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Barratt Developments off the boil

Published: 11:25 18 Apr 2016 BST

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Shares in the UK homebuilder Barratt Developments recently hit their lowest level since June 2015. The upcoming EU vote, weakness in the prime London housing market and a weak update from Persimmon have all hit sentiment.  However, Barratt is currently expected to return 100p a share by November 2017.       

The UK home building sector is cyclical and can see periods of optimism and pessimism even in the midst of a long-term bull market.  Barratt Developments, for example, saw its shares fall 25% from the 2014 peak to the year’s low point.

Last week’s closing share price of 509.5p is 23% lower than the high of 662.5p seen in September 2015.   This time around we are further into the UK housing cycle, which increases the risk that the market will turn in the near-term.

In April the extra 3% stamp duty came into effect on second homes and buy-to-let property in the UK.  The uncertainty of the EU vote may be hitting demand and in London the top end of the market is seeing weakness.

Barratt Developments: turning farm land into homes

 

Source: Barratt Developments

Turning to UK homebuilders and the latest trading update from Persimmon showed a slowdown. Weekly private sales per site so far in 2016 increased by 6% on a year ago which means that the last seven weeks only saw a 2.5% increase.

The update led to a sell-off across the UK homebuilding sector with Barratt ending the week 6.4% lower than the high it saw on Wednesday.  The next update from the group is on 11 May with final results set for 7 September.

Barratt Developments’ valuation: yield appeal

Forecasting the future is easier said then done and therefore the near-term valuation of a stock is a good place to start.  A low valuation should offer investors a “margin of safety” even if there is a difficult period ahead.

Barratt Developments saw earnings per share in the six months to December 2015 increase by 40% to 23.9p.  The operating margin improved by 1.9% on a year ago to come in at 16.1% in the period.

The most recent forecast for earnings per share for the financial year to June 2016 is 54.2p.  The forecast P/E for the next 12 months comes in at a relatively modest figure of 8.68X earnings (based on a share price of 509.5p).

Barratt Developments had a modest net cash position at the end of 2015 and expects to have net cash in excess of £250m at June 2016.  The company should therefore be able to overcome a period of weakness in the housing market.

Given the strong cash position the group is undertaking an attractive capital return programme.  Combined with ordinary dividends the total amount currently forecast to be returned to shareholders by November 2017 is in 100p.

This offers a dividend return of 19.6% over 19 months (based on a share price of 509.5p) but is dependent on profits meeting forecasts.  The ordinary dividend has a target coverage ratio of 3X and is driven by the annual profit outturn.

Barratt’s forecast dividend payout schedule

Source: Barratt Developments investor presentation

Barratt’s key driver: the UK housing market

The UK housing market has seen robust price growth since the downturn with the market picking up in 2013.  The economic recovery, falling unemployment, the return of real wage growth and low mortgage rates have all provided support.

The average UK mortgage rate for an 85% loan product was 3.5% in early 2014 but has recently fallen to just over 2%.  This is because the recent slowdown in UK growth is expected to push further out any future rate increases.

The UK housing market is one in which demand exceeds supply in part due to a slump in building following the financial crisis. The four largest UK listed homebuilders are increasing supply but are also returning excess capital.    

UK housing market demand and supply

 

Source: Barratt Developments investor presentation

The prime London housing market has, however, become overheated and is set to see significant supply growth in medium-term.  Demand is also weakening due to higher stamp duty rates and the slowdown in emerging markets.

Barratt Developments is, though, a national builder and its exposure to London is at affordable price points.  In the six months to December 2015 the group saw 90% of London completions come in at £800 per sq ft or less.

Summary

The UK housing market may see weakness in the coming months due to the EU referendum and the extra 3% stamp duty on buy-to-let and second homes.  The prime London market has also recently started to see price weakness.

The longer-term output for UK housing still remains robust, in our view, given the supply to demand imbalance.  Low mortgage rates and schemes like Help-to-Buy are helping to get new buyers onto the housing ladder.

The key risk for homebuilders is a fall in home prices due to higher mortgage rates and/or economic instability.  With Barratt’s operating margin 16.1% the group would see profit fall by half if house prices fall by only 8%. 

UK home price index since start of 2004

Source: Office for National Statistics

Barratt Developments has a strong balance sheet and is diversified across the United Kingdom.  As long as the housing market doesn’t see a major downturn the current valuation appears to be attractive.

Over the next 19 months the company is expected to return just under 100p a share to investors. This is just under a fifth of the share price and in the subsequent year, to June 2018, the forecast yield is currently 7.6%.

This report was produced by Fat Prophets Senior Research Analyst, Andrew Latto

 

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