Gross margins increase
In the fourth quarter, gross margins (excluding interest and write-downs) increased to 25.4% compared to 24.6% a year ago. For the full fiscal year, gross margins were 24.6% versus 24% for fiscal year 2012. The open question for the builders is how long they can continue to increase gross margins. Building material prices are increasing, and skilled labor is getting harder to find. Virtually every builder noted that they’re struggling to find skilled construction workers and that wages are increasing. One of the side effects of the housing bust has been the exodus of skilled construction workers from the sector. After the bust, housing starts fell off a cliff, and they’ve been mired below the previous lows ever since. Many construction workers ended up finding jobs in trucking and the energy sector. Most market participants expect home price appreciation to cool in the upcoming year, and the builders won’t be able to increase margins simply by raising prices.
SG&A and earnings
SG&A (selling, general, and administrative expenses) benefited from a one-time insurance benefit in Q4, but even still, it’s been decreasing as a percentage of revenues. This speaks to some of the operating leverage the builders have. If revenues increase 45%, they don’t need 45% more people in the corporate office. Rising prices have helped them increase operating margins as well. For the fourth quarter, earnings were $94.9 million, or $0.054 a share.
For the full year, SG&A decreased to 12.7% from 15.3% for fiscal year 2012. Net income was $170.6 million, or $0.97 a share. That doesn’t compare to last year’s earnings due to a revaluation of deferred tax assets.
Valuation and outlook
With the acquisition of Shapell, Toll Brothers looks well-positioned for growth going forward. The secular (long-term) story for the builders is fantastic—we have underbuilt for over a decade and household formation has been depressed. The low household formation numbers of the post-bust environment were not due to fertility rates 25 years ago. They were due to young graduates who have been unable to find a job in this economy. As we’ve seen from the recent economic data, the labor market is turning around, albeit slowly. This represents pent-up demand that will unleash. In previous upturns, we’ve seen housing starts over 2 million units a year. It’s not inconceivable that housing starts could triple over the next few years. That’s a lot of growth.
What’s the catch? Toll is trading at a very high multiple of 29x earnings. That multiple is discounting a lot of growth. One thing to remember with the builders is that they are very cyclical. During boom times, they will trade at mid to high single-digit price-to-earnings ratios. So an investor could end up being absolutely correct about future earnings only to find that multiple compression negates that growth as the stock goes nowhere.
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