Builders' merchants to keep 'spiralling' next year

The 11-year bull run in the UK’s housing market is formally over, according to new Land Registry data, which should have come as little surprise to anyone. Yet while housebuilders have endured a difficult 12 months, the building materials and merchant companies are about to enter their third successive year of tough trading.

The slump began in the back half of 2021, as soaring materials costs bit into demand, causing the unravelling of the pandemic-induced DIY boom. This time 12 months ago, many thought that by now the situation would be looking up, particularly as they were facing easier comparative periods, said Flor O’Donoghue, an analyst at stockbroker Davy.

“But that hasn’t been the case at all... the outlook is pretty bleak.”

Last month, the Construction Products Association said it no longer expects the sector to recover next year. After several successive quarterly downgrades, it now forecasts a 0.3 per cent contraction next year, on the back of a 6.8 per cent shrinkage this year.

The continued decline in new housing starts – which were 25 per cent lower year on year in the three months to October, according to data provider Glenigan – as well as a lack of appetite for major DIY projects while mortgage costs remain high are the two biggest drags on the industry. "The November Index shows the sector is continuing to spiral downwards," the latest Glenigan report said. 

The market for non-residential work also remains tough. New office projects are down 39 per cent year on year, while starts on new hotel and leisure schemes have dropped by two-thirds, Glenigan found.

Disappointingly, the boom in infrastructure work expected as a result of the government’s commitment to spend £650bn during the lifespan of the current parliament isn’t translating into sustained growth, either.

There has been a flurry of activity on major projects such as HS2’s first phase, Thames Tideway and Hinkley Point C, but many of these have hit peak activity, and rising costs have caused viability concerns around newer schemes, leading to project delays. The CPA is forecasting a 0.5 per cent decline in infrastructure activity this year and a 0.1 per cent slowdown in 2024, “to take account of government announcements of pauses and delays to roads and rail projects”, economics director Noble Francis said.

HS2’s second phase is the highest-profile casualty, but around 30 road schemes initially planned for the next five-year Road Investment Strategy starting in 2025 have also been kicked into the long grass, he added.

Bricking it

The slowdown has affected listed building materials and merchants businesses in different ways, but brick makers such as Forterra (FORT) and Ibstock (IBST) have been among the hardest hit, witnessing share price declines of 55 per cent and 44 per cent, respectively, on their 2021 peaks.

“Those businesses, by their very nature, have to run a very high level of fixed cost,” O’Donoghue said.

Each one had embarked on major capacity expansions with a view to soaking up more of the demand for imported bricks (which stood at around 500mn last year). However, brick demand has plunged by around a third, and despatches are currently “running below the levels seen in 2009”, Forterra said last month. Both have now taken action to curtail capacity, such as mothballing older sites. Marshalls, whose share price is 73 per cent lower than its 2021 peak following an ill-timed acquisition, has also had to restructure.

Although the builders’ merchants don’t have under-utilised manufacturing plants to worry about, they still carry “quite a lot of fixed costs” in terms of the depots they run and the stock levels they need to hold, said Aynsley Lammin, an analyst at Investec. They can’t afford to lose too many branch staff without affecting service levels, so if they want to make significant cuts it involves closing branches. “And I’m not sure that’s on the agenda yet,” he said. “Unless they really expect a leg down in terms of activity that will be sustained through to 2025 I wouldn’t expect any big, structural cuts”.

Moreover, although he thinks that “it’s still too early to call the bottom” of this market, given that more consumers are rolling off fixed-rate mortgages and will therefore have less disposable income, there could be a recovery in the second half. UBS analysts predict that the Bank of England will be the first of the central banks to cut interest rates, starting with 25 basis points in May and repeating this over the next two quarters. This would certainly be a fillip for housing starts, although Lammin thinks any increase in investment in the second half is likely to be “tentative”, with many decisions likely to remain on hold until after a general election.

Improved inflation data, which raised hopes of earlier cuts, was behind a 4 per cent rally in building materials and merchants' stocks last week, according to Peel Hunt, and there were signs of life elsewhere. Distributors Grafton (GFTU) and Norcros (NXR) reiterated full-year guidance after putting in “resilient” performances, and Genuit (GEN) upgraded its full-year profit expectations, although admittedly this was more to do with cost savings than recovery.

And although kitchen maker Howden Joinery (HWDN) said earlier this month that full-year earnings will be “at the lower end” of guidance, its like-for-like sales are still 30 per cent higher than pre-pandemic levels. Its shares are up 23 per cent this year.

Although it sells a discretionary product, Howden’s business model has held up well, allowing it to “trade through weaker markets”, O’Donoghue said.

However, in terms of a recovery play, he favours the two big brickmakers given the operational leverage benefits they will enjoy from a recovery in sales.

Earnings downgrades mean that neither currently looks like a bargain on a price/earnings basis, but “in theory, they should have bounce-back capability on the basis that they've fallen the most,” he said.