KeyBanc Downgrades Toll Brothers, Projects Limited Upside

Toll Brothers Inc TOL reported fiscal fourth quarter earnings Tuesday that fell short of expectations and contributed to a selloff in the overall homebuilder group.

The Analyst

KeyBanc Capital Markets' Kenneth Zener downgraded Toll Brothers' stock rating from Overweight to Sector Weight rating with no assigned price target.

The Thesis

Toll Brothers reported 9 percent year-over-year revenue growth, while the adjusted gross margin rose from 22.1 percent last year to 22.5 percent, Zener said in a research report. (See Zener's track record here.)

This should serve as a sign that the company's growth prospects continue to be stable and order rates are following seasonal trends, the analyst said. At the same time, Toll brothers is facing modest gross margin pressure, so a higher community count would be needed to offset the cost headwinds, Zener said.

The homebuilder guided its fiscal 2018 deliveries between 7,700 to 8,700 homes at an average price of $810,000 to $860,000, according to KeyBanc. Gross margin guidance of around 24 percent would mark a drop of 50 basis points on a year-over-year basis, which could be attributed to lower profits from California and New York City markets.

Despite Toll Brothers showing meaningfully improved asset efficiency throughout fiscal 2017, cost headwinds are pointing toward moderating gross margins, Zener said.