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Insights from Toll Brothers’ EBITDA Margin

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Defining EBITDA

EBITDA (earnings before interest, taxes, depreciation, and amortization) is one of the important measures of a company’s financial performance. EBITDA is calculated as revenue less expenses. For EBITDA calculation purposes, expenses should exclude interest, taxes, depreciation, and amortization.

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Importance of EBITDA

EBITDA is an important financial parameter for large companies with significant assets and for companies with a high amount of leverage on their balance sheets. EBITDA is not generally a useful evaluation tool for small companies with low leverage.

Homebuilding is a highly capital-intensive industry, and most homebuilders require a high amount of leverage to run their businesses. In this environment, EBITDA is useful for evaluating the financial performance of individual homebuilding companies.

Since EBITDA gives an idea of a company’s earnings independent of its capital structure, EBITDA margin is also useful for peer group comparison.

Modest EBITDA margin

Toll Brothers’ (TOL) EBITDA margin was at 11.4% for fiscal 2014, compared to 7.8% in 2013 and 4.5% in 2012. In fact, the company’s fiscal 2014 EBITDA margin was the highest it had recorded since 2007.

Toll Brothers’ recent margin expansion comes on the heels of negative EBITDA margins from 2009–2011. Negative margins during 2009–2011 were mainly due to declining home sales, lower average sales prices, and higher construction materials costs.

Peer group

Toll Brothers’ (TOL) EBITDA margin is lower than Lennar’s (LEN) 12.9% EBITDA margin and higher than D.R. Horton’s (DHI) 10.1% EBITDA margin. KB Home (KBH) is the only laggard in the pack with an EBITDA margin of 5.8%.

Toll Brothers’ recently improved EBITDA margin came as a result of the company’s cost control strategies as well as its decision to pursue a different product mix by targeting move-up buyers in order to yield higher average sales prices.

Investors looking for diversification in the homebuilding sector can consider ETFs like the SPDR S&P Homebuilders ETF (XHB) and the iShares US Home Construction ETF (ITB). Toll Brothers (TOL) forms 7.78% of the holdings of the iShares US Home Construction ETF (ITB).

In the next part of our series, we’ll discuss Toll Brothers’ debt position.

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