Profit from London's property boom

Don’t expect profits on anything like that scale of returns from the sector this year as the valuation anomalies have largely been corrected. But there should still be good gains to be had and the one company which looks ideally placed is Bellway (BWY: 1101p), one of the largest housebuilders in the UK and a business that has built more than 100,000 homes since it was formed in 1946. Importantly, in the past four years Bellway has expanded into the buoyant London market and the benefits of this strategic move should be seen when the company issues a pre-close trading statement on Thursday, 7 February.

Operating margins are likely to have risen from 10.1 per cent to 12.5 per cent in the six months to end January 2013, helped by the 20 per cent plus margins earned on sales in the south east and the London markets, in particular. And with the tailwind of the government’s New Buy initiatives breathing life into the first time buyer market, and the Bank of England’s Funding for Lending scheme offering a cheap line of credit to banks and building societies for up to 4 years, not only is mortgage availability improving, but lending costs have been trending down in recent months. Equally positive for the housebuilders is the fact that the large players replenished land banks when it was cheap after the housing market went into reverse five years ago. As a result, the combination of cheap land and rising property prices in the more prosperous parts of the UK are driving operating margins up.

Moreover, with completions rising, the net effect is sharply rising profitability. For instance, in the financial year to July 2012, Bellway’s pre-tax profits jumped 57 per cent to £105m on revenues up from £886m to £1bn which reflects a 6 per cent rise in completions (to 5,226 units); a 6 per cent rise in average selling prices (to £186,648); and a near 3 percentage point rise in operating margins to 11.4 per cent. These trends are set to continue for some time yet given the positive dynamics mentioned above. In fact, after only six months of the current financial year, Bellway had already booked 76 per cent of its budgeted target of 5,500 home sales with average selling prices up a further 4 per cent to £196,000, so is well on the way to lifting pre-tax profits to £135m on sales of £1.1bn for the 12 months to 31 July 2013 as broking house Northland Capital predict. That would give EPS of 85.7p and underpin a 25 per cent rise in the dividend to 25p. On that basis the shares may look richly valued on a 12.9 times earnings estimates and offering a 2.2 per cent potential yield.

But there is little reason to expect Bellway’s profit growth to grind to a halt at this stage of the housing cycle and, given the benefits of rising margins, a modest 10 per cent rise in turnover in the 2013/14 financial year would see pre-tax profits increase to £168m and EPS jump to 106p according to Northland. Moreover, net of dividends, net assets will ramp up sharply, too. On the basis of the above profit projections expect book value to rise to at least 1,000p a share by the end of July 2013 and to around 1,080p a share 12 months later, so in effect the shares, at 1100p, are trading on a modest 2 per cent premium to July 2014 book value and are priced on around 11 times forward earnings.

True, Bellway’s share price is already up 5.4 per cent since the start of the year when I advised buying shares in all eight FTSE 350 homebuilders in order to take advantage of the sector’s tendency to outperform the general market in the first quarter of the year ('Foundations of a rally', 10 Dec 2012). Moroever, with housing market tailwinds working in the company’s favour there is little reason to expect these gains to come to a shuddering halt right now even though the price is now up 70 per cent in the past eight months.

FTSE 350 Housebuilders' performance table in 2013

In fact, a further upbeat trading update next week is more likely than not to extend the sector rally, and Bellway’s share price, in particular. In the circumstances, I would run your profits on all eight FTSE 350 homebuilders and see a decent trading opportunity in Bellway’s shares to rack up more gains in the next couple of months. My end March target price is 1250p for the company which if achieved will provide us with another 13.5 per cent upside.

■ Finally, I will be taking a four-week break during April to complete a book on 'Profitable stockpicking', my follow up to Trading Secrets: 20 Hard and Fast Rules to Help You Beat the Stock Market. The book will be published in early summer.

MORE FROM SIMON THOMPSON ONLINE...

Since the start of this year I have written no fewer than 15 online articles, all of which are available on my homepage. These include articles on the following companies or investment strategies:

Telford Homes, MJ Gleeson, Mallett, Rugby Estates (Taking profits after a winning streak, 28 January 2013)

Market timing(Lessons to learn, 24 January 2013)

Communisis, Netcall (Bumper trading gains, 23 January 2013)

Crystal Amber, API, Sutton Harbour (More upside to come, 22 January 2013)

PV Crystalox Solar (Seeing the light, 21 January 2013)

Bloomsbury Publishing (A publisher for the digital age, 18 January 2013)

Housebuilders first-quarter effect and performance table on all my recommendations from the final quarter of 2012 (Stockpicking Marvels, 16 January 2013)

Eros (A share firmly in the picture, 15 January 2013)

Netcall (Jumping the gun: take two, 15 January 2013)

Moss Bros, Communisis (Jumping the gun, 14 January 2013)

Stanley Gibbons, MJ Gleeson, Spark Ventures (Small cap wonders, 11 January 2013)

IQE, Trading Emissions ('A tech share worth buying now', 10 Jan 2013)

S&P 500 portfolio of dog shares (Dog shares barking back, 8 January 2013)

Air Partner (A share ready to take off, 7 January 2012)

FTSE 100 traded options strategy (Highly profitable options, 3 January 2012)

Telford Homes, MJ Gleeson, Molins, Noble Investments (Rampant bargain shares, 31 December 2012)