With the luxury of hindsight it’s pretty clear that UK housebuilders were heading for a perfect storm in the run up to the 2007/08 stock market crash. Not only were they to find themselves at the wrong end of a bank-led recession, but as the market peaked many were overbought, over indebted and over optimistic that the good times would carry on. In the year-long value tailspin that followed, housebuilders and their investors got savaged.
In the aftermath, at least as far as share prices go, the housebuilding and construction sector entered a period of post-traumatic inertia. As it stands, opinions are sharply divided on whether the sector is on the road to recovery or whether the threat of falling house prices means it’s a risk too far for many investors.
On one hand, mortgage lending rates – which are widely blamed for depressed sales of new homes – remain low. Likewise, government efforts to grease the lending wheels and chivvy buyers with initiatives such as NewBuy and the Funding for Lending scheme are too embryonic for their impact to yet be fully known. Meanwhile, critics have pointed to the proliferation in recent years of so-called shared equity schemes as a cause for concern. These deals involve housebuilders ‘lending’ buyers something like 25% of the cost of a new home in order to smooth mortgage application process. As a consequence, housebuilders have increased their exposure to the risk of falling house prices.
The counter argument from industry watchers, indeed the housebuilders themselves, is that a ‘stable’ housing market is all they need. As long as house prices and mortgage lending don’t fall, then housebuilders can still turn a profit – indeed, that’s just what they are doing. On this point, there are factors in their favour, not least the perennial problem of an undersupply of new housing in the UK. During the downturn the emphasis changed to building higher margin family homes (rather than apartments), particularly around London and the South East where demand is higher. In addition, the downturn presented an ideal opportunity for housebuilders to buy up land (often at distressed prices), which analysts suggest is now feeding into the latest financials.
While general sector sentiment is uncertain, one of the patterns emerging is that construction companies are showing increasing signs of fundamental and technical strength. A year ago, a group of construction companies were appearing on our bargain stocks lists – such at Benjamin Graham’s NCAV screen – and were clearly being ignored by the market. But now reported sales figures are on the up and their share prices are displaying some serious index-beating momentum. Let’s cast our eye over some notables.
1. The big one
Persimmon (LON:PSN) is the market’s largest housebuilder based on market cap (£2.23bn) and it’s in interesting stock for a couple of reasons. First, in February it announced plans to return £1.9bn (£6.20 per share) of cash to shareholders through dividends over 9.5 years, from 2013 to 2021. At the current share price, that takes the dividend yield from 1.66% to a forward yield of 8.25% - and it’s a bold statement from Persimmon about its expectations for the future. Further to that, the group has just announced that it is acquiring south-east housebuilder Hillreed Homes for £35.7m. Analysts claim that’s the biggest deal the sector has seen since the downturn and, again, an indicator of Persimmon’s confidence. However, a strengthening share price since the end of the summer means Persimmon now trades at a price-to book value of 1.18x – and that premium could well be a deterrent to risk averse investors.
2. The small one
By contrast, one company that continues to be undervalued against its assets despite strong 1-year price momentum is East London housebuilder, Telford Homes (LON:TEF) . With a market cap of £65.6m, Telford is among the smallest in the sector but anticipation of a leap in profits in 2013 means it trades off a P/E of 28.8x and a P/B of 1x. The company’s dividend growth record was obliterated during the market downturn but it has made a commitment to a progressive policy, with the forward yield currently at 3.4%.
3 & 4. The mid-caps
The least exciting share price improvements can be found among the mid-cap housebuilders despite the fact that they are all reporting generally improving sales figures. Bellway (LON:BWY) is about a week away from releasing its 2012 preliminary figures but an update in August was punctuated with positive indications and pre-tax profits are expected to beat estimates at around £98m. There has been some modest upward momentum in Bellway shares over three months but it does trade at a marginal premium to book value. By comparison, fellow mid-tier players Bovis Homes (LON:BVS) and Barratt Developments (LON:BDEV) are noticeably undervalued by the market against the value of their assets (to a lesser extent, so is Taylor Wimpey). Barratt has shown much stronger price momentum over the past year but there is no dividend until 2013.
5. The smart one
Last year, premium housebuilder Berkeley Group (LON:BKG) put in place a ten-year framework to return £13 per share to investors by September 2021. In the meantime it is ploughing cash into land and property development. Berkeley has recovered admirably from the economic crisis, and so has the popularity of its shares, which have been trending up since the end of 2010. As a result its shares also trade at a 66% premium to the value of the company’s assets. It may be some comfort to know that last year’s pre-tax return on shareholders’ equity, one of Berkeley’s core performance targets, increased by 21.2% on shareholder equity that increased by £170.4m to £1,099.8m. As a consequence of its growth record, Berkeley qualifies as a Jim Slater Zulu Principle stock.
UK housebuilders: work in progress
Shares in UK housebuilders have displayed some impressive strength versus the market over the past 12 months as the sector continues its fragile recovery from disaster five years go. To their credit, many of these companies have focused on slashing debt at the same time as building land banks at much more attractive prices. Some have also been at pains to reinstate and begin growing their dividends. While those performances could warrant further inspection by investors, on valuation metrics many are trading at prices close to book value. One of the key questions for investors is whether mortgage lending and house prices will remain stable enough for long enough to inspire enough confidence that it’s a sector that really has recovered. But given that six-month share price momentum is such a strong leading indicator of future share price returns, there may be more to come.