Vistry looks like a house market bargain

By the end of last week, Bellway (BWY) was down 31 per cent, Taylor Wimpey's (TW) shares had dropped by 26 per cent, Redrow’s (RDW) by 25 per cent, Vistry’s (VTY) by 24 per cent and Persimmon’s (PSN) by 23 per cent.

There are several reasons for this. One has been the government’s strong-arming of companies in the sector to pledge billions of pounds to replace potentially flammable cladding on old apartment blocks, with a threat to lock those who don’t toe the line out of the planning system.

Another has been the health of the housing market, with fears that the Bank of England’s attempts to fight inflation with higher interest rates will turn slowing house price growth into a full-on slump.

On top of this, there’s cost inflation. Building materials prices rose by a fifth in the year to May and 74 per cent of builders responding to the Construction Products Association’s latest trade survey said growth was being constrained by labour shortages, which is pushing up wages.

Despite this, there’s evidence that the gloom has been overdone. The most obvious is Inclusive Capital’s £1.5bn swoop for Countryside Partnerships (CSP). The US-based activist went public with its approach on 30 May – made at a 31 per cent premium to Countryside’s then market price – after twice being rebuffed by the board. Since then, the housebuilder’s biggest shareholder has thrown its support behind a sale process, helping to further lift share prices sector wide.

Inclusive is the second activist to target a UK housebuilder in recent months, after Elliott Advisors launched a campaign for changes at Taylor Wimpey last December.

Bargain basement builders

After a punishing run, UK housebuilders look overly cheap – especially to US buyers benefiting from an additional sterling discount given the pound’s 7 per cent year-to-date slide against the dollar.

The sell-off now looks overdone. Investment bank Jefferies said in a note on 23 May that current sector valuations imply a nine percentage point drop in next year’s return on equity. Barring any impairments, this would equate to a 65 to 80 per cent hit to earnings per share, or a 5 per cent drop in sales volumes accompanied by a 10 per cent fall in average selling prices.

This seems unlikely given the country’s ongoing supply-demand imbalance. And although strong cases could be put forward for buying several listed housebuilders, Vistry seems particularly well positioned.

The company changed its name from Bovis Homes in January 2020 after buying Galliford Try’s housebuilding arm, Linden Homes, and its partnerships division for £1.1bn. The fact that £675mn of this was paid for via the issue of new shares meant Vistry entered the pandemic without too much debt. Indeed, despite managing fewer completions than expected in 2020 when Covid-19 hit, the group been throwing off enough cash to pay down borrowings, and finished 2021 with net cash above £200mn.

The deal made Vistry one of the top five UK housebuilders and it is already well on its way towards achieving five-year targets set out at the time.

The housebuilding arm, which generated 69 per cent of last year’s revenue, had a goal to build 8,000 units by 2025 and earn both a gross margin and return on capital employed of 25 per cent. Last year, house completions jumped by 41 per cent to 6,551 units, as the average selling price edged up £2,000 to £305,000. The unit’s gross margin grew by 4.7 percentage points to 22.3 per cent and its ROCE was 22.2 per cent.

The partnerships business acquired in 2020 offers another string to its bow, though. This arm works with local governments, housing associations and other social housing providers to develop mixed-tenure schemes, as well as building projects outright for specialist build-to-rent investors.

As a result, it should be less prone to market cycles and enjoy a much higher return on capital – beating its 40 per cent medium-term target last year – as it doesn’t have to tie up as much funding in securing plots.

Partnerships currently has about 100 schemes in the pipeline – 33 of which were on site last year. A greater focus on mixed tenure schemes helped to push the division’s operating margin up from 6.7 to 9.2 per cent – just below its 2022 target of 10 per cent.

Rate rise reticence

Vistry is facing the same headwinds as other housebuilders, including the prospect of demand being dampened by higher interest rates. Capital Economics expects continued gradual rises this year, and for the UK base rate to peak at 3 per cent next year.

This will have a “cooling impact” on housing market growth if this translates to higher mortgage rates, Nationwide’s chief economist Robert Gardner said last week. The building society reported a slight slowdown in house price growth in May, but it remained at double-digit levels – up 11.2 per cent year on year. This year, Pantheon Macroeconomics expects the twin effects of rising mortgage costs and cooling consumer confidence will push house price growth down to 5 per cent this year.

For many would-be homebuyers, affordability is an increasing concern. Office for National Statistics data published in March showed house prices in England reached a new high of more than nine times workplace-based earnings in England last year, double the level recorded 20 years earlier. The ratio in London stood at 13 times.

Vistry’s focus outside the capital helps in this regard. So does its emphasis on affordable housing development. Affordable homes made up 25 per cent of completions in Vistry’s housebuilding arm last year and it was the only listed developer appointed to Homes England’s 2021-26 Affordable Homes programme, securing an £83mn grant to deliver 1,474 properties.

Besides, even if demand softens, few forecasters are predicting house price falls given the tightness of supply. Although the number of new homes completed last year rose by 19 per cent to 175,390, this remains well below a target of 300,000 new homes the government has set to meet supply.

The stock of new homes on the market for sale dipped to a new low of 31,000 in April, 24 per cent below the same month last year and more than 40 per cent below pre-pandemic levels, broker Goodbody said in a recent note.

Vistry removed uncertainty by signing up to the developer pledge created by Gove’s department, through which it agreed “to address life-critical fire safety issues” on any buildings above 11m it had built in the preceding 30 years. The company estimates this will cost an extra £35mn to £50mn on top of the £25.2mn of provisions it had already made – plus up to £3mn to its administrative costs. Relative to cash on hand and forecast profits, this looks easily digestible.

Pricing power persists

Ditto inflationary pressures. Build cost inflation, currently running at about 6 per cent, “is being more than offset by price increases”, said chief executive Greg Fitzgerald in an upbeat trading update last month. Adjusted profit for 2022 is expected be “at the top end” of market expectations, which at the time stood at around £415mn.

House broker Peel Hunt forecasts earnings per share will grow 17 per cent to 145p. That puts the shares on 6.3 times earnings – below both peers and a five-year average multiple of 9.1. And while a two-times dividend cover policy means only half of net profits are likely to be distributed, excess cash is being returned in the shape of buybacks.

This seems especially smart, given Vistry trades at a near-20 per cent discount to its 2021 year-end net asset value of £2.39bn. The strength of current trading, and supportive structural factors, both suggest the market is overly pessimistic. For those with faith in its long-term prospects, the shares offer a rare opportunity to pick up a bargain in the housing market.