Bull/Bear Report -- Is Toll Brothers (TOL) A Profit Builder?

There is always an element of the bizarre in the stock market. What seems positive is viewed negatively and vice versa. It can be maddening.

Lately we have been seeing more maddening activity than normal making it very difficult for investors to keep a Rational grip on their portfolios. One sector that has been trading in a crazy way this year is the homebuilding group.

Can you believe that stocks in the sector are some of the best performing stocks in 2008? I can't believe it, especially with all the bad news that continues to flow from the real estate market.

The only sense I can make of it all is that there are some big bets being placed that real estate has indeed hit rock bottom. Even though prices continue to fall, the malaise must come to an end at some point.

Population growth and an older housing stock suggest that building must rebound. At least that is what those buying homebuilder stocks are suggesting. If the construction companies can survive the recession in real estate, they will be poised for a huge rebound when demand returns.

Or maybe we are just seeing the shorts cover what has been a very good position over the last several years.

I don't think so. Even though homebuilding remains anemic, there have been some positive trends. Builders are no longer speculating like drunken sailors meaning cancellation of contracts are much lower than during the darkest days.

Management of these companies seems to be acting very responsibly. Instead of building inventory to keep workers working and sales flowing, they are cutting back on new projects and they have jettisoned excess land inventory.

In other words they are taking their medicine and in doing so are positioning for future success.

Do you think it's time to buy/sell/or hold? Get my opinion and find out what our bloggers think when you continue reading...

Given the huge dollars made during the boom, balance sheets of the biggest and best players are in great shape. They can withstand many more quarters of weakness and still be in a position to prosper when the pendulum turns.

In the new world sales may be lower, but at least these companies can earn a profit. Then, if there is another boom sales profits would return to levels seen during the good times.

Our stock of the week, Toll Brothers (TOL) is a prime example of what is happening in the group. The company has sold excess inventory and worked hard to reduce speculative building.

In its recent result, the company continued to write-off assets, but saw cancellations improve. Their strategy seems to be working.

The issue now is what to do with the stock at its current price of $25 per share, up nearly $10 from its lows. Shares now trade for 1.2 times book value. Historically, the time to buy is when shares trade for less than book value.

Is TOL a buy, sell or hold? Here is what our core bloggers have to say:

Bull Case - Tom Armistead

Toll Brothers (TOL) is sitting on top of a horde of cash, actively looking for opportunities to pick up land at fire sale prices, well-prepared to capitalize on the financial difficulties of smaller, weaker builders and the banks who made bad construction loans. Bob Toll is an industry veteran, with a long record of success, and understands the housing cycle as well as anyone. TOL caters to the luxury home segment and will lead the housing recovery, which may occur sooner than most analysts expect.

My first investment experience with TOL was not a happy one. I had been doing well with options, thought TOL was over-priced, and sold some naked calls on it. Quite a few naked calls, as a matter of fact. Of course the stock promptly rallied while I watched in horror. After the daily pain got to be more than I could endure, I cut the position in half and sold some puts under the theory the stock couldn't go both directions at once. That at least proved to be true and I eventually closed the remainder of the position with a manageable loss. In due course homebuilders tanked: if I had stuck to my guns, I would have made a profit. I have not sold any naked calls since.

So I learned to respect Toll Brothers.

I added TOL to my SLO portfolio in September last year and have added to the position on a few days when the market, the homebuilding index, and the stock were all down. I have a 17% profit and expect to make 50% or more when the housing recovery gets going.

I did a longish blog on Homebuilders, to include TOL, KBH and RYL, on 8/15: rather than rehash it, here is a link:

http://www.investorplaceblogs.com/users/toma47/2008/08/homebuilders_survival_of_the_f.php.

The recent bailout of Fannie and Freddie may very well spark a rally in the homebuilders, on the grounds that the availability and cost of mortgages will be improved, preventing further deterioration in the housing market. That may be temporary, but based on the strong balance sheet and the ability and opportunity to refill their pipeline with new land at bargain prices, I now plan to hold TOL, currently at 24.20, for a target of 32.

Bear Case - Jim Van Meerten

Seems a lot of people are predicting the salvation of the home builders. But is Toll Brothers (TOL) the best of the breed?

I like to compare a featured stock to it's index and then see if there is another stock in the sector that may even be better.

TOL seems to be beating the index but let's look at a 2 1/2 month chart comparing the Home Builders ETF (XHB) with Toll Brothers (TOL) and Beazer (BZH).

I think I'll bet on Beazer BZH.

And then this interesting comment to Jim's post:
After every quarter there is a live conference call between Bob Toll and analysts.
I can never understand why the analysts don't ask more probing questions - for example - recently just under 5% of the company was sold to Abu Dhabi investors - I haven't once heard anyone ask Bob T to comment on this. Are there plans to sell more pieces of the company? And what is the extent of the input, if any, that the Abu Dhabi investors have? and why is it so "hush hush"?

Re: cancellations - Because sales are down it makes sense that cancellations will be down - however, you will see higher cancellation rates when a high rise condo building is completed and starts to settle in a particular quarter. If the company makes it through a quarter without one of these buildings in the mix - it makes sense that the cancellation number will be lower but... STAY TUNED... in Hoboken, for example - the 2nd building at the Maxwell Place complex is ready for closings - it will be interesting to see these numbers - (not sure what's going on in NYC).

The company has laid off 100's ( I saw a report that said 1000) of its employees - these are primarily sales people, field construction, support staff - yet there is an ARMY of PM's, Sr. PM's, AVP's, VP's, Div. Presidents, Div. VP's...you get the idea - it is not uncommon for a division of 3 communities (3-5 sales people) to be "overseen" by 2 PM's and 4 VP's (it's the norm)!!! What's up with that?

Finally, RE: TBI Mortgage - before any questions are asked of this entity - establish the capture rate among Toll's buyers. The analysts need to toughen up - dig deeper.

-----
In my opinion, I would hold TOL at these levels. The stock is no longer the screaming buy it was previously. I do think the company is taking the right steps in a very difficult market. When that market turns owners of TOL should do just fine.

Jamie Dlugosch
Executive Editor, InvestorPlaceBlogs

by The Freshman |  09/12/08  |  Stocks: BZH, KBH, RYL, TOL, XHB,