Toll set to rise
Posted
Jan 22 2008, 02:54 PM
by
Robert Walberg
This may seem crazy, especially with the global financial markets in the midst of the worst turmoil we've seen in nearly a decade, but the Fed's decision to slash the funds rate by another 75 basis points sent the first strong buy signal in the depressed housing sector in over a year.
One stock that stands out among the battered and beaten up homebuilders is Toll Brothers. The stock rallied nearly 5% on Tuesday on volume of 6.4 million shares -- nearly four times the daily average volume.
Truth be told, the Fed's decision to cut short-term interest rates isn't going to have a big or immediate impact on mortgage rates. Mortgage rates are tied to the long-end of the yield curve, and long-term rates are apt to remain stubbornly high due to the current anxiety in the financial markets. Nevertheless, the Fed's action is important for two reasons. First, it told the market that the Fed will do whatever it takes -- read more rate cuts -- to reduce the economic impact of the housing downturn. Second, and this is tied to the first, the rate cut changes market psychology. Instead of fearing a prolonged downturn, investors will start to look to the time when conditions improve and housing starts to firm.
Investors shouldn't underestimate the impact of the change in psychology, especially when a) builder sentiment is very near all-time lows and b) short-sellers have been betting aggressively against the sector -- and the stock. Nearly 16% of Toll's float is currently being sold short. If bears sense a change in the market's mood regarding the industry they will be forced to cover those short positions, creating a nice wave of buying. With virtually no sellers left -- face it who's still long the sector -- the path of least resistance is to the upside. As for builder sentiment, it too has only one way to go from here -- and that's up.
Basically, the news cycle has been negative for so long that the bad news is largely reflected in the stock's price. In other words, the downside impact from another story talking about weak housing starts/sales etc. won't be significant as the news will come as no big surprise. Conversely, any good news, even if that is defined by being news that isn't as bad as expected, is apt to trigger some buying interest given the stock's depressed valuations. Toll currently trades at 0.77 times book value -- well below industry norms. The company's price/sales ratio is also materially below market levels. Meanwhile, Toll has the highest operating margins in the sector, it generated about $900 million in free cash flow over the last 12 months, its debt/equity ratio of 0.64 is among the best in the industry and insiders still own roughly 29% of the stock.
Housing stocks probably won't march straight up from here given lingering concerns about oversupply and deteriorating financials, but the worst of the selling is over and with the Fed now committed to doing whatever it takes to solve the credit crisis, the risk/reward ratio has turned bullish for the first time in many, many months. I'll take the plunge and add some Toll Brothers, with an upside target of $24.
Let me know if you agree that now's the time to buy housing stocks and if so, what is your favorite stock in the group.
