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New-home sales, which fell 10.5% in February, will likely continue to slow this year. And, not surprisingly, analysts aren't expecting homebuilders' profits to grow anywhere near the torrid pace of the past several years. As a group, the publicly traded homebuilders have suffered a sharp decline in their share prices since last summer. So does that mean now is the time for investors to go bargain-hunting? Carl Reichardt, an analyst as Wachovia Securities, says yes -- but be selective.
Reichardt sees opportunity among the big players that generate positive free cash flow and are likely to steal market share from small fry during lean times -- companies such as Ryland Group and Lennar, among others. He also likes luxury-home leader Toll Brothers, which, though not among the giants, competes mainly against small custom builders and has a strong presence in markets where the supply of land is limited. He says the company's well-known brand name, as well as its relative size, scale and geographic diversification, come in handy in a slowing market and help the firm win out over its competitors in the long run.
Reichardt upgraded his rating on Toll Brothers to "outperform" this week.
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The Horsham, Pa.-based company caters to wealthier customers: The average selling price for its homes is about $660,000. Although it operates in 21 states, most of its sales are in the Northeast, including the Washington, D.C., area. Reichardt says the company should benefit from the impending retirement of well-off baby boomers, and he notes that its target buyer demographic -- households earning more than $100,000 a year -- is growing at six times the national average.
But Toll Brothers' stock (symbol TOL) has mostly been on the decline since last July. The stock, recently $35, is down 40% from its 2005 peak. That the company lowered its 2006 sales outlook last November didn't help. Wall Street's profit estimates have fallen considerably since last summer, when, Reichardt notes, analysts were calling for the company to earn $5.53 per share in fiscal 2006. He thinks the current average 2006 estimate of $4.99 per share is more realistic. Yet the shares trade at only seven times that estimate -- cheap enough to make this volatile stock compelling, in Reichardt's view. "Expectations are low and valuation reflects it," he says. From here, he figures expectations are more likely to go up than down.
--Lisa Dixon
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