On firm foundations

And that price objective looks firmly based on sound foundations as Inland has just announced yet another smart looking deal, a joint venture with Christian Candy’s CPC Group, the property company behind a number of high profile luxury London property developments, to fund the acquisition of brownfield sites with the potential for residential or mixed-use development in south east England. CPC will contribute 80 per cent of the capital to the venture which has an initial investment period of three years and Inland will act as operator with the plan to profit from selling acquired land holdings once they have received planning consent. It makes commercial sense too because this way Inland – which now has a land bank of more than 4,000 plots, so is well on its way towards its target of 5,000 plots – can profit from its expertise in sourcing profitable land deals which otherwise it would have had to pass over due to capital constraints.

It’s a win, win situation in my view as it capitalises on the value inherent in Inland’s management team while at the same time mitigating financial risk to the company as Inland is only contributing 20 per cent of the capital to the venture. News of this deal prompted shares in Inland to pass through my previous 60p target price and means that they are around 160 per cent ahead since I included them as one of 2013 Bargain shares at 23.5p (‘How the 2013 Bargain shares fared, 7 February 2014).

Admittedly, precise details on the financial involvement of both parties have yet to be divulged, but Inland has ample resources to invest having cash on its balance sheet of £11.1m at its last financial year-end. Factoring in borrowings of £28.4m, and a zero dividend preference share issue of £11.6m, net debt of £28.9m equates to 45 per cent of shareholder funds of £64m. The key take for me is that this joint venture with CPC leverages the profit potential from further land acquisitions without the need for Inland to take on more debt.

Clearly, analyst Duncan Hall at finnCap is impressed enough with the progress as he has just picked Inland as one of the broking house’s 10 top picks for 2015. Mr Hall has been a long-term bull of the shares and has a 70p target price too. In my view, irrespective of the gains from the CPC joint venture, the underlying value in the company more than supports such a target.

Strong fundamentals

Buoyed by activity in the south east of England housing market where Inland operates, finnCap expects Inland to report pre-tax profit of £12m on revenues of £88.9m in the fiscal year to end June 2015, up from £8.6m and £39.8m in fiscal 2014, rising to profits of £14m in 2016. Current year estimates look nailed on as they are based on 270 private completions of which 161 units had already been made by the start of December, leaving scope for potential outperformance.

On this basis, expect EPS to rise from 2.87p last year to 4.7p for the 12 months to June 2015, increasing to 5.5p for the year to June 2016. This easily underpins finnCap’s forecast for a 50 per cent hike in the dividend per share to 0.9p in the current year, rising to 1p in fiscal 2016. So not only are the shares priced on a modest forward PE ratio of 11 for the 2015/16 financial year, but there is a prospective dividend yield of 1.5 per cent too.

On a price-to-book value basis the valuation is hardly exacting either. That’s because the 1,675 plots Inland owns or has contracted with planning consent are in its books for £26,000 each, or a total of £109m. But analysts believe the open market value of these plots is nearer £65,000, implying an uplift of £65m, or the equivalent of 32p per Inland share. That’s a significant sum in relation to Inland’s last reported net asset value of £64m at its June 2014 financial year-end.

But even this underscores the value tied up in land as the open market value of those 1,675 plots excludes the development profit which Inland will make once the land is built on. This could be as high as £20,000 for each plot according to some analysts which doesn’t seem unreasonable once you consider that Inland generated a gross profit margin of 39 per cent and an operating profit margin of 26 per cent last year. In addition there will clearly be upside from the controlled land bank of 2,000 plots too. Indeed, according to Mr Hall at finnCap, Inland’s profit participation from three large developments alone could be as high as £60m, or the equivalent of 30p a share.

This means that the underlying value in Inland’s land holdings is worth closer to 90p a share using open a market values and is highly supportive of the current share price. Analyst Nick Spoliar of brokerage W.H. Ireland has a sum-of-the-parts valuation of 100p a share.

Risks

True, the forthcoming general election introduces political risk into the equation. However, as I noted when I advised jumping the gun early and buying all the FTSE 350 housebuilders at the end of November (‘A standing dish’, 25 November 2014), a potential change in leadership is unlikely to harm prospects for Inland. Indeed, chief executive of Barratt Developments, Mark Clare, who was a member of the Lyons Housing Commission which carried out an independent review of housing for the Labour Party, points out that if the party wins the election, it is likely to focus on the affordable end of the market. It’s therefore worth noting that more than half Inland’s private sector completions were part funded using the government's Help-to-Buy initiative last financial year and had an average purchase price of £256,000.

Moreover, if a new government seriously wants to ramp up new build rates in the housing market then this can only increase demand for Inland’s valuable land holdings, not to mention offering scope for an easing of the antiquated planning process in the country. And it goes without saying that cash strapped local councils and housing associations will be unable to do this alone without the assistance of the private housebuilders and land developers. Either way, it looks like ‘plus ça change’ for Inland, in particular, and for the large listed housebuilders generally.

Target price

So with shares in Inland breaking out and now testing the 62p bull-market high dating back to 2007, and the housebuilding sector entering into its historically sweet first quarter period during which time it has rallied over 11 per cent with only five down years since 1980, against a 3.3 per cent average return for the FTSE All-Share index, then not only is the fundamental case for investing strong, but there is positive share price momentum and a favourable technical back drop.

In the circumstances, I am happy maintaining my buy recommendation on Inland shares at 61.5p and have an end March target price of 70p. Buy. I am also maintaining my positive stance on the nine FTSE 350 housebuilders whose share prices have risen by an average of 5.8 per cent in the six weeks since I jumped the gun and recommended buying early in a market down around 2.3 per cent.

FTSE 350 Homebuilders price performance (25 November 2014 to 5 January 2015)

■ Simon Thompson's book Stock Picking for Profit can be purchased online at www.ypdbooks.com, or by telephoning YPDBooks on 01904 431 213 and is being sold through no other source. It is priced at £14.99, plus £2.75 postage and packaging. Simon has published an article outlining the content: 'Secrets to successful stockpicking'