The prospect of interest rate rises and the cooling off of the London housing market have soured sentiment towards the house builders this year.
Steadfast investors who have retained the faith can remember a time when house-builders were not so friendless.
There was a prolonged period when most of the companies were rolling in cash following the introduction of the government’s well-intentioned ‘Help to Buy” initiative.
The law of unintended consequences took over and the initiative had the effect of inflating prices and thus making houses even less affordable but it also inflated the builders’ margins.
Special dividends, buyback schemes and extravagantly generous management incentive plans
Awash with cash, even after some had rewarded management for having the good luck to be in the right industry under the right government, many companies handed lots of lolly over to shareholders, either in the form of share buy-backs, dividends, or both.
Savvy investors who were not already shareholders quickly got on board to scoop up the dividends; it was not quite like the “carpet-bagging” era when the building societies hurled themselves lemming-like onto the London Stock Exchange and people opened up building society accounts willy-nilly in order to benefit from the denuding of members’ funds, but it was, seemingly, a can’t miss, jamboree time.
The sector has always been cyclical and it would appear that the consensus view is that we are now on the downswing of the cycle; that may be true but the share price weakness has pushed projected earnings multiples for many of the sector’s constituents into interesting territory.
Earnings multiples are low from a historical perspective
Barratt itself is currently trading on a price/earnings (P/E) ratio (based on projected earnings for this year) of 7.5, compared to a 10-year average of 22.9.
Bellway’s projected P/E is 6.9 (10-year average: 8.7); Redrow’s is 6.5 (58.3) and Crest’s is 6.0 (n/a).
Of the three, Crest might justifiably be classified as a crisis stock, after it recently reported a dip in pre-tax profits in its half-year results in addition to a contraction in its margins that was expected to continue into the next financial year, but recent trading updates from the other two have been upbeat.
Elsewhere in the sector, retirement home specialist McCarthy & Stone PLC (LON:MCS) is another stock that could probably be put in the doghouse along with Crest Nicholson, but most of the other big names are trading on projected earnings multiples that are below their 10-year averages.
The days of bumper dividend payouts may be drawing to a close but the sector is still a good one for income investors as well, with many of the house-builders offering projected dividend yields of more than 9%.
Normally, anything above a yield of 6% would be treated with suspicion and would signal that the market is expecting a dividend cut but the three stocks projected to yield more than 9% - Bovis (9.2%), Persimmon (9.1%) and Taylor Wimpey (9.0%) - all seem to have the dividend payment covered by projected earnings, albeit just about in Persimmon’s case.
Persimmon’s free cash flow (FCF) last year was 1.1 times it projected dividend pay-out this year while the FCF dividend cover ratios for the other two are better still; Bovis’s is 2.4 and Taylor Wimpey’s is 3.9.
Reasons to be fearful - Part III
Downside risks certainly remain and the speed at which the current government is shedding cabinet members suggests that the prospect of a Labour government is one of the main ones.
It was noticeable in the last General Election that the Labour Party had unusually high levels of support from younger voters. This group is one that would benefit from a radical overhaul of the housing market so that the point of owning a house is more to do with having a roof over one's head than it is to fulfil the role of a surrogate pension scheme.
Interest rate rises, Brexit, fragile consumer confidence, rising levels of anger over property speculation in a period where homelessness is an increasing problem – all of these could upset the apple-cart for house-builders.
Notwithstanding the above, as one City analyst put it: “Unless the UK slips into a full-blown recession these multiples offer far too much value”.