Bellway, just too cheap

Using conventional valuation metrics against its rivals, Bellway is the cheapest on nearly every count. On broker Numis's estimates, the shares are trading on just 1.1 times net tangible assets for 2015 compared with Berkeley Group and Persimmon on nearly double that. Earnings growth is also pretty dramatic, too, because even though the shares have risen nearly fourfold from a trough of 378p six years ago, they are still on just seven times forecast earnings for 2015.

Bellway is a quality operation, too. Return on capital employed in the half-year to January jumped from 10.5 per cent a year earlier to 17.1 per cent, and Numis believes this could hit nearly 20 per cent by the end of next year. But it's also worth looking to see how these numbers stack up on an historical basis. Operating margins peaked in 2006 at 19.3 per cent, so these could be achieved by next year. Return on capital employed in 2006 was 23.4 per cent, so there is still some way to go. And while it's true that the benefit on margins of switching to family homes and using cheaper land is finite, Bellway can still drive earnings by increasing output. Taking annualised first-half completions for the current year shows that the number of units sold is currently 15 per cent below the peak touched in 2007.

Maybe Bellway's not cheap, just all the other housebuilders are overvalued, but we don't think so. To bring values crashing at least one of the key pillars supporting the current boom would have to be swept away. This would only happen if there were a significant increase in interest rates - Bank of England governor Mark Carney regards this as a measure of last resort. It could also happen if mortgage availability were restricted or if the government withdrew current assistance packages such as Help to Buy. Neither of these seems likely.

In fact, trading from February to May this year for Bellway suggests that the positive trend is firmly entrenched. During that period sales rose by 11 per cent, with weekly reservations running at 177 per week, while the forward order book of homes due for completion in the next financial year has jumped from £380m a year ago to £670m. Cash flow has strengthened as a result, and despite spending £400m on land since August last year, net debt has shrivelled from £95m to £47m. This is despite the group's greater use of bank lending as opposed to using land creditors, because bank debt is cheaper to service. Bellway also redeemed its £20m of 9.5 per cent preference shares in April. Terms have also been agreed on a further 4,900 plots, while all the land required to meet next year's growth projections is already in place with planning consent.

Demand for new houses, boosted by the Help to Buy scheme, means that Bellway now expects to boost legal completions in the current year by around 20 per cent. This demand is also having a positive effect on margins because the group has found it can scale back on incentives without hurting demand. Inevitably, there will be some pressure generated through increased costs, as sub-contractors move to repair their own margins so badly dented during the downturn. However, these increases can be recouped so long as selling prices can be adjusted higher.

Shareholders have not been forgotten through all of this, and the half-year dividend was lifted by 78 per cent. However, the forecast dividend is still three times covered by projected earnings, and the shares offer a projected yield of 4.5 per cent next year.