FTSE 350: Housebuilders still look cheap

Arguably, the sector’s price-to-book multiples suggest an even greater opportunity. Only Persimmon (PSN) and Berkeley (BKG) trade at anything like a premium to net assets. Most are only valued at carrying value – or as analysts at Jefferies recently put it, “close to or below liquidation values”. All this from a cohort whose average return on equity exceeds 15 per cent and which has paid out dividends equal to 30 per cent of its combined current market capitalisation in the past half decade.

Of course, what lies ahead won’t look like the last five years. To many investors, near-term forecasts are either far too rosy or mask plenty of pain coming down the road.

The biggest source of pain remains the ultimate price of a settlement around the vexed issue of fire safety. While recent figures contained detailed costings on the likely bills, these were topped up – and in some cases multiplied – after the companies in question signed an industry pledge to remedy fire safety issues across the sector’s historic high-rise developments. Overnight, Barratt (BDEV) upped its provision by as much as £400mn, Bellway (BWY) added £300mn to its previous estimate of £186.8mn, and Redrow (RDW) hiked its liability from £36mn to £200mn. Crest Nicholson (CRST), having recorded £47.8mn in charges since 2019, expects further charges of between £80mn and £120mn.

These provisions, though widely anticipated and manageable given the sector’s large cash buffers, hit the investment case in two ways. First, they constrict appetite and available capital to boost construction, thereby reducing the benefit of any operational gearing in an inflationary environment. Second, more cash will now be diverted away from dividends, thereby damaging a key plank in the sector’s investment case. No wonder share prices failed to react as if the bad news was now all priced in.

Amid the gloom, trends continue to move in the sector’s favour. For one, while the conversation around housing has understandably continued to focus on selling prices, people have become less fussy about newbuild properties since Covid-19 hit.

According to a survey by FJP Investment, 26 per cent of homeowners are more likely to consider buying a new build compared to before the pandemic. Two-thirds of those aged between 18 and 34 were also found to be open to a newly built home. Part of this is undoubtedly related to the rush for greater space on the outskirts of cities and towns. But at a time when increasing numbers of young people are locked out of the property market, any rung on the ladder is better than none.

Herein lies the key dichotomy the sector. One of the key reasons UK house prices march ever higher is due to a supply-demand imbalance that will likely persist even as interest rates rise.

Until a sclerotic planning system is made fit-for-purpose, the government’s ability to meet demand rests largely on the shoulders of the housebuilders and their enormously valuable land banks. And while there can be no denying the heightened political risk and uncertainty around the cladding issue, neither should the sector’s defensive qualities and asset bases be overlooked.

Accordingly, reinvestment in the pipeline should probably replace dividends as investors’ core focus. This month’s introduction of the so-called residential property developer tax, which amounts to 4 per cent of pre-tax profit and sits on top of fire safety provisions, may well incentivise capital expenditure. Perhaps the grounds are even readying for M&A.