Playing the housing market

A pre-close trading update in mid-December was upbeat and led to modest upgrades not only for the 2015 financial year, but also for this year and next. Analyst Alison Watson at Investec Securities predicts the company's reported pre-tax profits will increase by around 14 per cent to £32.3m in 2015, rising to £34m in 2016 and £35.6m in 2017. A de-risked and pre-let development pipeline gives substance to these forecasts and should make the forthcoming full-year results on Thursday, 24 March 2016, and the accompanying outlook statement, a rather good read.

Pipeline of de-risked developments

For instance, Henry Boot has a pre-let agreement in place for a 479,000 sq ft distribution unit with logistics giant Great Bear Distribution at the 200 acre Markham Vale business park in Derbyshire, having already forward funded and a pre-sold the completed development to M&G Real Estate Investments. Work started on the site in November and is scheduled to complete by mid-2016. The industrial warehouse has a gross development value of £35m and Henry Boot should make a 10 per cent margin, accounting for more than 10 per cent of current year profits.

The former Terry's Chocolate Factory in York has potential to generate some tasty returns too. Residential developer PJ Livesey has already started converting the 170,000 sq ft building into 179 apartments and first sales are likely to be booked in the near future. In addition, the former head office on the site has been pre-sold to Springfield Healthcare Group. By my reckoning these two deals have a gross development value of £40m of which Henry Boot could make development profits of £10m this year and next, so underpinning around 15 per cent of the aforementioned profit estimates for its 2016 and 2017 financial years.

I would also flag up a potential £30m gross development profit to be earned over the next three years on phase one of the new 750,000 sq ft Aberdeen Exhibition and Conference Centre, full details of which I discussed previously ('A six shooter of small cap buys', 10 March 2015). Work on the first phase is scheduled to start midway through 2016.

Hallam Land's valuable residential land bank

One of the key takes for me in the pre-close trading update was the stellar progress being made by Henry Boot's residential land development arm, Hallam Land. Having sold six sites in the first half of 2015, and exchanged contracts on another three, the company closed out the sale of four strategic land sites before the year-end, highlighting the ongoing buoyant market for strategic land. In total 1,750 strategic land plots were sold in 2015, representing a 59 per cent increase on the prior year.

Moreover, Henry Boot has 40 sites with residential consent encompassing a total of 12,500 plots, a record high and double the level in 2012, and a strong pipeline of deals with house builders to acquire some of this land. In addition, the company has a further 12,500 plots in the planning process across 35 sites, and 110 sites under option or subject to planning promotion agreements. These are valuable holdings, something that is not being reflected in the balance sheet valuation of land development assets in the company's accounts. In fact, excluding plots in the planning stage, the current book value of the 12,500 plots with planning consent equates to only £10,000 per plot, or £126m in total.

The low carrying value in the accounts explains why Henry Boot makes large profits on its land holdings when they are sold on and their open market value is realised. It also explains why the company's EPRA net asset value per share is expected to have increased by 10 per cent to 164p in 2015, and is predicted to rise to 178p by the end of 2016 and 192p by the end of next year. Or put it another way, once you strip out dividends of 6.5p a shares for 2016 from forecast EPS of 18.7p, and a payout of 7p a share in 2017 from forecast EPS of 19.5p, then the predicted growth in EPRA net asset value can largely be accounted for by the retained profits in the business alone. This still leaves substantial hidden value on the balance sheet.

Target price

So, with analysts at broking houses WH Ireland and Investec Securities both upgrading their earnings estimates, and the company highlighting a robust pipeline for the year ahead, then it seems rather harsh to value the shares on only 12 times current year earnings estimates and on a modest 23 per cent premium to what are very conservative looking estimates of book value. The prospective dividend yield of 3 per cent is attractive too.

In the circumstances, and ahead of next month's full-year results, I feel very comfortable re-iterating my buy advice and my target price of 260p with Henry Boot's shares trading on a bid-offer spread of 220p to 222p. Analyst Alison Watson at Investec maintains a target price of 292p, and Nick Spoliar at WH Ireland has a target price of 317p. Buy.

Housebuilder first quarter trade

My favoured first quarter housebuilder trade hasn't been plain sailing so far ('Time to start building once more', 7 December 2015). If you followed my advice to buy shares in the nine FTSE 350 home builders in early December then you are marginally in profit. That's still better than the performance of the FTSE All-Share index which is down by over 5 per cent in the same eight-week period, highlighting the tendency of the sector to outperform the market at this time of the year. Indeed, it was noticeable how shares in the housebuilders held up, and even made gains in some cases, during yesterday's heavy market sell-off.

Clearly, the spike in risk aversion since the start of January has made investors more cautious generally, but I still expect the short-term trading strategy to post positive returns by the end of next month.

FTSE 350 Housebuilders' key financial data and share price performance

For starters, the chances of UK base rates rising this year look to be non-existent in my view. The 37 per cent collapse in the oil price since the start of November, and the fall-out from the economic slowdown in China, means that the main focus of the Bank of England's Monetary Policy Committee will be on deflationary threats to the UK economy rather than the risk of their 2 per cent inflation target being hit. Lower fuel and energy prices, falling logistics costs embedded in food prices, and a softening of private sector wage growth, are likely to continue to hit the headlines in the coming months as the UK's consumer price index reading struggles to stay positive.

This is good news for homeowners who can realistically expect rock bottom mortgage rates to prevail for some time yet. The chancellor has done his bit to prop up the housing market, not only offering a range of 'Help-to-buy' funding to homebuyers, but his decision to slap a 3 per cent stamp duty surcharge on buy-to-let property has major implications too. When taken together with changes in the tax treatment of rental income earned from such property investments, this will have the effect of actually subduing supply of properties in the residential rental market and quite possibly lead to higher rents for tenants where landlords try to recoup the Exchequer's higher tax take. If anything this will make the decision for many tenants to jump onto the housing ladder not only a financially sound decision, but in some cases a necessity. Buy-to-let sales only represent a small segment of the new build market, so any softening of demand from this segment of buyers is likely to be taken up by the homeowner market.

Add to that a housebuilding industry that is still reaping the financial benefits of building out shrewdly purchased land, and the odds point towards a slew of favourable outlook statements being released during the forthcoming results season. And there is a supportive valuation argument to justify maintaining exposure on this short-term trade: the FTSE 350 housbuilding sector trades on a sub-market average PE ratio of 11 for 2016, and is underpinned by a prospective dividend yield of around 4.3 per cent. I continue to rate the housebuilders a buy on a short-term basis.

I would also recommend maintaining your exposure to the one small-cap company in the sector I have been following, Inland (INL:83p), shares of which have rallied by 10 per cent since I highlighted a gaping valuation anomaly seven weeks ago ('On a roll', 15 December 2015). As I noted in that article, analysts at brokerage Stifel have upgraded their current-year net asset value per share estimate by 20 per cent to 93p (June 2016 year-end) to reflect a 'hidden' £88m valuation surplus on land holdings that have previously been held in the accounts at cost. The company will be moving to EPRA accounting at its results next month, so expect a substantial uplift in the carrying value of land on its balance sheet. My target price remains 90p and I have a break-up value of 100p, slightly below Stifel's June 2017 EPRA net asset value estimate of 107p. Buy.

MORE FROM SIMON THOMPSON...

I have written articles on the following companies this year:

■ Grainger: Buy at 243.5p, target 280p; Dart: Take profits at 580p; Crystal Amber: Hold at 159p; Redde: Take profits at 203p; Burford Capital: Run profits at 196.5p; Renew: Run profits at 404p; Plethora Solutions: Speculative buy at 4.5p ('Stock check', 5 Jan 2016)

■ Elegant Hotels: Buy at 118p, target price 130p to 135p ('Check in for a profitable stay', 6 Jan 2016)

■ Safestyle: Run profits at 272p ahead of pre-close statement on 25 Jan 2016 ('Clear cut gains', 6 Jan 2016)

■ Epwin: Run profits at 143p, new target 170p ('Epwin on the acquisition trail', 6 Jan 2016)

■ GLI Finance: Recovery buy at 37.5p ('GLI shelves fundraise and its chief executive', 6 Jan 2016)

■ LXB Retail Properties: Buy at 97.5p, new six-month target 120p; Urban&Civic: Buy at 286.5p, target 325p; Conygar: Buy at 172p, target 200p ('Hot property, 7 Jan 2015)

■ Somero Enterprises: Buy at 139p, target 185p; 1pm: Buy at 70p, target 82p; First Property: Run profits at 53p; Avation: Buy at 145p, target 200p ('Small-cap value plays', 11 Jan 2016)

■ 32Red: Run profits at 147p; Netplay TV: Buy at 7p ('Chipping in', 12 Jan 2016)

■ Cambria Automobiles: Buy at 87p, new target 95p; Vertu Motors: Buy at 76p, target range 85p to 90p ('Motoring ahead', 12 Jan 2016)

■ Global Energy Development: Hold at 24p ('Cash rich, but unloved', 12 Jan 2016)

■ KBC Advanced Technologies: Bank profits and sell in the market at 183p ('Tech watch, 13 January 2015)

■ Sanderson: Buy at 75p, target range 85p to 90p ('Tech watch, 13 January 2015)

■ Trakm8: Buy at 300p, new target 400p ('Tech watch, 13 January 2015)

■ Amino Technologies: Buy at 120p, new target range 155p to 160p ('Amino has the ammunition', 14 January 2015)

■ easyHotels: Buy at 89p, initial target 100p ('easyHotels ramps up expansion', 14 January 2015)

■ Stanley Gibbons: Hold at 58p ('Stanley Gibbons fundraise', 14 January 2015)

■ Miton Group: Buy at 28p, target 35p; Moss Bros: Buy at 97p, target 120p to 130p; Bioquell: Buy at 140p, minimum target 170p; UTV Media: Trading buy at 184p ('An awesome foursome', 18 January 2015)

■ Equity market strategy ('Bear Market signals', 25 January 2015)

■ STM: Buy at 47p, target 80p; Stadium: Trading buy at 103p; Fairpoint: Run profits at 150p, target range 200p to 220p ('Exploiting market anomalies', 1 February 2015)

■ Character Group: Buy at 505p, target 600p; 1pm: Buy at 67p, target 82p; and Entu: Hold at 68p ('A trio of small cap plays', 2 February 2016)

■ 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 £2.95 postage and packaging. Simon has published an article outlining the content: 'Secrets to successful stockpicking