This Weeks Best Bond: Toll Brothers (TOL)
3.792 YTM 03/15/2014
Toll Brothers has operated as a home constructor for over 40 years. Based in Horsham, Pennsylvania, they have won numerous national awards such as America’s Best Builder, National Builder of the Year, and the National Housing Quality Award. Toll Brothers has developed, built, financed, and sold homes in twenty states from the eastern coast clear to California. They have vertically integrated into this sector holding assets from timber land to title and escrow services. Toll Brothers also develops, owns, operates golf course country clubs.
At Durig Capital, we have developed a process to review, select, purchase and monitor corporate bonds on an ongoing basis. Enclosed is our review, along with supporting documents/links, showing why we believe Toll Brothers corporate bonds make sense in clients’ portfolios. We reviewed thousands of separate corporate bond listings to find what, we believe, is currently the best corporate bond for investors. The following illustrates our selection criteria.
Step 1 – Yield Curve at 3-7 Years Out.
There have been some interesting developments in income investing. First, the Feds hinted at continued support of repurchasing US bills, notes, and bonds as a means to keep interest rates low in an effort to support economic growth. While this is not necessarily good news for fixed income investors, it does acknowledge and reinforce their future plans and eases the investors nerves regarding future lending rates. Another note of interest was the issuance and sale of Microsoft’s (MSFT) fixed income securities. Mircosoft sold $4.75 billion three and five year notes with a yield to maturity of .875%. This represents historic lows. Microsoft is one of only four companies that currently receives an AAA rating (the highest). These low yielding highly rated issues are ideal for investors with certain criteria, although we believe through our criteria many bonds are available that offer higher yields, whose risk of default are profiled incorrectly.
While reviewing thousands of issues, we were intrigued by Toll Brothers offerings. They currently offer four different issues that mature before our seven year horizon and a fifth that will be useful constructing a yield curve as seen in Step 5.
Step 2 – We like companies that are profitable.
Toll Brothers has been effected by the virtual halt in the housing market. They have reported losses for the last two fiscal years. For the quarter recently ended, July 2010, Toll Brothers reported earnings of $.16 per diluted share. Annual earnings will still be negative due to loss recognition that happened earlier in the fiscal year, however a positive earnings quarter is an indicator that the hard times might be behind them.
To give you insight into the housing market we quote Joel H. Rassman, former CFO of Toll Brothers, made the following comments before a real estate summit in summer of 2010. “Although demand in recent weeks has been quite choppy, in general, we continue to believe that the housing market has emerged from its darkest period of late 2008 through early 2009. Interest rates remain near historic lows, affordability is near historic highs and there are positive signs of growth in the economy. We believe pent-up demand exists.” Leadership views Toll Brothers as an entity that is emerging from the gloom and brighter days are ahead.
Step 3 – We like companies with high cash and short term investments to long term debt ratios.
Toll Brothers reported $1,640.41 million of cash and short term investments and $1,964 million in notes payable. Although this ratio is not above the level of one that we like to see, it still is a very good ratio for an company in an industry that was at the epicenter of the financial crisis.
Management has been very conservative with there investments. After such a shock to the operating environment, often the companies that are remaining were in strong economic condition before the events occurred. Toll Brothers is one such company. While navigating the turbulent aftermath, firms still operating are able to acquire assets from folded competitors for substantial discounts. Toll Brothers is the leader of the industry and is currently utilizing both it’s size and industry clout in acquiring assets at distress discount prices. Management is being very conservative in the asset acquisition process.
Step 4 – We like companies that have flexible balance sheets
Below one will find a comparison ratios within the industry. The two ratios listed below are important to Durig Capital selection process. We like to see a high, preferably above one, cash and/or cash equivalents to long term debt as this means that the company has enough cash to payoff all debt, or in Toll brothers case, purchase assets at attractive prices. Toll Brothers financial ratios are significantly better based on these two important metrics’s as seem below. This is allowing them to amass operating assets needed in the future, land, materials, ect, on their terms. This could benefit future margins.
|Company||Toll Brothers (TOL)||K.B. Homes (KBH)||Lennar Corporation (LEN)||DR Horton Inc.(DHI)|
|Cash and Equivalents/Long Term Debt||.7255||.6127||.448||.6130|
The way that Toll Brothers has been financially guided through the crisis is impressive. Management noted in their quarterly report the following:
“Since October 31, 2006, we have increased our cash position (including U.S. Treasury and Agency securities) by approximately $1.01 billion and reduced debt by approximately $337 million. At July 31, 2010, we had $1.64 billion of cash, cash equivalents and marketable U.S. Treasury and Agency securities on hand.”
Leaderships foresight in 2006 to initiate these balance sheet transactions could not have come at a better time and has put Toll Brothers in an excellent position five years later.
Step 5- We like companies with strong coverage ratios.
Toll Brothers has achieved a level of financial strength that is surprising all things considered. The coverage ratios are not what we like to see however Toll Brothers is emerging from arguably the largest housing down turn in modern history. To be positioned as well as Toll Brothers is considering the utter chaos that has hit the housing market and overall financial crisis is impressive. They survived the eye of the housing hurricane and are now in the desirable poll position, as conditions continue to settle, to accelerate out of the recent downturn.
Step 6 – We like higher yields in shorter time frames
Important Yield Forecasts
One of the attractive features that Toll Brothers debt offers is the different issues. We are highlighting the 2014 issue as a shorter term issues has not been recommended in Durig Capital’s This Week’s Best Bond. The 2014 issue matures in less than 42 months. Toll Brothers different maturities have the same underlying financial frame work so we would recommend using any of the issues to assist in the laddering process. They received a rating of Ba1/BBB- which in our opinion gives them a yield investors are seeking.
Enclosed is a link to other high yield corporate bond offerings so you can conveniently compare Toll Brothers current yields to other similar rated issues.
Toll Brothers debt offers clients a position with a company that may be emerging from an industry that was the epicenter of the financial crisis. They have been and are continuing to position themselves well for future operations. When the housing and financial sectors of the market rebound from one of the worst markets, Toll Brothers financial positioning, foresight and execution though the financial crisis has positioned it well.
Yield to Maturity 3.792 %
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Disclosure: Durig Capital’s is currently recommending this issues and it’s client’s currently do have positions in Toll Brothers bonds.
To know more about this Toll Brothers bond call our fixed income specialist at 971-327-8847