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Persimmon primed for margin squeeze

The housebuilder is facing rising build costs as it tries to improve the quality of its homes as well as weakening sales
May 9, 2019

Persimmon’s (PSN) efforts to improve the quality of its buildings and accuracy of moving-in times have started to hinder forward sales growth. And while the government’s Help to Buy scheme has helped turbocharge the housebuilder’s profit growth over recent years, plans to review contracts for the equity loan scheme could further dampen sales. Yet despite trading risks and the possibility that returns have already gone beyond their cyclical peak, the shares are trading well above their long-term average valuation.

IC TIP: Sell at 2190p
Tip style
Sell
Risk rating
High
Timescale
Long Term
Bull points

Fat dividend yield

High operating margins 

Bear points

Forward sales slowing

Shares trade at a premium to book value

Help to Buy restrictions

Cost inflation

Recently, Persimmon has faced criticism over its construction quality and the accuracy of customer moving-in times. It was awarded the lowest score of all major housebuilders in the latest Home Builders Federation new homes survey at three out of five stars. To address these issues, Persimmon plans to sell homes much closer to the date at which they are completed. However, in the first four months of the year that meant the number of active sales outlets was 350, behind the 375 during the same time in the prior year, and the weekly private sales rate per site was 5 per cent lower. As a result, forward sales of £2.7bn during the first four months of the year was £100m behind the same period in 2018. Legal completions during the first half of the year are expected to be flat on 2018.   

As sales growth slows, build-cost inflation is picking up and is expected to come in at 4 per cent. "Build and other direct costs" is by far the biggest reason why overall cost of sales totalled 52 per cent of 2018 revenues, compared with 14.6 per cent for land costs. Further efforts to improve quality and customer service could add to upward pressure on operating costs. Management has already unveiled plans to invest in staff training and in technology at the end of last year, with the aim of improving communication between regional offices, customer care departments and customers. What’s more, in March the group also announced a new policy of allowing buyers to retain 1.5 per cent of the home value – equating to around 6 per cent of the build fabric costs or £3,600 – until any faults identified at the point of key release are resolved.

The rise in build costs looks set to outpace average sale price (ASP) growth since the start of the year, which was up just 0.6 per cent on the year at £237,850 at the start of May. A similar slowdown was seen in house price growth across the UK. All this suggests margins may have hit their cyclical (and all-time) peak following an increase from 28.2 per cent to 30.8 per cent  last year.  Brokers are already forecasting a margin decline.

The government’s decision to tighten the criteria for help-to-buy eligibility may also impede Persimmon, with almost half of its customers using the scheme last year. While the deadline for the scheme’s operation was extended by the chancellor to 2023 in last year’s Autumn Budget, only first-time buyers will be eligible for the equity loan scheme from 2021. What’s more, the Ministry of Housing, Communities and Local Government has said it plans to assess developer performance when awarding contracts.   

PERSIMMON (PSN)    
ORD PRICE:2,190pMARKET VALUE:£6.98bn
TOUCH:2,189-2,190p12-MONTH HIGH:2,913pLOW: 1,826p
FORWARD DIVIDEND YIELD:10.7%FORWARD PE RATIO:8
NET ASSET VALUE:1,006pNET CASH:£1.05bn
Year to 31 DecTurnover (£bn)Pre-tax profit (£bn)*Earnings per share (p)*Dividend per share (p)
20163.140.78206110
20173.420.98259135
20183.551.10286235
2019*3.611.11287235
2020*3.671.10289235
% change+2-1+1 
Normal market size:1,000   
     
Beta:0.81   
*Peel Hunt forecasts, adjusted PTP and EPS figures