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Shares of high-end homebuilder Toll Brothers (TOL) are for sale today following the company's upside Q4 earnings results that featured a familiar and less bullish trend within the industry. Although TOL is more insulated from affordability issues than most of its peers, such as D.R. Horton (DHI) or KB Homes (KBH), the company is still relying on incentives to support demand. After mortgage rates popped higher in September and October, causing the new home market to soften a bit, TOL responded by increasing its incentives, which is expected to cut into Q4 margins.

• Specifically, TOL guided for Q4 adjusted home sales gross margin of 26.25%, continuing a downward trend that's now becoming more of a concern for investors. In Q4, adjusted home sales gross margin of 27.9% did beat its guidance of 27.5%, but it was down from 28.8% in Q3. Given that many of TOL's customers are all-cash buyers -- about 28% paid all cash in Q4 -- the company is less impacted by high mortgage rates, but it's not completely immune.
• During the earnings call, TOL tried to ease those concerns surrounding its declining margins, stating it views its Q1 adjusted gross margin guidance as an anomaly from both a mix and incentive standpoint, adding that it expects Q1 to mark a low point for the year. With that in mind, the company stuck to its FY25 adjusted home sales gross margin guidance of 27.25%.
• TOL's Q1 Deliveries guidance of 1,900-2,100 units also looks underwhelming, equating to yr/yr growth of just 3.8% at the midpoint of the range. Deliveries growth is typically more modest in the seasonally slow Q1, but TOL did achieve stronger growth of 6% in 1Q24.
• On a more positive note, TOL has started to pull back on incentives recently as market conditions improve ahead of the start of the upcoming spring season.
• Furthermore, the company remains quite bullish on its longer-term outlook due to a few key factors. For instance, first-time homebuyers accounted for only 24% of the market over the past year, which is the lowest level in over 40 years. Therefore, the market is mostly comprised of move up, or move down buyers, who are financially secure and typically have significant equity in their current homes. This matches TOL's target customer. Additionally, a substantial supply/demand imbalance in the housing market remains, while the median age of an existing home in the U.S. is over 40 years old, making new homes a more attractive investment.

Affordability issues have finally caught up to TOL as the luxury homebuilder has had to boost incentives in order to keep demand humming. However, we don't view the slide in gross margin as a game-changing situation that significantly alters an otherwise bullish narrative for TOL. Demographic and industry-specific trends remain in its favor, while the prospect of lower rates in the year ahead should only strengthen demand further.