Housebuilders - A 'V' shaped recovery

Being so close and so dependent on the banks and lending institutions, was there a stock market sector worse hit during the 18 month 2007-2009 credit crunch than residential property? Very doubtful and although such a view has to remain largely subjective, the evidence is compelling with big players Berkeley Group Hldgs, Bellway, Bovis Homes Group, Barratt Developments Plc, Persimmon and Hentry Boot all suffering lost, or more accurately ‘no’ sales, horrendous balance sheet damage from write downs and defaults, non renewal / calling in of debt and consequent near death experiences.

However, the recovery to rude financial health of these same companies during the period June to August 2009 has been equally staggering and has confounded the early 2009 brokers forecasts, economists' dire predictions and financial journalists doom-laden copy. One such example of this being Barratt Developments Plc which were a SELL recommendation at 71p December 2008, another SELL at 150p as recently as July 2009 and now trade at 278p (www.investorschronicle.co.uk) and this recovery was missed by nearly all of the brokers' forecasts.

WHAT HAPPENED

Certain government initiatives listed below, some of which were introduced nine/twelve months ago, are now having a very beneficial effect on the sector and the wider economy. By their nature, such measures take time to have an effect and the general media, perhaps for their own narrow reasons, and scores of economists completely failed to read the longer term trends.

In January 2009, economists (www.ft.com) were forecasting that house prices would fall by 20% in 2009 and that prices of new build homes would fall by up to 45%, citing the ‘seized up mortgage market’ – a problem that had already been addressed.  All this has turned out to be utter nonsense with average house prices during August 2009 now confirmed as near identical with December 2008 and rising again (www.halifax.co.uk). The reasons for the recovery are better affordability, low levels of inventory for sale and low interest rates, most of which should have been apparent to the media and economists back in January 2009.

Interest Rates

In October 2008, the Bank of England base rate was 4.5% p.a. This was reduced to 2.0% in December 2008, 1.5% January 2009 and finally down to its present level 0.5% in March 2009.  However this time, it has also of course coincided with the need to get back to traditional banking in order to greatly reduce risk and to return to profitability. Hence, banks are paying savers based on 0.5% p.a. charge, requiring borrowers to have 10% deposits (more usually 25%) and charging mortgages 4% p.a. and upwards. Despite the difficulties, mortgages are becoming more readily available and affordable. As recently this week HSBC have announced a mortgage product with a 1.99% p.a. coupon for a 40% deposit. (www.hsbc.co.uk )

Shared Equity Scheme

Announced nearly two years ago, this enables low earners with growing families to access larger properties by means of a mortgage for a minimum 50%  of the property value and a government backed very low interest loan with 10 year deferred repayment or higher interest rate. It is now proving very popular with over 11,000 completions in the last eighteen months ( www.bbc.co.uk/1/hi/business )

Homeowner Mortgage Support Schemes

This enables those faced with sudden loss of income to defer up to 30% of their mortgage repayments for up to two years.

All of the above elements have played their part in getting the house market moving again from its annus horribilis in 2008 and seen the FTSE 350 Housebuilders Sector Index rise by over 40% since the beginning of June 2009 ( www.ft.com )

The Players

The most interesting players in the sector look to be:

• Persimmon has a market capitalisation of over £1500m, making it the second largest company, behind Berkeley, in the sector.  PSN has had a particularly torrid time during the 18 months to 30 June 2009 with turnover down 40% on the immediately comparable period. The company is now funding a quarter of its sales through Shared Equity Schemes. Took a fearful balance sheet hit in its Annual Report for the year to  31 December 2008 by writing down its land bank and work in progress by £652m however wrote back a small part of that in the half year to 30 June 2009. PSN has been conserving cash by amongst other things suspending its dividend with the end result that group debt is now down to 30% of equity and net assets even after the write down are over £5 per share. This together with the improved prospects are the main support for the current share price of 520p.
• Bovis Homes Group is a mid range FTSE 350 size company with a market capitalisation of £660m and its sales story is similar to the others , down 50% in the year to 31 December 2008 and this trend continued in the six months to 30 June 2009. However it has recently reported an astonishing 92% increase in reservations which is one of the main reasons for the share price surge from 267p in late 2008 to its current 497.50p. A programme of overhead and general cost saving together with dividend suspension has resulted in the near elimination of debt from the BVS balance sheet putting the group in a very strong position to re-enter the land buying market. Net assets of over £5 per share support the current share price.
• Henry Boot -  with a market capitalisation of £120m, this is a smaller company than those listed above but an extremely interesting current proposition. The company did not suffer as much during 2008 , mainly the result of an astonishing deal in which, in early 2008, it sold some of its Devon land bank for near £60m which is 50% of its usual yearly sales. Six months later and it would have been fortunate to realise 20% of the actual proceeds for this parcel of land. BHY has maintained its dividend payments during recent troubled times for the sector, has low group debt and trades at 95p per share. This is way below net asset value of 128p, a figure bolstered by a sizable land bank written down to current value, and represents value in the current market.

Conclusion

All FTSE Housebuilding Sector Companies are in recovery with interestingly most, including Henry Boot, priced at around five times the earnings of a couple of years ago. Most will have their sights set higher than this so over a two/three year period Bovis Homes Group and Persimmon will most likely be seen to be value at present levels. However, for more immediate gains, my choice is Henry Boot.

Why?  The company has just published its results for the half year to 30 June 2009 and although profits were, as with all in the housebuilding sector, significantly below the comparable period last year, the key message with Boot is that this is attributable to the very lucrative Devon land deal in early 2008 and that the Chairman reports that 2009 saw ‘higher property division trading income and a good contribution from the construction division’.

The half year results were then further hit by a large fair value write down of its investment properties. This is of course in common with many other property companies and will probably be compensated by a write back during the current six months i.e. in my view, it should be ignored for the purposes of prospectively valuing the shares on a six/twelve month time frame.

A high proportion of Boot's earnings have always come from their land promotion side, the purchase of parcels of land, realisation of development potential including obtaining attractive planning consents and then the usual profitable sale. This aspect was lacking from Boot's results in the recent six months with predicable effect on the share price.  The company retains a large land bank, and although Sheffield based, heavily weighted to the south east.

The land development operations, still strong balance sheet (£33m of undrawn cash facilities at 30 June 2009 from an agreed commitment of £101m) and the Chairman’s good report of current activities make Henry Boot (currently 93.5p at 16.09.09) my share pick from the residential property sector.

References:

• http://www.henryboot.co.uk/pdf/financial/2009/2009-Half-Annual-Report-Accounts.pdf