Tom A's Stock Picks

Toll Brothers - Luxury Homebuilder needs help from Congress

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I thought Toll Brothers (TOL) earnings were pretty much in line: they made money if you look past the writedowns, and debt to capital hit a new low of 22.7%. I was pleased with the strength of the balance sheet and noted that sales declined 30% from last year, in line with guidance. But, here are Bob Toll's comments:

"We believe Congress should jump-start demand for new homes with an initiative that will bring buyers off the sidelines and into the market, and thereby stop the downward spiral of home prices. As we have said before, we favor a tax incentive for all those who buy homes within nine months of the Bill's passage; this would create a sense of urgency. Interest rates are low, supply is abundant and a buyer's market prevails. With a little motivation, the new home market could turn around, which would have a very positive impact on banks, bond prices and many other areas of the economy. Once home prices stabilize, Congress could then more successfully address mortgage issues; however, without stabilization of home prices, trying to address mortgage issues may be difficult at best."

I wasn't aware he held that view, and I found it surprising, to say the least. Those who cater to the wealthy should not need help from Congress. Admittedly it would be a panacea for everything that is wrong with this country; as noted, it would fix the banks, the bond market, the whole mortgage mess...It seems almost unAmerican to be opposed to such a beneficial approach by Congress.

I would suggest the Homeowner Credit Rehabiliation Act of 2008. This would wipe out all outstanding mortgage debt that was in excess of 80% of the appraised value of the house. None of the debt so discharged would be taxable as income to the beneficiary. Any homeowner who has defaulted on his mortgage and been foreclosed would receive a Constructive FICO Score, mandated by Congress, of 750, together with a grant of cash equal to 20% of the median home price in his area, based on 2006 values. To earn this largesse, the homeowner would be required to buy a house within the next 90 days, to create a sense of extreme urgency. My approach is obviously superior because it actually creates buyers.

How to pay for this? We could start by permanently abolishing the Estate Tax and reducing the capital gains tax rate to 10%. The trifling and arbitrary distinction between long term and short term capital gains should be abolished. Income taxes start at a rate of 15%, decreasing steadily to 5% for the economically more productive members of our society. The AMT would be abolished. Otherwise, we would be hurting 890 million taxpayers, unjustly and unjustifiably.

Perhaps I am naively idealistic in imagining that Congress will address the issue so constructively.

Getting back to TOL's numbers, my thesis has been that the stronger homebuilders, after allowing for write-offs, will be able to make small profits on reduced sales, while hanging on to their best land and positioning themselves for the eventual housing recovery. Once recovery resumes, they will be able to increase net tangible book value at 20% per year, as they did for the ten years leading up to the housing slump. The investor who takes a homebuilder position at the proper time will profit for many years into the future.

TOL's numbers are consistent with my thesis and I will continue to hold the shares. As far as the help Bob Toll says he needs from Congress, I wish him all the luck in the world as I am a shareholder and would benefit in due course. But he really would do better to stick to his knitting and work on strengthening the balance sheet and planning for the future without help from Washington. After all, I am reading in the papers that construction loans (such as residential developments) are starting to go bad. TOL, if properly positioned, could acquire inventory at fire sale prices, setting up years of profitable operations.