Toll Brothers Earnings: New Orders Surge Despite Higher Mortgage Rates

Higher mortgage rates have been a double-edged sword for homebuilders. On the one hand, homebuilders have had less competition from the resale market due to the so-called rate lock-in effect. That is, about 84% of mortgaged homes have a rate below 5%, which has discouraged sales listings of existing homes. On the other hand, housing affordability has worsened as the average 30-year fixed mortgage rate has trended higher over the last four months, exceeding 7% by mid-August.

Toll Brothers TOL has shifted toward a more speculative building strategy (that is, building homes without a sales contract in hand) to capitalize on the dearth of for sale existing homes. Indeed, management said 40% of new orders and 28% of deliveries during the fiscal third quarter were spec homes. This strategy has paid off so far with third-quarter new orders surging 77% year over year to 2,245. Unlike other homebuilders, Toll Brothers has been less aggressive on offering sales incentives and price reductions to lure prospective buyers. As such, the firm’s profitability has outperformed many other public homebuilders. Third-quarter adjusted gross profit margin of 29.3% improved 100 basis points sequentially and 140 basis points year over year. Nevertheless, Toll Brothers’ average selling price of new orders declined nearly 27% year over year. Management called out a mix shift toward lower-price geographies and its “affordable luxury” product as primary factors. Considering an improving demand backdrop, Toll Brothers has begun to raise home prices and lower sales incentives. Still, the average sales incentive of $45,000 per home is elevated compared with $16,000 during the year-ago quarter.

We’ve increased our fair value estimate 12% to $85 per share, due, in part, to our more optimistic near-term outlook for home deliveries and profitability. We also have greater conviction that Toll Brothers can operate with a leaner cost structure over the longer term.