Is now the right moment to call time on our bull rating for UK housebuilders? That requires a fine-line judgment call because there are two pretty convincing cases, on the one side justifying doing just that, and on the other maintaining our so-far very successful buy stance.
One thing that does seem certain is that the pace of recovery will slow considerably. That's not because the need for more housing is any less acute; it's just that housebuilders are running into constraints that look set to limit their ability to maintain the sort of growth seen during the past six years, notably labour shortages.
Taking a look at the reasons for changing our stance, it's clear there is a strong case for cashing in some or all of the gains seen in the past five years, as the table illustrates. Valuation metrics look a little stretched in some cases, too. Persimmon (PSN), our Income Tip of the Year, is trading on 3.3 times net tangible assets, well above the sector average of nearer two times. There are also concerns about cost inflation, notably raw materials, such as bricks and skilled labour shortages, that are driving up wages. As a rule of thumb, costs make up roughly half of a property's selling price. So as long as costs do not rise faster than half the rate at which selling prices rise, there is no pressure on margins. However, costs are now rising at a time when selling price increases are moderating.
On the plus side, the argument for remaining bullish is stronger for some housebuilders than others. Persimmon and Berkeley Group (BKG), for example, have pledged to return significant amounts of money through special dividends right through until 2021. Rising share prices have trimmed the yield, but both companies still offer approximately 5 per cent. Further support comes from the fact that housebuilders cannot open new sites fast enough to keep pace with demand. Forward order books continue to grow, while inflation in land prices remains benign, allowing the big builders to stock up land on terms that meet their own internal hurdle rates. And if they slow down land acquisition, having built up substantial land banks, there will be a lot of extra cash sloshing about, which could well come the way of shareholders. Output has been rising, too, but at 158,000 houses delivered in 2014, this is still nearly 30 per cent below the peak recorded in 2007.
| Company | Share price (p) | 5 years ago | % rise |
|---|---|---|---|
| Barratt Developments | 615 | 96 | 541 |
| Bellway | 2387 | 529 | 351 |
| Berkeley Group | 3229 | 805 | 301 |
| Bovis | 1080 | 352 | 207 |
| Crest Nicholson | 520 | 220 | 136* |
| Persimmon | 2016 | 307 | 557 |
| Redrow | 455 | 107 | 325 |
| Taylor Wimpey | 191 | 25 | 664 |
| *Since flotation in February 2013 |
Source: IC
After such huge share price gains, some investors will rightly feel a lot more cautious. This is where the judgment factor comes into play. Anyone looking to buy at the bottom and sell at the top is in the wrong game; much better to leave something for someone else and realise profits.
We still think housebuilders are in a sweet spot. Mortgage rates are unlikely to rise yet and even when they do, the increase will be small, while most mortgagees will have already locked into fixed rates. Demand will continue to outpace supply, and the government has made several incentives available to help first-time buyers. That said, further gains are likely to be more restrained, and now might be the time to differentiate between the housebuilders themselves.
We still like Persimmon, but the shares are the most expensively rated in the sector, having risen nearly 40 per cent since the start of the year. So for those seeking to crystallise this gain, now might be the time to take profits. For income-seekers, though, the shares are worth hanging on to, and we change our recommendation to hold. Bellway (BWY) also remains attractive because it is relatively cheap compared with its peers. The forecast price to net tangible assets ratio for 2016 is 1.7 for example, well below the sector average of 2.2, and the forecast dividend yield is 3.5 per cent. Berkeley Group retains its attraction as an income play, and it's worth noting that, in valuation terms, the group is sitting on land (principally in and around London) with a gross development value of more than £5bn. But given the huge rise in the share price, we are changing our advice to hold. Taylor Wimpey (TW.) is another income play, with strong cash generation supporting a string of special dividends, leaving the shares worth holding on to. It's hard to find fault with Crest Nicholson (CRST) either, with its expanding dividend and substantial land bank with a gross development value of roughly £10bn, and we retain our buy rating. Of our other buy tips, we are recommending selling out of Barratt Developments (BDEV), given the modest yield, and are moving Bovis (BVS) to a hold.
