Tuesday, 10 September 2013

Housebuilders – a recovery with strong foundations or a castle built on sand?

There has been much comment about the housebuilding sector. It is one that is close to many investors’, and indeed householders’, hearts as well as providing George Osborne with a “get-out-of-jail” card. Everyone has an opinion on house prices, the housebuilders, their profits and their shares.

What is known for sure is that the industry is cyclical. The last time it reached a high point was in 2007/8 when the number of housing starts reached 210,000 per annum and a low in 2009 when housing starts reached 110,000 per annum. At this point, many housebuilders were on the point of failing under a mountain of debt, having geared up to buy a lot of very expensive land. Since then, most companies have repaired their balance sheets via rights issues, using the proceeds to either stay alive (e.g. Barratt Developments and Taylor Wimpey) or to take advantage of the land-buying opportunity that presented itself (e.g. Berkeley Group and GallifordTry).

Since 2009, most housebuilding companies have been able to replenish their land banks at prices that give them good margins. This is what is beginning to show through in the current results. Gross margins are now approaching or exceeding 20% (Bovis Homes 23.0%, Persimmon 19.7%, Taylor Wimpey 19.6%). 

Initially, the Government sought to stimulate demand for new homes via the Funding for Lending scheme (providing banks with cheap money to lend on) and the FirstBuy scheme, but the banks were keen to keep the money to repair their own balance sheets and the house buyers were still too nervous of the economy (and their job prospects) to commit to new purchases. It was the introduction of the Help-to-Buy scheme in April that has caught the imagination of the first time buyer as it effectively reduced the level of initial deposit required and reduced the risk. The second part of the scheme is due to occur in January 2014 as the scheme is extended to ‘second-hand’ homes.

Opinion is clearly divided on the Help-to-Buy schemes with the new Governor of the Bank of England clearly of the view that they could contribute to an asset bubble – a view with which I concur. The housebuilders are now seeing demand accelerate – recent comments have been that sales rates and reservation rates are significantly higher (Bovis has seen a 43% increase in private reservations in the year to date, Taylor Wimpey’s are up 38%, Bellway’s are up 27%, while Barratt’s forward sales are up 53%). Reported revenues have been rising in the first half of 2013 – Barratt’s are up 21%, Bellway’s have increased by 20%, Bovis’s are up 17%, while Persimmon and Taylor Wimpey have seen increases of 11 or 12%.

What is interesting is the increase in their profits. Barratt’s pre-tax profits are likely to be up over 60% in the first half of 2013 compared with the first half of 2012, Taylor Wimpey’s profits were up 42%, Persimmon’s 39%, Bellway’s 25% and Bovis’s are up by 19%.

So, revenues are increasing nicely.  However, the number of completions has been much less. Bovis and Taylor Wimpey only completed 2% more homes in H1 2013 than H1 2012, Barratt completed 4% more and Persimmon 6%. Average selling prices have however increased by at least 4% (in the case of Bovis and Barratt it was over 14%) despite the housebuilders reporting that house price inflation was between 1% and 2%. Is the balance entirely due to product mix (more higher margin larger properties, fewer apartments)? Profits have been accelerating, margins have increased and it suggests that asset prices are beginning to resemble a bubble.

It is of course in the housebuilders’ interest to sell as few houses as possible at the moment as margins will continue to increase as asking prices are bid up. Going forward, profits will continue to increase and there are likely to be upgrades to market estimates. This is what the current rating of the shares is suggesting. 

What could go wrong? Interest rates could rise, the second part of Help-to-Buy could be postponed or cancelled, housebuilders could start to sell many more units (in line with what the country actually needs) and then find they have to pay up for replacement land. Which is where we started – when the price of land got too high. The key question is when will the forward rating of shares reflect the earnings growth in prospect? Yes, the housebuilders are making hay while the sun is shining, but this is why we are suggesting that it may be time to lock in some profits for a rainy day.

Stephen Williams
Equity Analyst

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