As part of the merger announced by Barratt Developments PLC (LSE:BDEV) and Redrow PLC (LSE:RDW) today, the pair described the deal as a “uniquely compelling” opportunity to “create an exceptional UK homebuilder” – though some suggested it looked like two worse-for-wear individuals hugging each other for support.
The reality is somewhere in between the utopian and cynical extremes, though the merger does have a defensive feel to it.
Alongside accepting a takeover from its larger FTSE 100 rival, Redrow announced a 57% drop in half-year profits today and said subdued recent trading means its full-year results will be at the low end of its previous guidance, while Barratt’s interims showed a 70% plunge in profits and that housing completions are expected to fall 18.6-21.5% for the full year.
Furthermore, the prospects of political change in the UK, with Labour possessing a large lead in the polls ahead of a general election due within a year, is likely to perturb many in the sector, after many years of very supportive policy from successive Tory governments (although Michael Gove as housing secretary has not been popular with the industry).
With Labour’s policies, including more of a focus on affordable housing, tenant rights and tax reforms to address disparities, seem to be aimed at cooling an overheated market for the larger gain of greater stability in the long run, curbing the likelihood of the rapid price increases seen in recent years.
Giving grounds for optimism, the wobbles experienced in the housing market in the past year and a half have been a direct consequence of rising Bank of England interest rates, combined with a cost of living squeeze.
Rates are widely anticipated to come down this year and by the time that Barratt Redrow is created in the second half of 2024, the first cuts are likely to have happened, which is likely to spark at least some extra life into the market.
Further softening any pessimism for the pair are combined coffers bulging with aggregate net cash of £874 million and “at least £90 million” of cost savings expected from the third year after completion of the deal from shedding 10% of the combined workforce and the closure of nine offices.
Investors in Barratt are not impressed, with the shares down 5.5%, while Redrow’s were up almost 16%.
Redrow founder Steve Morgan, who built the company up from a drainage contractor in the 1970s and holds a 16% stake, has backed the deal, with the share price higher than when he stepped down from the CEO role in late 2018.
Shares in both companies are still below where they were before the first pandemic lockdown, however, Barratt more than 40% lower, while Redrow was down around 30% before today’s news but now less than 20% off its all-time peak.
Strategic rationales for the deal make some sense, with strength in scale amid a market that may remain under pressure despite some easing rates later in 2024, but nowhere near near-zero conditions of the financial crisis-to-pandemic years.
Barratt will also be getting Redrow’s landbank of 24,565 plots, with 37,500 in its “strategic land portfolio”.
This adds to 63,614 owned and controlled by Barratt, which it equates to 4.5 years supply, and over 102,000 plots in its strategic land bank.
However, it’s reflective of what’s happened in the sector’s pressures that the total carrying value of this land bank has fallen to £2.98 billion from £3.25 billion despite the number of plots rising 15%.
Valuation implications for the sector
Barratt is offering 1.44 of its own shares for every share of Redrow's. Based on Barratt's last close of 530p from the day before, that meant the all-stock offer represented a 27% premium to Redrow’s 600p share price.
This valued Redrow at 1.29 times its tangible net asset value (TNAV) per share compared to 1.02 times book value from the close yesterday.
One rule of thumb for housebuilders is that their shares are "potentially cheap when they trade around one times book value and below and are probably expensive when they trade toward two times TNAV and above," said Russ Mould, investment director at AJ Bell.
Based on this, FTSE 100 rival Taylor Wimpey is trading at 1.17, just above Barratt’s 1.13, while troubled Crest Nicholson PLC (LSE:CRST) is the "potentially cheapest" at 0.66 times and FTSE 250-listed Bellway PLC (LSE:BWY) at 0.97.
Based on the same Redrow multiple, this was calculated to imply 95% upside to Crest Nicholson current shares and 33% for Bellway.
At the higher end stand blue chip pair Persimmon at 1.42 times book value and Berkeley Homes with 1.51, only exceeded by Vistry at 1.74 times due to its stronger tilt than the rest of the sector to social housing partnerships.