Mortgage malaise continues
The weak mortgage market remains the biggest uncertainty. Figures released last week show the average first time buyer deposit is now £55,000, meaning that new home purchase remains beyond the reach of many. While government initiatives such as HomeBuy Direct have helped in some degree, they are is focused on the Midlands and the north where a greater proportion of household incomes are below the £60,000 qualifying threshold.
That means a return to the high-volume housebuilding models of the boom is out of the question. "The key constraint to volumes is only being able to sell to credit-worthy customers who have very large deposits," says Mike Farley, chief executive of Persimmon. In the boom, Persimmon was delivering 16,000 new homes a year. The current level is nearly 10,000 a year.
Rival Barratt expects its full-year completions to hit 12,000, down from a peak of 18,000. “In this market, it is all about margin recovery, therefore we are absolutely not chasing volumes," says chief executive Mark Clare. "To do so would be folly when there is such a lack of mortgage availability.” Even so, last week Barratt announced it will start eight London sites in the next six months driven by strong demand from investors at home and abroad for properties in the capital.
Land strategies diverge
The national picture remains subdued, however, and the sudden drop in volumes means the housebuilders are all sitting on 'legacy landbanks' of plots, often purchased for twice as much as they would fetch today. Coupled with the fall in house prices, this will constrain margin recovery until the landbank is 'churned'. Most housebuilders operate a four-year land bank model, but the collapse in volumes means some now have enough plots to deliver six years of supply at today’s levels. So why on earth are they out buying more land?
“Now is a great time to buy land - we could be at the bottom of the land market,” explains David Ritchie, chief executive of Bovis. Confirming Bovis has enough land for six years supply at today's volumes, he adds, “we will bring forward new sites where we can make higher historic margins, and blend it over the next few years [with legacy land]."
Similarly, Barratt reports it has exchanged contracts to purchase 7,700 new land plots (equivalent to 13 per cent of its landbank) which in time, will deliver full margins. The accepted wisdom is that for those out buying sites, it will take at least three or four years for margins to fully recover. However, if house prices continue to rise, it will happen sooner.
Persimmon is adopting a different strategy, with Mr Farley looking to reduce the company's current balance of 61,000 land plots by not replacing every one he builds on. "Working on the basis of a £30,000 replacement cost per plot, the non-replacement of land points to a £200m to £300m cash release from the land bank over time," he adds.
Valuation variance
The land debate is a critical factor in how to value the housebuilders. More bearish analysts, including KBC Peel Hunt’s Robin Hardy, look to PE ratios which remain uncomfortably high across the sector. After the short-term performance boost that the selling season is hoped to provide, Mr Hardy remains concerned about longer term valuations. Taking Bovis as an example, to obtain a ‘normal’ mid-cycle PE rating of 8.5x by the end of 2012, he calculates that Bovis would need to report EPS of over 40p per share. However, Mr Hardy struggles to see it reaching half of that level.
Alternatively, when valued in relation to forecast Net Asset Value (NAV), the housebuilders look less expensive. For example, Barratt’s current NAV is 200p - a 35 per cent discount to its current share price - but analysts have niggles about the carrying costs of its land plots (£44,000 per plot versus nearer £30,000 for Taylor Wimpey and Persimmon) which helps to explain the discount.
But Barratt did not write down the carrying value of its landbank as aggressively as other builders. By contrast, those who did make hefty provisions can now augment NAV by making ‘write backs’ on the way up. This has already happened at Persimmon and Bovis expects to do the same at full-year results.
Meanwhile, it was encouraging to see that even the recent snow falls didn't hit the industry too hard - despite decimating visitor numbers at sites across the UK, there was a big uptick in virtual visitors during the snowy season. Barratt, for one, reported a 100 per cent jump in website traffic, with 4,000 sales leads a week coming through its websites. “Most house purchases now originate from a web inquiry but we’ve still got to work hard to turn those inquiries into visitors, and visitors into sales," says Mr Clare.
Certainly, if we were stock-picking housebuilder shares on the basis of who has the best website, Barratt would win hands down. Innovations such as searching for new homes near a particular school are way ahead of the pack, and the quality and clarity of information provided for nervous first time buyers is impressive.
