Berkeley's premium is tough to justify

On the morning of Berkeley Group’s (BKG) results release there was a lot of other news to take on board. Core UK inflation hit a fresh 30-year high; the two-year gilt yield reached 5.1 per cent, the highest level since 2008; national debt hit 100 per cent of GDP for the first time in over six decades; and annual house price growth slowed to a pace not seen since September 2020 when Covid-19 restrictions dragged on the market.

Berkeley was among the worst performers in the FTSE 100 alongside fellow housebuilders and real-estate investment trusts whose shares fell by 2 per cent to 4 per cent. The prospect of higher interest rates is weighing on the sector, and the news from Berkeley’s own results was mixed at best.

Starting with the good news: the increase in pre-tax profits beat consensus forecasts while revenue and operating profit also ticked up. Like most housebuilders, Berkeley is sitting on net cash, though its £405mn is particularly comfy and much more than last year when it had £263mn in its coffers. This is prudent when interest rates are likely to remain high over the coming months; investors now expect the Bank of England base rate will peak at 6 per cent.

Higher rates mean that the housing market slump could drag on for longer than first predicted. Berkeley said there was a “lack of urgency” in the market and forecast that sales would drop by a fifth over the reporting year. Combined with rising construction costs, this could further reduce its operating margin, which fell 103 basis points to 20.3 per cent.

Dividends returned this year, though they remain 21.8 per cent below 2021 and 23.8 per cent below 2019. The issue is not earnings, as the dividends are well covered. Modest distributions are likely an indication of low confidence in the coming months, which is to be expected in this market but not great news for income-seekers.

Given this, it is hard to justify the company’s 20 per cent premium to net asset value, especially with many peers now trading on discounts - notwithstanding Berkeley's focus on wealthier buyers. On a price/earnings ratio, the shares look better value, though the predicted drop in earnings makes them less so. Therefore, at this price, we downgrade our rating. Sell.

Last IC View: Hold, 3,593p, 22 Jun 2022