Q1 2024 Earnings Summary
- Strong demand and better-than-expected sales, with the company experiencing a meaningful uptick in demand that has continued through February, and reporting that January was better than normal seasonality.
- Sustainable high gross margins of 27%-28%, driven by a unique position in land buying and disciplined underwriting practices, allowing the company to acquire land with high returns and maintain higher margins.
- Increased operating efficiency and higher sales per community due to the spec building strategy, enabling the company to raise community absorptions from 24 per year in 2023 to 27-28 per year in 2024, with potential to reach 30 per year.
- Declining Average Selling Price (ASP) May Pressure Margins: Toll Brothers expects a decrease in ASP in the second half of fiscal 2024 to the low $900,000s from over $1 million in the first half. While the company attributes this to a strategic move into the affordable luxury market, the lower price points could potentially impact overall profit margins.
- Potential Risks with Increased Speculative ("Spec") Building: The company's shift to building more spec homes—from less than 10% to now 40-50% of sales—might expose Toll Brothers to higher risk if market demand softens. Increased reliance on spec homes can lead to higher inventory levels and holding costs if homes do not sell as anticipated.
- Possible Gross Margin Compression Due to Mix and Costs: Toll Brothers anticipates a lower gross margin in the second quarter (27.6%) compared to the first quarter (28.9%), primarily due to mix shifts and increased incentives on spec homes. This trend could signal challenges in maintaining gross margins amid changing product mix and cost pressures.
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Capital Allocation and Returns
Q: How will you drive returns higher beyond the land sale?
A: Doug Yearley explained that the recent land sale was a unique, one-off event ( ). He emphasized that Toll Brothers will continue seeking opportunities to be more capital efficient, drive gross margin, and grow the company. This includes expanding in existing markets, focusing on the affordable luxury segment—which now represents over 40% of sales and closings—and increasing their spec home strategy, with 50% of first-quarter sales being spec homes ( ).
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M&A vs. Share Buybacks
Q: Are you considering acquisitions or focusing on buybacks?
A: Yearley stated that while Toll Brothers is always involved in M&A conversations and has acquired 15 builders over 30 years, they are very selective ( ). He mentioned that the M&A market has heated up, but investors can expect more capital returned to shareholders through buybacks and dividends rather than new acquisitions ( ).
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Gross Margin Sustainability
Q: Can gross margins remain at current high levels?
A: Management believes their gross margins of 27%–28% are sustainable long-term ( ). This confidence is due to their unique land buying position, conservative underwriting—requiring gross margins north of 25% and IRRs over 25%—and less competition in their price point ( ). They also benefit from highly accretive upgrades averaging $150,000 per home ( ).
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Spec Strategy Impact
Q: Is the increased spec home strategy permanent?
A: The shift to building more spec homes began due to the tight resale market but is now considered long-term and structural ( ). Factors include the aging resale inventory (average home is 45 years old), confidence from success in affordable luxury communities, and improved cycle times. The spec strategy is expected to continue at the 40%–50% level, enhancing absorptions and returns without compromising quality or brand value ( ).
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Absorptions and Community Sales
Q: Can you achieve higher sales per community?
A: They expect to increase deliveries from 24 homes per community in 2023 to 27–28 in 2024, partly due to the spec strategy and reduced cycle times ( ). Long-term, they see potential to reach 30 homes per community per year, improving overall efficiency and returns ( ).
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Guidance Conservatism
Q: Is your delivery guidance conservative?
A: CFO Martin Connor indicated that their guidance construct remains consistent with prior periods ( ). While a strong spring selling season could lead to deliveries beyond current guidance, they are comfortable with their estimates and will update in three months. The build-to-order nature of their business adds predictability as the year progresses ( ).
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Pricing Strategy
Q: How are you balancing pricing amid demand?
A: In Q1, Toll Brothers had price increases in about two-thirds of communities but also modestly increased incentives on spec sales, resulting in overall flat pricing ( ). They are beginning to implement modest price increases as they progress into the spring season, while remaining cautious due to rate fluctuations ( ).
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ASP Decline Due to Mix
Q: What's causing the projected ASP decline?
A: The anticipated decline in average selling price to the low $900,000s in the back half of fiscal 2024 is entirely driven by mix ( ). This reflects their strategic move into the affordable luxury segment, which is now fully in place and expected to continue influencing future business ( , ).
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Gross Margin Variance
Q: Why is Q2 gross margin guidance lower than Q1?
A: The majority of the 90-basis-point beat in Q1 gross margin was due to high-margin mix acceleration ( ). In Q2, they expect an inverse effect with less high-margin Pacific and Mid-Atlantic deliveries and a higher percentage of spec homes, which typically have slightly lower margins ( ).
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Market Conditions in Texas and Florida
Q: Is increased resale inventory affecting you in Texas and Florida?
A: Yearley reported that Texas is performing exceptionally well across all four markets they operate in, with optimism for continued success ( ). In Florida, while they are smaller in Southwest Florida, both Florida West and East are experiencing a strong February, driven by seasonal demand ( ).