The board's decision to ramp up the company's housebuilding operation looks well-timed in light of the pick-up in housing market activity this year. The government's Help to Buy mortgage guarantee scheme and the Bank of England's Funding for Lending operations are both clearly supportive of the housing market. Moreover, with the new Bank of England governor Mark Carney signalling that the low interest rate environment is here to stay for the next couple of years at least, this can only boost the confidence of home buyers and transaction levels.
This is all good news for Inland, which sold 55 units in the financial year to end-June, up from only 15 homes in the previous six-month period. These sales generated revenues of £11.4m, up from £1.7m, and absolutely smashed the forecasts of analyst Duncan Hall at broker FinnCap whose earnings estimates are now under review. Mr Hall had previously expected Inland to sell 25 residential units in the six months to end-June, generating housebuilding revenues of £5m and a profit of £1m. In the event the company sold 40 units and reported revenue 66 per cent higher at £8.3m. So even if operating margins are only maintained at 20 per cent, the additional £3.3m of revenues adds £660,000 to Inland's profits to make the contribution from the housing operation around £1.66m for the second half to end-June 2013, rather than £1m forecast.
Results to smash expectations
It also means that Inland's full-year profits for the 12 months to end-June 2013 will handsomely beat finnCap's previous estimate of £4m, up from £1.6m a year earlier. That's because the company had already trebled pre-tax profits to £3m in the second half of 2012. Furthermore, it completely blows finnCap's previous forecast for the financial year to June 2014 out of the water. The broker had been predicting that Inland would only make 70 residential completions to generate housebuilding revenues of £15.4m and profits of £3.4m in that 12-month period. I would be astonished if those estimates were not beaten since Inland's developments are in the buoyant south-east of England housing market.
Prospects for the housebuilding operation look well underpinned, too, by a number of acquisitions made, including a 40-unit site near St Albans with a gross development value (GDV) of £10.2m; and a new 155-unit scheme on a one-acre brownfield site in Woolwich with a GDV of £32m. Terms have also been agreed on three sites in Buckinghamshire to build 220 units, and planning permission has been granted for a 101-home scheme on the southern part of St John's Hospital, Chelmsford. The GDV of that scheme alone is £34m.
Inland also has a lucrative housing operation at Drayton Garden Village, a joint venture development in West London. The scheme encompasses 453 homes across seven sites and has forward sales contracted or agreed of £42.5m. Interestingly, Inland's profit share from Drayton Gardens is around 74 per cent, but is expected to rise to 90 per cent by next March. The profit embedded in the development is likely to have risen once you mark holdings to market value and factor in the strong house price growth in London and the south-east this year. Previously, Inland had estimated that future net profits from Drayton Gardens were worth 5p a share. I expect this estimate to be raised when Inland reports full-year results next month.
Buoyant land sales
The story gets even better when you consider that Inland is enjoying strong demand for land sales to housebuilders. In fact, in the financial year just ended the company sold 355 plots with planning permission which generated revenues of £15.35m. This excludes the 76 units sold at Drayton Gardens, which brought in a further £5.3m of revenues. Moreover, Inland's combined revenues from housing operations (£11.4m) and direct land sales (£15.3m) is 10 per cent higher than finnCap's previous forecast of £24m and that's before you factor in the contribution from Drayton Gardens.
Inland's board has sensibly been replenishing land holdings and just before the end of June exchanged contracts on four further sites in deals worth £9m. These add 366 residential plots to take the land bank to above 2,000 plots. The company certainly has the funds to do deals as it had cash balances of £12.2m and net borrowings of only £3.7m at the end of June, having raised £4.9m of new funds through a placing at 27p a share in May to fund the acquisition of more sites for development.
Expect massive earnings upgrades
Although finnCap's earnings estimates are under review, it doesn't take a genius to realise that there will be significant upgrades. I would not be surprised at all to see Inland treble pre-tax profits to £4.8m in the financial year just ended to produce EPS of around 2.2p. It could be more.
So, with the shares trading just below a conservative book value of 33p after recognising the 5p a share of net profits from Drayton Gardens, and with profits set to receive another massive lift in the current year to end-June 2014 on the back of increased activity in the housing market, the business is enjoying one heck of a tailwind. It's also good news if you purchased the shares when I first advised buying at 23.5p ('Bargain shares for 2013', 8 February 2013). They have since risen 38 per cent to 32.5p. And I am confident they will be significantly higher after Inland reports its forthcoming full-year results when a wider audience realises the profit potential in its land holdings and the massive ramp-up in its housebuilding operations. My new target price is 40p. Trading buy.
Built on solid foundations
Continuing with the property theme, my advice to buy shares in Bovis Homes (BVS: 790p) has yet to reap the profits I expect, but I still think it will after the company reports half-year results on Monday 19 August. I previously recommended buying at 820p after a buoyant trading update last month. My target price is 900p, which if achieved will provide us with a 10 per cent gain.
To recap, in the first half of 2013, Bovis achieved 1,389 net private reservations, a 40 per cent rise on the same period last year. Importantly, the trend is accelerating as net private sales per site per week improved by a quarter to 0.59, reflecting the improving quality of active sales outlets and the positive impact of stronger homebuyer sentiment. In the second quarter, Bovis achieved net private weekly sales per site around 60 per cent ahead of the prior year. It's only reasonable to expect further good news next week.
Bovis' sales also have a distinct second-half bias, so have more potential for earnings upgrades as the year progresses resulting from the improving sales environment than for other builders where sales volumes are more evenly spread. Moreover, with selling prices ahead of expectations and margins on the rise - operating margins rose from 8.7 per cent to 11 per cent in the first half of 2013 - return on capital is set to hit 10 per cent this year, up from 7.7 per cent in 2012.
In other words, Bovis offers investors the quadruple whammy of improving sales, margins, return on capital employed and cash generation. In the circumstances, it's hardly surprising that analysts have been hiking estimates.
Earnings upgrades
For instance, construction analyst Anthony Codling at Jefferies has raised his 2013 pre-tax profit estimate by over 7 per cent to £73m, based on revenues of £521m, up from £425m in 2012. This means underlying pre-tax profits are set to rise almost 40 per cent and drive EPS up from 30.6p to 42.2p. This easily underpins a 33 per cent hike in the dividend to 12p a share. It could be more. For 2014, Jefferies expects revenues to rise further to £586m, pre-tax profits to hit £95.5m and EPS to surge to 56.6p. On this basis, expect a dividend of 15p.
True, a forward PE ratio of 14 for 2014 may seem steep. However, it is fully justified once you factor in Bovis' land holdings, the profit potential in the land bank and scope for more earnings upgrades as the housing market recovers.
Land holdings
At the start of the year, the company had 13,776 consented plots with potential gross profit of £600m, calculated using sales prices and build costs at the time. This was £76m higher than at the end of 2011. But future profits from those plots will have risen markedly. In fact, in the first half of 2013, Bovis added no fewer than 2,767 consented plots on 18 sites to its land bank - double the number of sales - and has contracts in place to add another 1,018 plots to the consented land bank in the second half. Bovis expects to earn an eye-catching return on capital of 20 per cent on these acquisitions.
In addition, Bovis also has 19,318 potential plots of strategic land where it has "strong visibility on the potential to convert a number of sizeable land holdings into consented opportunities during 2013 and 2014". Combined, a total land bank of over 34,000 plots equates to 13 years' build based on an annual build rate of 2,800 completions. This is by far one of the longest and most valuable land banks in the sector.
It also means that the company's book value of £758m significantly underscores the true value of the land and the embedded profit in the plots when they are built out. The value in these land holdings explains why Bovis commands a market value of £1bn, or 1.3 times conservative book value, and a higher earnings multiple than rivals. The company also has very low gearing.
Positive technical set-up
After a share price surge post last month's bumper trading update, shares in Bovis have retreated back to test the 785p breakout level. This is textbook stuff, where a former major resistance level turns into support. In my view, the price action to date is a precursor to a rally through the 860p mid-July high towards my 900p price target. Next week's results are the likely catalyst. Trading buy.
Time to take a Russian gamble
A decent buying opportunity has set itself up in shares of Russian warehouse developer Raven Russia (RUS: 69.25p). I first advised buying the shares at 69.3p ('A major buy signal beckons', 11 Mar 2013) and the price subsequently rose 14 per cent to my 80p target price. When I last updated the investment case ('A share ready to bolt', 20 May 2013) I upgraded my fair value price to 90p, a level I am comfortable with ahead of half-year results later this month. They are likely to make pleasant reading and prove a catalyst for a re-rating.
That's because Raven Russia has already confirmed it has 1.3m square metres of its portfolio of Grade 'A' warehouses in Moscow, St Petersburg, Rostov-on-Don and Novosibirsk let out. In total, this equates to 97 per cent of the total portfolio and generates an annualised net operating income (NOI) of $183m, including pre-lets. The total potential NOI is $192m, which could be hit "by the year-end if current market conditions continue". The warehouse and logistics market is still very strong, with Jones Lang LaSalle forecasting vacancy rates in Moscow of between 1 and 3 per cent over the next 12 months. Tenant demand in Raven Russia's portfolio remains 'robust'.
Despite this positive backdrop, Raven Russia's share price trades on a 15 per cent discount to 2012 diluted net asset value of 125¢, or 80.8p a share. It's my view that with rental income rising, and vacancy rates narrowing, there is scope for valuation uplifts. The yield on the shares remains attractive at 5.5 per cent. Ahead of the interim results, the shares are a decent buy.
Please note that in response to requests from dozens of readers, I published an article last week outlining the content of my new book, Stock Picking for Profit: 'Secrets to successful stock picking'
