A housebuilder whose dividends aren’t on the line

This picture will eventually change when the market recovers, a prospect that some investors are already starting to anticipate. Last week, shares in UK property developers and investors careered higher after lower-than-expected inflation data gave hope that rising mortgage costs could soon peak, and clarity might soon return. So is now a time to turn bullish on the sector? On balance, we think not, and remain bearish on several of its leading names. However, and without predicting a sudden upturn in events, we now think it is possible to view Taylor Wimpey in a more charitable light.

When it reports half-year numbers next Thursday, investors are braced for adjusted earnings to be down on the 9p per share figure recorded in the first six months of 2022. But while trading in 2023 is likely to have been tough, the increase in its dividend in March implies confidence in the future, and it has yet to contradict that with further updates. A better handle on costs than its peers, alongside deep cash reserves, a large land bank and a development pipeline that looks better suited to a housing recovery than some peers all provide reason for modest encouragement.

That cash pile is particularly important. While Taylor Wimpey trades on a higher price/earnings multiple than most of its peers, if you strip out net cash – which stood at £837mn at the end of 2022 – then the valuation suddenly appears much cheaper. And yet having a larger relative cash pile right now feels like a positive attribute. Not only does it provide downside protection and a source of serious interest income at a time of deep uncertainty, but it gives management considerable flexibility – which is critical to such a capital-hungry line of business as property development.

A strong cash buffer has also allowed the company to maintain a high level of dividend payment. Indeed, despite boasting the highest trailing yield in the sector, the market still expects 8 per cent for 2024.

This stems from a policy to distribute 7.5 per cent of net assets, which is largely comprised of a hefty and liquid land bank, ongoing developments, receivables and cash, less liabilities (largely comprising payables). Despite a small dip in the first half of 2022, shareholder equity has been on an upward trajectory since mid-2019, when net assets stood at £3.01bn. Analysts now expect that figure to sit at £4.49bn at the end of 2023, a decline of just 0.4 per cent on the 2022 full-year figure.

In practice, this means that in good times, shareholders can expect a payout from an increase in cash or earnings. And if earnings are hit by a slumping market, shareholders still benefit from a payout anchored by around £6bn in inventories and cash.

This holding pattern, while a source of resilience in the current trading environment, nonetheless leaves open the possibility that future dividend payments won’t be covered by earnings. Consensus forecasts for dividends per share of 9.37p and 9.28p this year and next, when seen against projected earnings of 8.67p and 9.35p, suggest that this tightrope is already being walked. The shares’ 10 per cent discount to book value suggests the market may already have its doubts.

Regardless of the wisdom of the dividend policy, the scale of Taylor Wimpey’s net assets remains a source of strength at a tricky moment. Analysts at Investec have assigned a 75 per cent chance of an “ugly” scenario for the housing market in which higher interest rates have a pronounced impact on those developers and land creditors with greater leverage. By contrast, Investec believes firms such as the asset-rich Taylor Wimpey can ride out this downturn while still paying investors. These features, along with a decent handle on working capital, help to explain why the company boasts better free cash flow as a percentage of turnover, relative to its peers – a position it is projected to maintain this year and next.

Naturally, sales prices are a concern. But while margins are likely to face serious pressure, the pain may not be as great as peers. In March, Taylor Wimpey said its forward sales were down a quarter, compared with a fall of 31 per cent for Persimmon (PSN). Given both housebuilders relied on Help to Buy for around a fifth of sales, the smaller hit to the former suggests it has done a better job of moving on from the scheme, which ended in March.

One source of help could be its business in Spain, which primarily sells second homes to international buyers. While the division accounts for less than 4 per cent of operating profit, it is growing and delivered an operating margin of 26.2 per cent in 2022, compared with 20.9 per cent for the broader group. A less price-sensitive customer base, alongside more manageable inflation, suggests Taylor Wimpey could do worse than expand this canny point of differentiation.

Another way in which Taylor Wimpey is unlike several of its competitors is a relative lack of post-Grenfell fire safety costs. Having initially committed £165mn for cladding remediation costs, it booked a further £80mn last April when it signed the Government’s Building Safety Pledge for Developers. The figure of £245mn – relatively unchanged, largely already digested and clearly accounted – remains the company’s best estimate of the costs required to bring its legacy buildings up to fire safety standards. It also stands in contrast to other housebuilders such as Barratt Developments (BDEV), which in 2023 will pay to fix fire safety costs for the sixth consecutive year.

Yet, as much as there are ways in which Taylor Wimpey is different from other housebuilders, it remains subject to the same market forces. If the market does turn “ugly” as Investec predicts it will, no firm in the sector would be shielded from falling demand. Being the best of a bad bunch doesn’t make you good.

Even if market conditions improve, politics might prove an obstacle. Housing may well come to define the next election, as Labour reportedly builds its as-yet unwritten manifesto around the issue and the Conservatives mounts its own response. Of particular note is Labour’s pledge to tackle land banking, which threatens to turn one of Taylor Wimpey’s biggest assets into more of a liability.

Quantifying this risk isn’t easy. Labour might not win, its land bank policy might not happen, and even if it does, Taylor Wimpey could respond by expediting its development pipeline. In another scenario, the Conservatives win and reintroduce Help to Buy, propping up sales. Or they do so before the next election. It is, in short, impossible to predict how politics might hurt Taylor Wimpey, and we shouldn’t forget that politicians and voters want more houses built. Whatever happens, it’s a reasonable bet that the shares will do better than their peers.