After posting solid gains in the first quarter, shares in UK housebuilders paused for breath in the run up to the general election, but resumed their upward path after the Conservative government won an unexpected clear majority. The question now is whether the pace of upward momentum can be maintained.
From a pure valuation perspective, using the ratio between the share price and net tangible assets per share suggests that valuations look stretched. But this is not the whole picture because land banks are booked at cost, whereas the gross development value is significantly higher. Whether the land bank can be built out to crystallise this value depends on what you think is going to happen to the housebuilding sector over the next few years. Without doubt, the sector is a cyclical play on the health of the economy, and while there will no doubt be bumps along the way, the outlook for a sustained period of economic growth looks pretty good right now.
There will always be questions about affordability, notably for first-time buyers, but at least all the essential ingredients are in place. Average earnings are rising faster than inflation (June CPI was zero), and mortgage rates are at an all-time low. There is also a range of government initiatives, principally help-to-buy, offering some assistance for those looking to climb on the first rung of the housing ladder, while stamp duty charges have been moved onto a sliding scale favouring cheaper priced properties. According to the Council of Mortgage Lenders, lending for house purchases and remortgages rose in May from April, but volumes were still down from a year earlier. What's more, after peaking at 3.28 in May 2014, the ratio between the average mortgage loan and gross earnings has been in steady decline and in May fell to 3.17. On top of this, competitive mortgage rates mean that first-time buyers are paying the lowest proportion of their monthly income servicing and repaying a mortgage since the CML began tracking the ratio in 2005.
House prices have risen strongly in many parts of the country, raising affordability issues, but higher prices are generally a trend that housebuilders follow rather than create themselves. A big contributor to house price inflation is a shortage of new build, but there are other factors at play, too. There is a correlation between new build and total sales of pre-owned property. Capital Economics has highlighted the fact that over the past 35 years, new build has comprised between 10 per cent and 14 per cent of overall sales transactions. The problem here is that sales of pre-owned homes have been in steady decline because of the increase in older home owners, who traditionally move house less frequently than younger owners. According to the Royal Institution of Chartered Surveyors, the average stock of houses per surveyor has fallen to its lowest level since records began in 1978.
| Tip price (p) | Current price (p) | Change + | Tipped | Dividend yield | |
| Bellway | 1,431 | 2,332 | 63% | 12/06/14 | 2.0% |
| Berkeley | 1,691 | 3,258 | 95% | 13/12/12 | 5.5% |
| Bovis Homes | 1,091 | 1,110 | 2% | 4/06/15 | 3.6% |
| Crest Nicholson | 334 | 541 | 62% | 25/09/14 | 2.3% |
| Persimmon | 1,519 | 1,987 | 31% | 8/01/15 | 4.8% |
| Telford Homes | 101 | 450 | 346% | 22/04/10 | 2.6% |
The implication is that housebuilders could possibly break out of this link by building more houses, without the risk of depressing prices. Indeed, housing starts in the first quarter of the year reached their highest level since 2007. And given the huge supply/demand imbalance it seems likely that output can continue to rise without any risk of driving prices lower. In fact, house price inflation is driven by the shortage of pre-owned homes coming onto the market. However, new housing construction may soon benefit from recent measures to free up more brownfield sites, while moves to accelerate planning applications from smaller builders could increase supply. Could is the key word here, because local authority planning departments suffer from a shortage of resources, while banks remain reluctant to lend money to fund speculative development.
In an ideal world, the big housebuilders would like to see a level playing field. Double-digit house price inflation benefits no one in the long run because it is simply unsustainable. So, as long as prices rise sufficiently to cover rising costs - principally a reflection of skilled labour shortages - and the number of sales sites continues to grow, the world would be a happy place. And, currently, we are about as close to that as we can be.
Recent trading updates from the housebuilders tend to underline this. Tip of the Year Persimmon (PSN) delivered a 7 per cent increase in first-half completions to the end of June. And while cost inflation is running at around 3 per cent, this was more than offset by a 4 per cent increase in average selling prices. In addition, active sites rose by 5 per cent. At Barratt Developments (BDEV) first-half completions were up by nearly 11 per cent, with average selling prices on private homes up 8 per cent. It was much the same story at Galliford Try (GFRD), and in all cases profits have risen significantly and other metrics such as operating margins and return on capital have risen. It's important to remember that these trading performances covered the period including the general election. So while share prices might have experienced a hiccup, sales certainly haven't. And looking ahead, forward order books are up sharply, while cancellation rates remain historically low. Berkeley (BKG) has shown how sentiment can run a steam roller through the share price. With a greater exposure to the more expensive end of the London market, its shares were barely changed just ahead of the election compared with the start of the year, as worries about a mansion house tax kept investors away. However, since the election result, the shares have risen by 40 per cent in just two months.
FAVOURITES
All housebuilders are performing strongly, so picking a favourite is not easy. However, two stick out from the rest of the pack because their huge cash generation is paying for special dividend payments. Persimmon remains on track to return £1.9bn to shareholders by 2021, which works out roughly at a dividend yield of around 5.5 per cent over that time. And with the dividend timetable already brought forward, some analysts reckon that the total payout could be even more. Berkeley operates a similar scheme, and the yield is similar. The 90p dividend declared in the second half to April 2015 completes the company's first milestone of 434p a share by September 2015. The group remains on track to return an additional 433p by September 2018 and the same amount again by September 2021.
OUTSIDERS
Using the same yardstick, but remembering all the time that all the housebuilders are in a sweet spot, it's hard to pick an outsider. Berkeley, Persimmon and Barratt Developments are all delivering above sector average dividend yields, and all the rest offer growth and the prospect of a rising dividend yield. So, on this occasion, we take the unusual step of suggesting that the sector momentum favours all the major housebuilders. Take your pick.
IC VIEW:
Most of the major housebuilders are IC buy tips (see table), and those that are not tips all have buy recommendations. This view is unlikely to change because in the wake of the financial crash there have been some major changes. Banks and building societies no longer hand out high loan-to-value mortgages like confetti, and new regulations require lenders to make very sure that repayments will not falter if there is a rise in interest rates, for example. Secondly, the economy may have been through a recession but that hasn't stopped young people growing up and wanting their own home, be it rented or brought. So there has been a huge backlog, with the scarcity of local authority building, and housing associations being knocked by the latest right-to-buy initiative, is only making matters worse. The key to sustained growth in the housebuilders will rest with keeping a lid on house price inflation, and it's in their own interests to do just that.
