Play the house builder recovery with Bellway

The UK housing market arguably faces greater uncertainty than it has done since the 2008 financial crisis. For major housebuilders such as Bellway (BWY), bruised by the slump in completions during the spring lockdown, that has called the pace of recovery into question. 

The chancellor’s stamp duty break announced in July has accelerated transaction volumes that were already benefiting from an element of pent-up demand, helping push up average sales prices. UK house prices recorded their largest annual growth in more than five years in October, according to the Nationwide House Price Index, at 5.8 per cent. In defiance of industry predictions made during the spring lockdown, house prices this year are forecast to grow, with real estate services group Savills (SVS) and online sales portal Zoopla expecting a 4 per cent rise in prices. 

Yet storm clouds could be gathering. The scheduled deadline for the stamp duty holiday at the end of March is expected to result in a natural easing of the growth in transaction volumes next year. Jones Lang LaSalle forecasts that the level of housing transactions next year will be flat on 2020, which at 1m is below pre-pandemic predictions of between 1.2m and 1.3m. What’s more, a further rise in unemployment and the impact of wage growth pressure on housing affordability is forecast to drive a 1.5 per cent decline in average sales prices in 2021, according to the real estate services group, before returning to growth in 2022. 

It is therefore unsurprising that shares in the housebuilding sector are trading some way below pre-pandemic levels on a price/book value (P/BV) basis. Mid-cap housebuilder Bellway, whose shares trade at an undemanding 1.1 times forecast consensus book value versus a sector average multiple of 1.6, is particularly eye-catching in this regard. Alongside resilient margins, a strong recovery in cash balances and a speedy return to dividend payments, there is reason to believe the market may be overly pessimistic in its judgment of Bellway. 

Stage set for recovery

The closure of construction and sales sites during the spring lockdown naturally dealt a blow to completions, which fell by almost a third during the year to the end of July. Bellway also incurred Covid-19-related expenses of £26m, relating to unproductive construction sites and aborted land deals, which drove pre-tax profits down almosttwo-thirds during the 2020 financial year. There was a further £47m related to post-Grenfell safety measures.

Longer times spent on site and the cost of implementing more rigorous health and safety measures are expected to continue to impact margins. However, productivity levels have gradually improved, and at the end of October were between 85 and 90 per cent of 2019 levels. No further construction sites were closed during the second English lockdown. 

Progress on boosting construction capacity has come at the same time the housebuilding industry has enjoyed a surge in demand, starting during the summer months. Like peers, Bellway has reported a sharp uplift in activity since July, with the forward order book up two-fifths against the comparative point last year and average weekly sales rising 31 per cent during the nine weeks to 29 September. 

Prior to the latest lockdown, that had given management the confidence to reinstate guidance for 2021 of around 9,000 completions, at an expected average selling price of approximately £290,000. That is against completions of just over 7,500 at an average sales price of £293,000 in 2020. Following some recent small upgrades, consensus forecast are for earnings per share to rebound by 33 per cent this year.  

Help-to-buy headwinds

The scaling back of the help-to-buy scheme will prove a challenge for the UK’s volume housebuilders. Customers using the scheme accounted for 35 per cent of Bellway’s sales last year, although that was a lower proportion than peers Persimmon (PSN), Taylor Wimpey (TW.) and Redrow (RDW). Management has already said that aligning output with regional price caps will result in “modest” price deflation after 2021. That could also be exacerbated by a further shift away from building in London, which accounted for 6 per cent of completions last year compared with 9 per  cent in 2019. The consensus forecast among analysts is for an average sales price of £284,000 during the year to July 2022.  

In an attempt to offset some pressure on sales rates that would result from the restrictions to the scheme, management has adjusted its land buying approach. During the last financial year it exchanged contracts to acquire just under 12,000 plots, with an expected average selling price of £280,000 in the hope that future sales outlets will offer customers an affordable product, with less reliance on the Help to Buy scheme. 

It is also worth noting that according to a report released by the National Audit Office last year, three-fifths of those using the scheme between 2015 and 2017 would have been able to afford a property without the support of Help to Buy, while 31 percent could have afforded the home they wanted. 

Like most housebuilders, Bellway’s balance sheet was in a much healthier position entering this recession than in 2008, when it had net debt of £238m or gearing (net debt as a percentage of net assets) of 24 per cent. Unsurprisingly, lockdown resulted in a substantial reduction in cash balances, which fell to just £1.4m at the end of July, from £201m in 2019. That put total gearing at 11 per cent after accounting for land creditors (money outstanding on land purchases to be paid when agreed milestones are met). However, since then cash balances have improved to a net £61.2m at the start of October and the position is forecast to increase further to £68m and £235m by the end of the 2021 and 2022 financial years, respectively. 

The recovery in completions, combined with a sturdy balance sheet, also prompted management to reintroduce the dividend, recommending a final payment of 50p a share. That has made it the only volume housebuilder to pay a dividend over 11 consecutive years. The consensus forecast is for an aggregate dividend of 96p a share this year, rising to 115p in 2022, giving the shares a prospective dividend yield north of 4 per cent.  

Bellway has delivered operating margins and a return on equity of around 20 per cent during the five years to 2019. In 2020, it managed a return on equity of 8.4 per cent – above mid-cap peers Barratt Developments (BDEV) and Redrow – and a respectable operating margin of 14.6 per cent. That track record of maintaining a decent margin even in the face of severe pressure on completions could help it to withstand headwinds from the end of the stamp duty break and tighter Help to Buy rules. 

There are undoubtedly myriad factors that could challenge demand for the UK’s housebuilders, including rising unemployment and potentially tighter restrictions in mortgage availability to name just two. Yet if Bellway can achieve the earnings growth forecast by analysts, there is the potential for the shares to re-rate in acknowledgement of post-pandemic recovery progress. 

Last IC view: Hold, 2,577p, 20 Oct 2020