Tuesday, 27 March 2012

Housebuilding sector and the NewBuy scheme.

Having been asked:
"With the goverment backed indemnity mortgages in partnership with all major house builders and few of the high street lenders.....which would be your pick of house building shares?" 

...and not having had a reason to look at house-builders for some time it seemed an opportune time to take a look given the relative buoyancy of house prices despite the credit crunch, lenders' apathy and the governments attempts to kick-start the housing and lending markets.

With the introduction of the NewBuy scheme buyers of new build homes, who might not yet have the required deposit for a current mortgage, could have access to 95% mortgages as long as they can afford the premiums.
"Under the scheme, the builder will put 3.5pc of the purchase price in a shared insurance ‘pot’ and the government will guarantee another 5.5pc."  that will help to reduce the risks to the lender.
Despite the scheme's introduction my initial reaction is that given the factors affecting the macro environment: recession, inflation, and credit squeeze, there is still more than a little faith required to invest in the sector. 
Current valuations only add to that risk.
However, the sector is traditionally very cyclical and geared to recovery and low interest rates but such is the chaotic and seemingly out of synch environment at present low interest rates themselves serve little purpose given the banks own attempt to improve their capital position.

Its therefore quite a surprise to see that the housebuilders on my watchlist all seem to have some kind of healthy recovery priced in with strong forecast earnings growth putting them all onto healthy mid to high teen forecast price to earning ratio's (a surprise to me anyway).

So stepping into the Tardis, the housebuilders still on my watchlist are:- Persimmon, Berkeley, Barratt's, Bellway and Bovis. 
Across them all Profit margins and cash balances seem relatively low. 
Dividend yields are usually good from this sector but are negligible currently reflecting the cashflow concerns for me.
Obviously the right decision to cut dividends to support cashflow in this case but without this prop it begs the question of why the share prices seem so healthily rated.

The other obvious metric is around landbanks and (if I am guessing the category correctly) I have looked at balance sheet "inventories" v sales as an indicator of how much is already in place to protect future growth. Values are subjective but you would hope they are all using a comparable criteria.
Borrowings also warrant looking at particularly if they have overpaid at the height of the last boom and therefore could still be paying for the inventory not being built upon.

Anyway Persimmon looks the weakest here as it has around £2bn of inventory v £1.5bn sales. So if inventory is the land bank it has land in place to cover 1.3 years (not sure of the proportionate cost of land to sales so will assume it is 1:1 but if it was 25% land cost then this would be 5.2 years and so on and so forth).
Barratt's figure is £3.3bn to £2bn, Berkeley is £1.6bn to £742m, Bellway is £1.27bn to £866m and Bovis is £800m to £364m.

Berkeley has the highest gearing of debt to equity at 24% gross but the most amount of cash at £266m which is enough to make the net debt position 0. Bovis is similarly in a net no debt position.
Barratt's at 14% gross gearing and Persimmon at 11.7% aren't in this luxurious position and carry net debt (not enough cash to cover borrowings). 
Bellway is 9.32% with a negligible 1.55% for the net figure.

So thats a plus for Berkeley and Bovis for me particularly when cashflow can be a concern in this industry as so much needs to be paid out upfront before a sale actually brings money in.
But on a general level Persimmon and Barratt's have the higher sales figures so if margins were the same then this would potentially generate a larger profit figure. 
It might seem like pile it high and sell it cheap but is there a quantity over quality factor as well?
On an overall plus for the sector, and despite the already healthy amount of expectation built into the share prices' of these companies, the underlying strength has surprised me, with debt and cashflows seemingly under control, and healthy forward landbanks.

But I would probably go for Berkeley due to it being in the strongest cashflow position but also look at the quality associated with the "brands" being sold and the potential premium that can be realised.  
Taking another view though, this might not be the area that would benefit most from the new scheme's customer demographics e.g pile it high!

Its interesting though and will be interesting to keep an eye on the sector to see if the initiative results in greater volumes during this bumpy recovery or if it just helps to shift "sticking" stock with the insurance premium serving the same purpose as a discount (the builder contributes 3.5% of the purchase price).
Banks and lenders are still key though and have recently been warned again about their capital positions whilst the still new Financial Conduct Authority continues to look for the powers required to enforce this so there might still be a sting in the tail.

Berkeley Group @ 1346p, -6p (-0.44%)
Bellway @ 839p, -20.50p (-2.39%)
Bovis @ 510p, +5p (+0.99%)
Barratt Dev. @ 151.50p, +0.8p (+0.53%)
Persimmon @ 661.5p, -1p (-0.15%)

Related articles:
http://www.telegraph.co.uk: Builders hope for mortgage guarantee boost

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