina Raimondo don’t make your jaw drop, it just might make you go ROFL.
ABC News correspondent Kayna Whitworth: I am curious as to your thoughts on today the Bureau of Labor saying that more than 800,000 fewer jobs were actually created than initially reported.
The reporter played a clip of former President Donald Trump: The administration padded the numbers with an extra — listen to this one — 818,000 jobs that don’t exist. So they said they existed and they never did exist. They built ‘em up so they could say what a wonderful job they’re doing.
Raimondo: No. When I hear that, first of all, I don’t believe it because I’ve never heard Donald Trump say anything truthful.
Whitworth: It is from the Bureau of Labor.
Raimondo: I’m not familiar with that.
They think you’re stupid.
Tim Young - Comedian
This jobs revision report allowed Fed Chair, Jerome Powell, to put a September rate cut on the table at his Jackson Hole speech.
The time has come for policy to adjust …. the timing and pace of rate cuts will depend on incoming data, the evolving outlook, and the balance of risks.
… inflation has declined significantly. The labor market is no longer overheated, and conditions are now less tight than those that prevailed before the pandemic.
And the markets took off. Now, macro experts would point out that the last time the Fed cut rates after a period of an inverted yield curve was in September 2007. Historically, the first-rate cut leading to an uninverting of the yield curve has been the start of a lot of economic pain. Something to keep at the back of your mind.
Given this backdrop, one would wonder how the rich are doing. You know, the people who buy million-dollar-plus homes. So I took a peek at Toll Brothers (TOL), the premium luxury homebuilder.
Toll Brothers - Lots Going its Way
TOL has a lot of tailwinds propelling it to greater heights. It is perceptible from management’s confident and bullish commentary.
Customer Base
TOL’s customer base is the well-to-do kind. Well, their average selling price is $975,000 - that says more than enough. Then there is the demographic shift and a huge wealth transfer from the boomers to the next generations.
... approximately 30% of our customers are first-time homebuyers. Most of these buyers are millennials, many of whom have waited later in life to form families and have accumulated greater wealth when they buy their first home. Some are benefiting from the greatest wealth transfer in US history from boomer parents who want to see their kids enjoy the fruits of their success and help them financially.
Note
TOL’s Financial Year runs from October to November. The most recent earnings release was on August 21 - Q3 2024.
The purchasing power of TOL’s customer base is evident from how they are paying for the homes. 28% of TOL’s buyers paid in cash in Q3 2024. The LTV (Loan-to-Value) for the rest 72% - who take out mortgages - is 69%.
The loan-to-value ratio for buyers who took a mortgage was approximately 69%. So for the 72% of our buyers who took a mortgage, on average, they put down 31%. These metrics highlight the financial strength and affluence of our entire customer base.
Low Housing Inventory
The undersupply of homes for sale due to underbuilt, aging stock and the lock-in effect of higher rates is keeping resale inventory at historically low levels. This is pushing more buyers towards homebuilders like TOL.
… even as interest rates move lower, we believe the supply of homes will remain challenged due to nearly 15 years of underproduction. Lower rates alone will not fully address the chronic undersupply of housing.
US Housing Supply
Incentives
Given TOL’s strong balance sheet - net debt-to-capital ratio of 19.6% and $893 million in cash and equivalents - it offers incentives to customers to buy down. TOL’s customers can buy down their rate to 4.38% for the first year.
Around 5% to 6% of the mortgage amount to buy it down. Remember that 4.38% is a one-year that reverts to 5.38% for the balance of the 29 years.
Now here is an interesting comment on the buy-downs.
... it's a great marketing gag. It drives traffic, but we don't actually sell a lot of it. People tend to take a pass on that version of the incentive, and they take the 5.5% average incentive (...comes out to about $50,000 to $55,000 on houses that are in the 950 range) .. and have a lot of fun in our design studios with it, and increase the finishes in the home. That goes to the affluent nature of our clients. They're not rate-dependent.
Regional Banks Pulling Back
A very important factor driving more business toward public homebuilders with strong balance sheets is the inability of smaller players to secure loans from regional banks.
... what we're actually seeing more from the smaller builders who are facing some capital crunch is land deals that they have tied up, they've processed approvals on, they thought about building homes on, they're having a hard time finding the regional banks to finance them. And while they can't make a full profit they would have made had they built homes, they can make a fair profit by flipping the land to us. And so, we're seeing quite a few deals like that out of the smaller, more local and regional builders.
Public Builders Gaining Market Share
While a shift towards more established players is happening, volumes across the industry have been falling since 2022. One may infer that while a luxury homebuilder like TOL is able to perform up to market expectations, the whole housing market is anything but healthy from a volume perspective. Add to that, what we discussed earlier: the inventory available for sale is at historical lows. This has huge implications for home affordability and availability.
Public Home Builders’ Market Share
Business Mix
Till last fiscal, about 60% of TOL’s business was BTO and the rest was SPEC.
Note
BTO stands for Build to Order. These are higher priced and higher margin custom builds. These give the home buyer flexibility in choosing the features they desire.
In the context of TOL, SPEC homes are built to a standard specification. These may be considered affordable luxury homes. Depending on when the buyer enters into a contract, they will have differing abilities to customize the home. The later in the construction process they buy, the less number of customizations are offered.
TOL has 40 design studios across the country that enable customizations and BTO homes. The design studios have a higher gross margin than the rest of the business.
End of 2023, the management announced a shift in strategy - increase the SPEC business and have a 50/50 split between BTO and SPEC. Seems the intent was to capture a lower price point market given the inventory availability in the overall housing market. Even with the successful pivot towards a lower-margin SPEC business and declining volumes, TOL has been able to maintain its margins and pricing power.
Inquiring minds would however want to know if even the well-healed consumer is pulling back on discretionary spending on the margins.
Financials
TOL - Income Statement Highlight
Note
The quarterly growth percentages are sequential, i.e. a comparison to the previous quarter and not with the similar quarter the previous year.
We are looking for improvement or deterioration for a line item. Also, we are looking for divergence across line items for a given time period.
Even though revenue growth has been volatile, TOL has managed to maintain a healthy and steady gross margin due to stellar cost management and pricing power. While the operating margin has fluctuated, it has shown improvement in this financial year.
Here is something to keep an eye on for TOL: Total Comprehensive Income. From time to time it has taken losses from JVs and other partnerships. (Source: 10Q Q2 2024). While it doesn’t impact the EPS, it could potentially impact cash flows.
TOL - Total Comprehensive Income
Note
Q3 2024 10Q is not available as of now. However, going by TOL’s historical filing record, it should be filed within a week.
ROE and EPS
TOL’s management’s key metric is ROE. The long-term goal is to maintain an ROE of more than 20%. For 2024, TOL is expected to deliver a 22.5% ROE. It is always good to see a company deliver on its promises. Given that, consider the following:
We are very focused on return on equity. One of the main levers of keeping return on equity high is having a robust programmatic stock buyback program. In addition, of course, to how quickly we can build and turn houses, and how efficiently we can buy land.
Buybacks are a common phenomenon. However, one needs to keep an eye on growth and operational efficiency when evaluating EPS growth. What has been the extent of buybacks and dividends since 2016?
Since 2016 we have repurchased ~50% of our shares which is 86 million shares at a $46 average price. We have also paid $575 million of dividends.
Conclusion
TOL has been returning capital to shareholders at a steady pace and has been able to manage its costs well. While its P/E of 10.24 looks juicy, its P/B is 2.02. Given its growth profile, it looks fairly valued. However, if one were to be bullish on the housing market, TOL is worth a look and should be on the top of the list among homebuilders.
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