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Building gains

Building gains
February 14, 2017
Building gains

That’s because I believed the risk premium embedded in sector valuations was simply too high given that news flow was highly likely to remain upbeat. And so it has proved as a slew of positive pre-close trading statements in the past six weeks have been well received by the market, so much so that share prices in the 10 FTSE 350 housebuilders have risen by an average of 9.6 per cent in the past six weeks, or almost five times the 1.9 per cent return on a FTSE All-Share index tracker. Given the trading strategy has created the ‘alpha’ I was looking for, and in double quick time, the question is whether or not the good news is now priced in?

FTSE 350 Housebuilders first quarter share price performance

CompanyPrice on 3 Jan (p)Price on 13 Feb (p)Percentage change %)
Crest Nicholson456p542p18.9%
Galliford Try1,291p1,514p17.3%
Redrow427p484p13.3%
Persimmon1,768p1,989p12.5%
Taylor Wimpey156p174.5p11.9%
Barratt Developments466p511p9.7%
Bellway2,453p2,607p6.3%
Bovis Homes820p861p5.0%
Berkeley2,808p2,929p4.3%
Countryside Properties241p229p-5.0%
Average9.4%
Deutsche Bank FTSE All-share index tracker (XASX)404.54121.9%

The government’s newly released White Paper on housing has proved to be a non-event from my lens. That’s rather good news for the major UK players who will continue to control their output as and how they like without political interference, and build up substantial undeveloped valuable land holdings, while the government looks as far away as ever from achieving the ramp up in new housing starts the country desperately needs. So, with that potential hurdle out of the way, I feel the investment risk remains to the upside given we are guaranteed bumper financial results statements across the sector in the coming weeks and ones that will reveal sound order books, impressive cash generation and hefty dividend hikes for shareholders, all of which points towards a continuation of the sector rally.

Critically, valuations remain attractive: the forward PE ratio for the FTSE 350 housebuilders is still below 9; the prospective dividend yield is around 5.5 per cent; and an historic price-to-book-value ratio of 1.9 times is not out of kilter with companies that are generating 20 per cent plus post tax returns on equity. So, if you followed my earlier advice I would continue to run your healthy profits on these FTSE 350 companies.

And the housing minnows?

I also advised buying shares in three small-caps in the sector just before Christmas ('Built for gains', 19 December 2016): East London housebuilder Telford Homes (TEF:355p); specialist housebuilder and brownfield land developer Inland Homes (INL:62.5p); and Urban&Civic (UANC:230p), a listed property group specialising in strategic residential land developments

Shares in Telford have rallied 11 per cent to 355p since that article, and the initial target price of 375p I outlined when initiated coverage at 289p last summer looks in sight ('London property trading play', 22 August 2016). On 10 times forecast EPS of 35p for the 12 months to end March 2017, offering a prospective dividend yield of 4.4 per cent, and rated on 1.4 times book value, I remain positive given the company’s focus on the more affordable end of the London housing market, and the de-risking of the pipeline through forward sales of private rented residential developments to institutional investors.

Inland’s shares have made more modest progress, rising only 6 per cent since my December buy recommendation, but I feel there is a buying opportunity here ahead of next month’s interim results for several reasons: a 38 per cent share price discount to the 100p a share EPRA net asset value of analyst John Cahill at broking house Stifel is extreme; Inland’s underlying diluted EPS is forecast to increase by a quarter to 6.8p in the 12 months to end June 2017, implying the shares are rated on only 9 times current year earnings forecasts; the payout per share is forecast to jump 15 per cent to 1.5p, so the prospective dividend yield is 2.4 per cent; and a read across from trading updates from other land developers suggests a strong flow of deals are being done. Inland's focus on the affluent south east of England property market is another positive given the chronic housing shortage in the region. Having initiated coverage at 23p in my 2013 Bargain Shares portfolio ('How the 2013 Bargain shares fared, 7 February 2014), I feel my 80p target is not unreasonable.

Shares in Urban & Civic have rallied around 7 per cent in the past eight weeks, but still look undervalued on a 19 per cent discount to historic EPRA NAV of 284p, and priced 29 per cent below EPRA NAV estimates of 324p and 332p, respectively, based on forecasts from analysts at Stifel and JP Morgan Cazenove. The valuation uplifts expected are eye-catching, but it’s worth noting that last year unserviced residential EPRA values per plot rose by a third to £24,500 at the company’s 1,432 acre freehold site at Alconbury Weald, incorporating Cambridgeshire's Enterprise Zone, with permission for 5,000 homes; and jumped by 16 per cent to £15,000 per plot at the 1,170 acre site in Rugby where permission has been granted for 6,200 new homes.

Bearing this in mind, the first house sale at Alconbury generated a £64,000 profit and produced an unserviced plot value of £71,000 per private plot, well above the appraised blended plot value of £24,500 calculated by CBRE Limited, an independent firm of chartered surveyors, which was used in Urban&Civic’s last set of accounts. That’s significant because CBRE have conservatively valued the two developments at Rugby and Alconbury at £105m and £197m, respectively, so these account for three quarters of the company’s net asset value of £410m. This means that the difference between the larger site valuation of Alconbury and Rugby, as included in the EPRA valuation, and current land parcel sales to housebuilders is around £91m, a sum worth 60p per share.

I feel that investors are likely to cotton onto this ‘hidden’ value when Urban&Civic next reports results and continue to rate the shares a value buy.

Netplay bid wholly unacceptable

Mergers and acquisition activity in my small cap hunting ground shows no sign of abating with Aim-traded online gaming operator Netplay TV (NPT:9p) the latest company on my watchlist to receive a formal bid. In fact, no fewer than 15 of the companies I follow have now been taken over or exited the stock market in the past two years. On average these special situations have reaped a healthy 50 per cent capital gain above my recommended buy in prices, but some of the exits have hardly been overgenerous. Indeed, just like the recent takeover of Aim-traded Constellation Healthcare Technologies (CHT), a provider of outsourced medical billing services to US physicians ('Aim-delistings', 29 November 2016), I am unable to recommend the Netplay offer.

That’s because the acquirer, Betsson, is only paying an 11 per cent premium to the company’s average share price over the past three months, and almost one third of the £26.4m cash consideration is being financed by net funds on Netplay’s own balance sheet after stripping out customer deposits. This means that Betsson, a company that has been a leading consolidator in the online gaming sector following its acquisitions of TonyBet and Racebets in 2016, Europe-bet in 2015 and Oranje & Kroon in 2014, is acquiring Netplay for less than six times cash profits to enterprise value based on analysts’ estimates for the 2016 financial year. The 9p a share cash offer is also well below the 14p a share valuation which analyst Greg Johnson at broking house Shore Capital deemed fair value at last autumn’s interim results.

I am also uncomfortable with a deal that was put in place prior to Netplay commencing bid discussions with Betsson, whereby chief executive Bjarke Larsen and finance director Akshay Kumar each receive a pay-off of 0.625 per cent of the value of the takeover, a sum worth £165,000, in addition to their statutory severance pay. They also have 3m share options each which are £30,000 in-the-money.

The lack of bid premium reflects the fact that Teddy Sagi, the founder of Playtech (PTEC), the gambling industry's leading software and services supplier, is the largest shareholder in that enterprise and in NetPlay too. Playtech provides NetPlay with software and related services in order to allow the company to conduct its business. In addition, Playtech licenses gaming technology and software and online games to members of the Betsson Group. In effect, Mr Sagi is using his muscle to push through this low ball offer at the expense of Netplay’s other shareholders. He is likely to succeed as institutional investor Henderson Global Investors, which has a 9.46 per cent stake, has indicated it will back the takeover. Not surprising the board is happy to cede away their combined 1.95 per cent shareholdings, so Betsson only needs a further 36 per cent of shareholders to accept for the scheme of arrangement to become effective. That’s likely, but it still doesn’t make the offer palatable.

I have more than a passing interest here as I originally advised buying Netplay shares at 12.5p (‘A share set to hit the jackpot’, 11 February 2013), and although the share price subsequently doubled in value, the uncertainty over the UK government’s new gaming Point Of Consumption tax meant it had fallen to 8.5p when I included the shares in my 2015 Bargain share portfolio. The prospect of hefty dividends was a key reason for doing so: Netplay’s board has paid out total dividends of 1.79p a share in the past two years, and 2.73p a share in the past four years. However, shareholders are now being denied a final dividend for the 2016 financial year (0.34p a share in 2015) even though they have held their shares for the whole of that 12-month trading period. This is a pretty shocking state of affairs and Betsson needs to up its derisory offer before I can possibly recommend accepting.

Riding all-time highs

It’s fair to say that investors have warmed to December’s placing by AB Dynamics (ADBP:600p), a UK designer, manufacturer and supplier of advanced testing systems and measurement products to the global automotive industry. The shares have rallied 22 per cent to another record high since my last update (‘Targeting record highs’, 21 November 2016).

The proceeds from the £5.4m fundraising will be used to accelerate existing development programmes and projects for new products, including simulator development, new specialised lab and track testing equipment and virtual vehicle testing; invest in technical and commercial centres in Japan, Korea, Germany and the US in order to provide greater control over routes to market and facilitate deeper relationships with customers; and fund additional facilities. In particular, the company has purchased land adjacent to its new manufacturing facility to build a 20,000 sq ft factory dedicated to its simulator business. The building, which will cost £2.2m, will now be operational in mid-2018, some 18 months earlier than expected.

It’s clearly a sensible use of the funds and there is no doubt that AB Dynamics is operating in a high growth segment of the automotive industry: in the five years to 31 August 2016, the company’s reported revenue and operating profit increased at a compound annual rate of 23.1 and 24.9 per cent respectively. However, having risen 247 per cent since I included the shares at 172p in my 2015 Bargain Shares Portfolio, they are now rated on 24 times cash-adjusted earnings estimates for the financial year to end August 2017. That’s hardly a bargain rating. But with the risk to conservative looking earnings forecasts skewed to the upside, on balance I would run your healthy profits and place a trailing 10 per cent stop loss on your holdings to protect your bumper paper gains.

MORE FROM SIMON THOMPSON...

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