Is there value in housebuilder shares?

The UK’s housebuilders are riding the wave of demand that has ensued as buyers seek to take advantage of the stamp duty holiday and the current help-to-buy scheme ahead of the 31 March deadline. 

Persimmon (PSN) revealed that the average weekly private sales rate per site was 38 per cent higher than the prior year during the four months to November, meaning completions for the second half would be at least in line with the same period in 2019. A rise in net cash balances to £960m prompted management to recommend a second interim dividend of 70p a share, which together with September's 40p payment, amounts to the same level as the 2019 final return that was suspended upon the outbreak of the virus.    

That followed Taylor Wimpey's (TW.) announcement that operating profits for 2020 would be at the upper-end of the £242m-£292m guidance range and materially ahead of the £626m top end of consensus for 2021. Meanwhile Redrow (RDW) said the value of private reservations in the 18 weeks to October were up 5 per cent at £630m, while the order book was 10 per cent ahead at a record £1.5bn.   

Yet while government stimulus has helped salve the wounds caused by the first lockdown, the market is still cautious around the sector's prospects next year. With the exception of Persimmon and Barratt Developments (BDEV), shares in the sector have failed to regain much of the ground lost since March and trade at material discounts to their five-year averages, on a price/book value basis. That is despite the rally in the shares that greeted news of a 90 per cent effective Covid-19 vaccine from Pfizer and BioNTech. 

Despite the post-lockdown bounce, completions in 2020 are still likely to be below the prior year after the government effectively put the housing market into deep freeze for almost two months. For those that have already reported figures for the 2020 financial year, that translated into lower sales volumes and earnings. An extension of the November lockdown and/or further such measures next year are still possible. And while most UK-listed groups will be keeping sales and construction sites open during England’s November lockdown, few are yet to reach full construction capacity.

While the furlough scheme has been extended until March, the spectre of rising unemployment, combined with the end of stamp duty relief, also threatens to sap demand and sales prices next year. Falling prices are bad news for housebuilders, both because operating margins are eroded, but also because there is less impetus to grow sales volumes, which in turn limits cash generation. In times of more substantial price falls, such as after the 2008 financial crisis, it can also result in housebuilders having to write-down the value of their land banks. 

Yet some are in better shape to withstand those risks than others. Higher operating margins offer one line of defence. On that score, Persimmon and Berkeley (BKG) come out on top, both maintaining operating margins of over 20 per cent over the past five and eight years, respectively.  

The operating margins of Persimmon, and to a lesser extent Taylor Wimpey, have benefited from them building a strategic landbank, which is acquired without planning permission, says Peel Hunt analyst, Sam Cullen. “Others tend to be buying oven-ready sites,” he says. After gaining consent, the largest housebuilders can earn a higher margin on the homes built on this land. Since June, Taylor Wimpey has taken advantage of more attractive land pricing, accelerating purchases to a gross £826m. That should enable it to grow sales volumes faster from 2023, it said. 

However, Persimmon and Taylor Wimpey have also been the biggest beneficiaries of the help-to-buy scheme, which accounted for 53 and 50 per cent of reservations during the first half. That will be restricted to first-time buyers and include regional price caps from April. 

Yet the lower average price points of Persimmon and Taylor Wimpey homes could mean they are better placed to attract first-time buyers and remain within new regional price caps. For example, only 13 per cent of Taylor Wimpey reservations were not to first-time buyers, while 16 per cent of Barratt Developments' sales in 2020 were to customers that would be ineligible under the restrictions. 

“The great thing about Persimmon is that they’re at a relatively low average price,” says Colin Morton, manager of the Franklin UK Equity Income Fund, which holds the shares. That should mean that many of their potential customers, who are also first-time buyers, are not included in regional price caps, he says. He believes that the government will continue some form of support to get people on the housing ladder, but says: “We always worry that the government will, at some point, decide to end this.”

Yet if the private market does stall, could affordable housebuilders prove more resilient? Countryside Properties (CSP) and Vistry (VTY) have shifted their operations increasingly towards partnership work with local and housing authorities. This carries lower margins but enhanced returns on capital as housebuilders have to invest less up front. 

“They are a bit more resilient because they tend to be large orders,” says Mr Cullen, referring to the multi-year contracts housebuilders such as Vistry have recently secured. However, given affordable housing is built on mixed-tenure sites developments, which also contain private homes, affordable completions are not immune from the impact of price deflation. 

Yet one thing all the housebuilders have in common is that their balance sheets were in much better shape entering this recession compared with 2008. In contrast to the last financial crisis, most of the housebuilders were in a net cash position and while those balances have depleted, they are forecast to recover by the end of the next fiscal year. 

The risks of a downturn in sales prices and an easing of demand following the end of the stamp duty holiday and help-to-buy restrictions could well mean investors need to get used to lower profit growth in the coming years. Alongside that are lower dividend expectations, based on analyst consensus forecasts. However, that has been reflected in share prices within the sector. For housebuilders Bellway (BWY) and Vistry, we think the potential to re-rate based upon current valuations looks particularly compelling given their resilient margins and balance sheet strength. 

How the housebuilers compare