Preliminary Analysis - BKG
Following excellent year end results, I decided to take a look at Berkeley Group. I have been looking at a number of British house builders over the past couple of months as the sector appears to have excellent prospects and a number of industry participants are once more highly profitable and paying out healthy dividends. For those who invested in or around 2012, the returns have already been phenomenal. The question now is, are some house builders still attractively priced, having come so far already?
Screen Summary
- With a PE ratio of 10.9x and a PCF of 9.4x, the company seems relatively cheap on an earnings basis.
- A PB of 2.8x would not be considered cheap, but this seems justified by the level of the business's earnings.
- ROE and operating margin of around 25% are both excellent, and superior to competitors in the sector.
- Revenue and earnings have been rising steadily for a few years now, with the company now committing to significant dividends too.
Current Trading
Berkeley Group announced that its net profit for the year ended 30th April is up to £423.5m from £292.2m in the prior period. This represents an increase of 44.6% and is a fantastic result from the company. Adding to this further, book value has grown by 12.5%, after paying out dividends, and the company ended the year with a net cash position of £430.9m up from £129.2m previously. The momentum in the business does not appear to have slowed at all and this fits with the story of rising house prices and foreign investment demand in London and the south east of England. Demand for Berkeley's developments in the area is, in part, evidenced by the fact that their stock of completed buildings sits at all-time lows, with current cancellation rates of 10% well below the long term average of 15-20%.
Differentiating Characteristics
Berkeley believe that they distinguish themselves through quality in all aspects of the service they provide and there is strong evidence to support this. Their development at Roman House won the top considerate constructors site from a pool of 9,015 sites across the UK. Their net promoter score (which measures customer satisfaction) is the highest in the sector and they are the only company in the UK which seeks to measure and address people's wellbeing in the properties they provide. I like that Berkeley have such a focus on quality, and a wide spread focus too with as much attention paid to customer satisfaction as the quality of buildings.
Forward Looking Statements
Going forward, management have set themselves a target of earning a cumulative £2bn in pretax profit by April 2018, and have committed to paying out 866p per share between September 2015 and September 2021. This equates to 144p annually during that period, which for somebody buying in now, at around £34 per share, means an annual yield of 4.2%. Given cash currently due on forward sales of £3bn, which gives high visibility to short term future earnings, it seems probable that management will be able to deliver on this target. The dividend yield in itself is highly appealing then, but are there further capital gains to be had as well?
By my rough calculations, if management succeed in earning £2bn pre-tax profit by 2018, then this equates to (assuming a 23% corporate tax rate) £1.54bn in after tax earnings. Deduct from this approximately £0.6bn in distributions and you have £0.94bn in profit taken to retained earnings over the three year period. Given that book value currently sits at £1.64bn, this equates to a 57% increase on today's net asset value. This gives a CAGR of 16.2% in book value, with a nice 4.2% dividend yield on top. This is, of course, a simplistic preliminary analysis, but the scenario is attractive and leads me to think that the opportunity is worth some further research.
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At the time of writing I do not hold a position in Berkeley Group – LON:BKG
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10 comments
Thanks Herbie - I was wondering about that too. I've never bothered to be anything but neutral - how dull !
bullish
bearish
Hi Veg Patch,
I keep meaning to ask.. What is the significance of the pink bar which some people have on their header when they post please.
Thanks.
NI
Hi Tom,
Very useful - your website looks like an interesting resource too. Thank you for sharing your analysis.
Cheers
Geoff
Hi Tom
Thanks for your post, i had a look at your web site very interesting , I really appriciate when people like yourself post free analysis because i find it so helpful to a new investor like myself. Keep up the good work.
Charlene
Hi Tom
V interesting post.
Funny how the markets view of this has changed. It used to trade on a DISCOUNT to NAV in c.1999-2000 given its perceived over reliance on the London market. Tony Pidgeley, Founder and then MD set about rectifying this valuation gap by initiating the return of capital to shareholders via special dividends (in return for a hefty but totally well deserved management incentive scheme).
Rob Perrins, then FD but now MD has continued this course. Berkeley stepped back from the London land market in 2004-2006, raised cash levels and deployed this post the GFC in 2009 onwards.
The rest is history and the group deserves praise for its fantastic results: Record profits, Operting margin c24%, ROCE 29%. The market as ever though is efficient and has rewarded shareholders by placing a price / NAV of just under 3x.
So, where are we today?
Supply
BKG supplies c10% of the London market and I hear that Rob Perrins describes the planning system in London as "broken". This situation is unlikely to change soon. However we are yet to see what influence a new mayor could have on the supply side.
Demand
BKGs demand is roughly 50% investors, 40% overseas buyers and c10% owner occupiers. London is as BKG puts it "a world City". Thus recent strengthening of GBP, increases in stamp etc will probably dampen demand from overseas buyers.
Investors are blessed with the lowest level of interest rates for a century, but this could change (upwards!!!)
So while demand is strong now, this could change. Also London first time buyers are now expected to pay over 9x their GROSS income. This is so far off the end of the historical scale it's slightly frightening. National prior peaks in 1999 and 2007 were c5x. If you are buying with that much leverage you cannot afford for interstest rates to rise.
Costs
London build inflation is running around c10%. Again if this continues it will serve to depress record margins and record ROCE.
land market
The land market in BKGs core Zone 1 area is white hot at the moment. If you notice that Berkeley actually used up more land than it bought in FY 15. So while it is not being vocal about its stepping back from the London market, actions speak louder than words.
Returns
BKG is currently in the sweet spot of its cycle, delivering apartments / homes on land bought in the depth of the GFC, such as Riverlight or Murano. My view is that margins will wane as costs increase faster than selling prices due to cost inflation and over stretched buyers. Its unlikely to be terrible as BKG is a past master at retrospectively increasing density and thus eking out more £ from each site. Finally I have looked and invested in this sector for nearly 20 years but I cannot remember a company in this sector with such high margins or ROCE. In my view this is a fine company but returns (margins & ROCE) are more likely to fall than rise from here. On nearly3x NAV I don't think the shares are priced for this scenario.
Just my view, I am not short and really respect the company, but trying to be balanced.
VegPatch
Hi VegPatch,
Thanks for taking the time to write up such a well informed response! My motivation for writing is as much for the development of my ideas as it is for sharing them and responses like yours are just what I was hoping for.
I think it is fair to say that your point stands and I do not really wish to challenge it, especially given that your analysis of the wider industry is based on significantly more experience than my own. In particular, I believe the points on overseas demand being dampened by a changing tax and FX environment, in addition to the potential for interest rates to readjust towards historical norms, are key risks here. I feel less concerned by the potential for falling domestic demand - as you say this is a relatively small proportion of Berkeley's revenue and I think that the long term structural need for housing in the UK is likely to provide some pressure in the other direction.
As Niels Bohr said, however, "prediction is very difficult, especially if it's about the future," and I try to bear this in mind given my non existent track record in forecasting. I don't know whether events will unfold as you say, although certainly that appears to be a highly plausible scenario, but I can hypothesise and I think that there are also a number of plausible macro economic circumstances that would be positive for Berkeley.
For example, in response to the concern over interest rates, while we would expect rates to revert north to the mean going forwards, the current situation in Greece or a similar event could see monetary policy shift towards QE on a large scale, driving rates down further. In response to foreign demand concerns, events such as the recent pull back in Chinese equities could see further capital flow to traditional safe havens such as London real estate.
Bearing in mind that the idea, if executed, would sit as part of a diversified portfolio, the question for me is, "is the company priced such that my expected return, giving weight to a range of economic scenarios, is likely to be positive?". Certainly looking at book value as you have we would conclude no, but on a discounted cash flow basis, I think that the answer is yes.
Like all of us, I am just trying to make a decision within the limitations of my own knowledge and experience, and so I am trying to reduce the problem down to a set of questions that I feel I can reliably answer myself. If you have any further thoughts though then I would very keen to hear them, as I think that it is good practice to pay equal attention to both sides of the argument. Either way, thank you for your valuable insight so far and I hope Monday sails by smoothly!
Tom.
Tom, thank you for your refreshing and informative posts.
I also liked those you did on Character (LON:CCT) and look forward to your further views on that company.
Keep up the great work!
Jane.
Hi Jane,
Thank you very much for your feedback, there's a lot more to come hopefully so the encouragement is much appreciated.
If you liked the posts on Character then you must have visited my site too! It's only been running for a couple of weeks and I am planning to upload the older pieces on here over the next week or two, in addition to continuing with my current research.
Have a great weekend for now!
Tom