Join our community of smart investors

Telford embracing low-risk model

Build-to-rent brings the benefits of a capital-light model
February 28, 2019

Between the writing and publication of this tip, Telford Homes (TEF) has warned on profits for the year to March 2020. The problems related to the slowing of private sales highlighted in the original version of this article as well as a planning delay at its City North site in Finsbury Park, which is expected to push £15m of profit from 2020 to 2021. Our tip article as it appears in the print edition of the magazine is presented below followed by an update related to the warning. We remain positive on the stock although the warning is a noteworthy disappointment and has sent the share price down 19 per cent to 282p.

IC TIP: Buy at 345p
Tip style
Growth
Risk rating
Low
Timescale
Long Term
Bull points

Shares cheaply rated against peers

Growing exposure to build-to-rent

Attractive dividend

Falling capital requirements

Bear points

Private sales slowing

Margins falling

As a London-focused housebuilder, Telford Homes (TEF) is at the sharp end of the slowing housing market and brokers' forecasts have been downgraded over the past three months to reflect caution about meeting private sales targets. However, Telford is adapting its business model to focus on the UK's need for affordable housing and the growing appetite of institutional investors for build-to-rent. The fundamentals of all its markets are underpinned by a chronic housing shortage in the capital.

Broker Peel Hunt forecasts that the proportion of Telford's revenue from private sales will fall from 71 per cent to 48 per cent in the current financial year and will be down to 39 per cent of the total by 2021. We feel the shares' lowly rating compared with peers (see table) is more a reflection of deteriorating conditions in a market that Telford has already significantly reduced its reliance on and fails to account for the huge opportunities in build-to-rent. A bid is also a possibility given the company's diminutive size and valuable build-to-rent skillset.

 

NameTIDMMarket capPriceP/TangBVFwd NTM PEDividend yieldEbit marginROCEFwd EPS grth FY+1Fwd EPS grth FY+23-month upgrade/downgrade3-month momentum
PersimmonLSE:PSN£7,444m2,352p2.3810.0%29%31%-2%0%-1%12%
MJ Gleeson LSE:GLE£426m780p2.2134.1%19%20%8%10%0%14%
The Berkeley Group LSE:BKG£4,917m3,824p1.8102.4%29%33%-26%-25%-11%
Countryside Properties LSE:CSP£1,381m309p1.783.5%15%22%14%10%-1%6%
BellwayLSE:BWY£3,521m2,863p1.475.0%22%26%3%3%-1%2%
RedrowLSE:RDW£2,119m587p1.474.9%20%24%5%5%-1%14%
Bovis Homes  LSE:BVS£1,361m1,013p1.3104.7%12%10%48%3%2%10%
Barratt Developments LSE:BDEV£5,808m573p1.387.8%18%17%5%3%-15%
Crest Nicholson LSE:CRST£974m379p1.188.7%17%17%-14%4%-15%5%
Telford Homes AIM:TEF£258m342p1.175.0%15%16%0%7%-10%12%
McCarthy & Stone LSE:MCS£671m125p0.9114.3%10%8%18%-6%9%-10%
             
Source: S&P CapitalIQ          

 

While build-to-rent is a fledgling sector in the UK, it is well-established in the US and popular with institutional investors given its ability to provide stable income streams. Premium offerings, which tend to come with large service charges attached, hold a particular allure for institutions and Telford's London focus caters for this. And while build-to-rent work is lower margin, the model is highly attractive for builders because it significantly reduces the capital tied up in a project, which is a key business risk.

An institution buys a plot of land from Telford, and then pays by instalments for everything from gaining planning consent all the way through to completion. Telford also does not have to worry about marketing costs. So while operating margins are expected to continue their fall from a peak of 17.5 per cent in 2015 to 11.9 per cent by 2021, return on capital – a key measure of profitability for the sector – should fare much better.

TELFORD HOMES (TEF)   
ORD PRICE:345pMARKET VALUE:£261m
TOUCH:337-348p12-MONTH HIGH:475pLOW: 267p
FWD DIVIDEND YIELD:5.1%PE RATIO:7
     
NET ASSET VALUE:311pNET DEBT:52%
Year to 31 MarTurnover (£m)Pre-tax profit (£m)*Earnings per share (p)*Dividend per share (p)
201624632.238.914.2
201729234.136.615.7
201831646.049.417
2019*38846.049.217
2020*45748.051.317.7
% change+18+4+4+4
Normal market size:3,000   
     
Beta:1.09*Peel Hunt forecasts, adjusted PTP and EPS figures  

Telford's latest build-to-rent deal was with European real estate platform Henderson Park and long-term rental housing specialist Greystar, which saw the sale of Telford’s Equipment Works site freehold and the construction of 257 built-to-rent homes and 80 affordable/social housing units for £105m. This site was acquired just before Christmas 2017 for a paltry £33.9m.

This is the third partnership deal with global property company Greystar, which is a leader in the US built-to-rent sector (or multifamily accommodation as it is known over the pond). Greystar describes itself as being in a period of "intensive investment" in Europe, where it currently has a development pipeline of over $2bn. It also claims to be keen to expand through acquisition in the region. Potentially this could be a very lucrative relationship for Telford and for shareholders. 

The company has expressed some concern about private sales, especially in relation to Brexit. But this side of the business still has desirable characteristics and in the long term should be supported by the imbalance of supply and demand in London. Telford is largely concentrated on east London, and although the term affordable is open to interpretation, private selling prices come in at an average of £537,000 and it has limited reliance on Help to Buy. And while Brexit and stamp duty changes may be weighing on demand from investors, there is still good interest from people who actually want to live in what they buy.

Looking at the group’s overall pipeline, we find that there is potential to build another 5,000 homes with a development value of around £1.65bn. And, crucially, the average selling price is below the £600,000 limit on Help to Buy, although the small percentage of homes that Telford has for sale above that level are more difficult to sell. Several new projects are under consideration, and Telford has also been selected to be on the Greater London Authority’s London Development Panel 2, which is expected to bring forward sites currently under public ownership.

Telford’s long and successful record of identifying and developing sites in London holds the potential to provide it with a competitive advantage in the UK's fledgling build-to-rent sector. The tie-up with Greystar adds to our enthusiasm. True, private sales represent a challenge, but priced at 1.1 times tangible book value compared with a sector average of 1.5, we think the market is not paying enough attention to the positives. Buy.

UPDATE:

The warning from Telford prior to publication of this article relates to construction delays relate to its City North site in Finsbury Park, where progress will be slowed by six months due to dealing with transport bodies and the need to coincide with works undertaken by third parties. Planning delays, most notably concerning its LEB building in Bethnal Green are likely to increase finance costs and push back the timing of profit recognition. The subdued private sales market is also an issue and Telford plans to accelerate its move toward build-to-rent.

As a result of the warning, profits are expected to be lower than the £40m expected in the year to March 2019.