Bellway (BWY) is the first company I look at in this week's round-up. Alpha subscribers can also read my analysis of Tristel (TSTL) and WH Smith (SMWH) here.
With one or two notable exceptions (Bovis and Crest Nicholson), the past five years have been very kind to housebuilding companies and their shareholders. Robust demand for homes, complemented by taxpayer subsidised mortgages in the form of the Help to Buy scheme, have seen more new homes sold for higher selling prices on land that was purchased at very attractive prices.
This is what happens in a rising housing market, but the current market is arguably different to any that has preceded it due to the availability of subsidised mortgages and therefore subsidised demand. You can see from the chart (below) that house prices in the UK were very subdued before Help to Buy was introduced in April 2013. It was removed from existing homes in December 2016, but remains for new build homes and is due to end in 2021.
The profitability of house builders has increased substantially since Help to Buy was introduced and for many companies this is now close to previous cyclical peaks. This has allowed shareholders to benefit from rising share prices and bumper dividend payments.
One of the chief criticisms of Help to Buy is that it has pushed up prices – it definitely has in my opinion – but has not seen enough new homes built. To be fair toBellway (BWY), it sold 10,307 homes last year which was an increase of 6.9 per cent on the year before. A 9.3 per cent rise in private average selling prices helped overall revenues increase by 15.6 per cent and operating profits by 14.2 per cent. The operating margin remained high – just below last year’s margin – at 22.1 per cent.
Despite these good results, Bellway shares have fallen by 20 per cent during 2018 as many investors question whether life is as good as it gets for builders. There are certainly grounds for thinking that it is.
Looking at profitability as measured by ROCE, Bellway is making as much money now as it was during the past housing market peaks in the early 1990s and mid 2000s.
For the past few years, builders have benefited from the selling prices of their homes increasing faster than new build costs. This may be coming to an end as build costs, in terms of materials and skilled labour, are increasing.
Help to Buy has become a very sensitive subject for the building companies. There are plenty of people – including me – who think that this has created a profits windfall for them. This is evidenced by increasing new build selling price premiums over equivalent local housing (I am seeing plenty of examples of this in Essex where I live).
But why is this happening?
My view is based on the fact that lenders are only lending 75 per cent (55 per cent in London) of the home’s selling price under Help to Buy. This means that they are less exposed to losing money if the home subsequently falls in value. Because of this reduced risk, the lender is less likely to down-value a home for mortgage purposes and this allows homes sold under the scheme to sell for more than an equivalent existing home. This premium is ending up in the builder’s pockets in the form of higher profits and margins.
Whilst bigger and higher quality homes can increase a builder’s average selling price, I am not totally convinced this explains the current rate of average selling price increases being reported by housebuilders. According to the ONS, UK house prices increased by 3.2 per cent in the year to August 2018. Bellway’s average selling price increased by 9.3 per cent – considerably more than perhaps can be explained by mix changes?
I have no doubt that the building companies would vigorously dispute they have earned windfall profits. Yet there is no shortage of 95 per cent loan-to-value mortgages available which does question why Help to Buy still exists. I asked David O’Leary, the policy director of the Home Builders Federation – a big supporter of Help to Buy – on Twitter a few weeks ago whether lenders were lending 95 per cent of a new build’s value. I did not receive a reply.
There is growing media interest in the scheme as well. A newspaper report in The Times last week highlighted that homes bought via Help to Buy cost more than one through a normal mortgage. The other key point to bear in mind is that the second buyer of a new build home will not be able to get a Help to Buy mortgage. It would be interesting to know what a lender of a 95 per cent mortgage would value the property at.
Help to Buy is so important to the future profitability of building companies because they have become so reliant on it to sell large chunks of their homes.
As much as 39 per cent of Bellway’s homes sold last year were through the scheme. Unsurprisingly, there are signs of nervousness amongst builders that the scheme will end in 2021 and will not be extended, and lobbying has begun to make sure that it is. If it does end, then it is by no means certain that current rates of profitability could be achieved.
If these concerns are groundless and the new build market holds up, then Bellway looks to be reasonably well placed. It is buying land at attractive prices (gross margins of 24 per cent based on current selling prices and costs) and has the scope to keep on increasing its annual build rate to as high as 13,000 homes. Build cost inflation is being kept in check by more standardised designs.
However, analysts’ forecasts for Bellway don’t look overly aggressive given the expectation that it will build more homes in 2018/19 and has a decent forward order book, but profit growth is expected to moderate.
The valuation of its shares as measured by price to net asset value (NAV) has fallen back this year and unlike profitability is not at a peak. This suggests that a downturn in profitability is being priced into the shares.
Over the last year or so, I’ve increasingly seen the housebuilding sector as an income play rather than one where large capital gains can be made – subject to the caveat that the housing market does not see a substantial fall in selling prices. Bellway is not the highest yielder in the sector – as it is not paying special dividends – but its dividend per share is currently covered three times by profits which suggests that it is both safe and has room to keep on growing.
Alpha subscribers can read the rest of this week's report, with analysis on Tristel and WH Smith, here.
