Toll Brothers Inc. TOL, one of the nation’s largest homebuilders, reported fourth quarter and fiscal 2015 (ending Oct 31) results on Dec 8 before the market opened. An earnings miss in the quarter pushed the share price down by 7%.
Despite rising 12.7% year over year, adjusted earnings of 80 cents per share missed the Zacks Consensus Estimate of 83 cents by 3.6%. Sales marginally beat the consensus estimates and grew 6% year over year. Though home deliveries rose 0.7% to 1,820 units, they fell in the North, Mid-Atlantic and South regions. Deliveries at the City Living division — Toll's high-end urban apartment unit — fell 37%. Gross margins were also lower-than-expected.
Toll’s comments about the oversupplied New York market turning more competitive, mostly at the high-end segment, probably hurt the share price. Management also pointed out that it might have to start incentivizing more in this market to boost sales.
This is the second consecutive earnings miss for Toll Brothers. The firm missed the Zacks Consensus Estimate for both earnings and revenues in the fiscal third quarter due to lower home deliveries and a lower-than-expected increase in the average price of homes delivered.
The earnings miss at Toll Brothers has once again rankled the housing market questioned the housing market recovery which is going through a slightly softer patch.
The Not-So-Good Near-Term Scenario
Recent housing data has been a little soft suggesting some weakening in the pace of housing recovery. Housing starts declined 11% in October, per data released on Nov 18, primarily due to a sharp plunge in the construction of multi-family units. Moreover, data released by the National Association of Home Builders (NAHB) showed that homebuilders’ sentiment index slipped three points to 62 in November. Existing home sales declined 3.4% in October due to supply shortages, after a September surge, per data released by the National Association of Realtors in November.
Many homebuilders like PulteGroup, Inc. PHM and KB Home KBH talked about tight land and labor resources resulting in production constraints in the past quarter. The labor market has tightened with limited availability arresting the rapid growth in housing production.
Also, limited capital for land and land development has left entitled lands in short supply. Labor shortages are resulting in higher wages while land prices are inflating due to limited availability. As such, rising land and labor costs are threatening margins as they limit homebuilders’ pricing power.
Moreover, tough weather conditions in the first half of the year resulted in land development and related community opening delays in some markets, mainly in Southern U.S. Some homebuilders like Pulte and Lennar Corp. LEN also complained of a slight slowdown in sales in the Texas/Houston region – mainly at higher price points – due to low oil prices and a resultant economic slowdown. Moreover, the regulatory environment for mortgages remains challenging.
The Bullish Fundamentals
The overall fundamentals of the all-important construction sector nonetheless remain strong and the soft data in November is seen by the market as only a temporary setback. As it is, the fourth quarter is seasonally the slowest for construction activity due to harsh weather.
Importantly, new home sales rose 10.7% in October, rebounding strongly from the steep drop in September. Building permits — a gauge of future constructions — rose 4.1% in October – an indication that construction activity might pick up.
This year has generally been good for the housing market, possibly the best since 2007 when the housing recession had set in. Job and wage growth, a recovering economy and improving consumer confidence, moderating home price gains, affordable interest/mortgage rates, rising rentals, rapidly rising household formation and a limited supply of inventory – all point to continued strong demand in 2016.
Though U.S. job numbers were disappointing in August and September, it picked up again in October and November, beating market expectations. With a fall in the unemployment rate, rising wages and decent consumer confidence, the U.S. economy seems to be back on healthy turf. Improving consumer spending power is in turn propelling the demand for homes.
With stabilizing demand, housing price gains are also moderating. Moreover, housing remained an affordable option in 2015 with mortgage rates below historical levels. Mortgage rates may however rise with a strong probability of a Federal rate hike at the December 16 meet. Even if we suppose an accompanying rise in mortgage rates with an interest rate hike, we believe they should still remain reasonable, keeping housing affordable.
Apartment rental rates have been moving up, making home buying financially attractive. Additionally, as the millennial generation leaves the nest, a sharp spike in household formation is translating into higher demand for new homes.
Further, there is a production deficit of both rental and new homes compared with housing demand resulting in pent-up demand against limited supply. Land and labor shortage is the primary limiting factor at present for the production of homes.
With oil prices still slumping and the job market looking good, the demand for new homes will be on the rise come 2016.
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