Redrow (RDW)

Redrow's share price gained 17 per cent in one day last week with news that the government may try to revive the UK's spluttering housing market by . Shares in all the quoted housebuilders were lifted but, in Redrow's case, any hopes of recovery look misguided.

Its biggest problem is vanishing profits. Its profit margins are already weaker than its main competitors and investment bank Landsbanki forecasts its margin will shrink from 21.9 per cent in 2006-07 to just 6.8 per cent in 2008-09. That will push the group into pre-tax losses (see table) and threaten the dividend.

Redrow's downbeat trading statement in July revealed that reservations were 55 per cent down year-on-year, and forward sales had dropped by 45 per cent. Cancellation rates were high at 30 per cent, and were said to have "increased significantly in recent weeks as customers have not been able to secure mortgage offers". This tallies with figures from the Building Societies Association, showing a dramatic withdrawal in new mortgage lending.

Despite lower sales volumes, Redrow's average selling price appears to have held up at £157,000 but this does not reflect the level of profit-eroding incentives on offer. For example, consumer website moneyfacts.co.uk reports that the average deposit demanded by mortgage lenders is now 20 per cent. So, to help sales, Redrow is effectively offering to pay home buyers a 25 per cent deposit on selected plots, in the form of a second loan repayable within 10 years.

We called Redrow's sales hotline 10 times to check the terms of this offer, but were greeted with an answerphone message each time. Perhaps this is because the group has announced it is in the process of to cut costs, and is putting the brakes on buying new land.

Click for a guide to the terms used in IC results tables.

Indeed, Redrow's land buying may be the main reason for its weak profit margins. Landsbanki estimates that one quarter of its current landbank of 17,350 plots was acquired within the past 30 months. Based on its latest figures, its average plot cost made up 22 per cent of its average selling price. Now that land prices and house prices are , write-downs to landbanks and works in progress are dogging housebuilders.

Redrow concedes that a "significant adjustment" will be announced at next month's full-year results. Landsbanki forecasts that Redrow's net assets will fall to 220p per share, implying a £240m land write-down.

City analysts concur that a write-down of this size would put the group in breach of its banking covenants, and Redrow has already hinted it is renegotiating a cashflow-related covenant with its lenders. The trouble is this may lead to higher borrowing costs, which will squeeze its margins even further.

Still, Redrow's problems have long marked it out as a takeover target - hedge fund Toscafund now owns over a quarter of the shares, and rival Bellway was once rumoured to be interested. However, the more pertinent worry is next year's sales figures, which will be depressed by the continued paucity of mortgage finance, and the fear that house prices will fall further. This leads brokers to forecast pre-tax losses and the suspension of dividend payments in 2008-09.

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