David Harbage Blog

Following on from earlier company specific articles on smaller or medium sized stock exchange listed businesses..

and our review of the house building sector on 6 July, we are taking a closer look at East London-based Telford Homes. In similar vein to ‘Kentz – the mini Petrofac’, this week we take a look at a relatively small house builder, which perhaps possesses the attributes to carve out a successful niche, if not become a leader, in its industry. Telford Homes (TEF), which listed on the Alternative Investment Market in December 2001, is a regional east and north London ‘brown field’ specialist which focuses on a value for money proposition (typically apartments, rather than traditional family homes), in both open market and social housing, via sustainable regeneration projects.

Intuitively, the company appears well positioned to benefit from ongoing relative strength in the London housing market – which possesses rather different dynamics to the wider UK landscape. Beyond evidence of its more resilient economy (owed in part to London’s prominence as an international centre), as reflected in the capital’s 10% rise in residential rents last year, a recent report from the mayor – highlighting an expectation for a faster growing population than the rest of Britain - called for 30,000 new homes per annum for the next 20 years, as compared to the actual build of less than 15,000 since 2007.

The Office of National Statistics (ONS) expectation that 70% of household growth is likely to arise from single person households plays to TEF‘s typical 1 or 2 bedroom unit. On a regional basis, the company’s professed belief in regeneration fits well with the major development of various sites and the expanded or new infrastructure for the Olympic Games, and TEF has clearly benefitted from other recent local initiatives. These include the Westfield Shopping Centre in Stratford and the £16 billion Cross Rail project, which have combined to enhance the appearance and worth of London’s East End.  

Unlike its larger peer, Berkeley Group, less financially strong house builders struggled in the downturn in the 2008 -2009 housing market (which impacted London, as well as the rest of Britain); TEF was no exception. Its management had to focus on the more resilient, but lower margin business, of building public housing-dominated developments for London boroughs – which brought a halt to its track record of revenue and earnings growth – something which the company has only just worked through, as evidenced in its trading for the year ended 31 March 2012. When announcing these results, executive chairman Mr Andrew Wiseman said that while the group had suffered longer term effects from the housing downturn, TEF was now in a strong position. He cited possession of available finance, as well as a healthy development pipeline, which enabled the board to be confident in forecasting a significant profit jump in the year to March 2013 and continued growth beyond.

In its last financial year, TEF completed 542 affordable homes (which facilitates good relationship with local councils and enables the group to remain competitive in purchasing land) and 460 open market units. The latter represented a 25% increase on the previous year, with average selling prices up from £259,000 to a flattered £339,000 (due to fall back in the current year). Gross profit margins rose from 15.1% to 17.6%, more pertinently operating margins went from 5.2% to 6.2%; pre-tax profit and the dividend rose 20% to £3m and 3p respectively, with the promise of substantial improvement in the second half of 2012.

TEF has a strategy of trying to sell early into the development cycle, partially driven by its financial model – which features proportionately higher levels of debt than most of the larger house building companies. An equity market capitalisation of £51.5 million compares to net debt of £54.6 million; gearing of 82.4% at year end reduces to 38%, when excluding effect of monies due on contracts already exchanged. In March 2011, TEF secured a £50 million long term bank facility (renewed at a cost of libor +3.5%) to enable the company to continue its land purchase programme. Developments currently being sold feature a 20 storey tower at Poplar E14, as well as at Bow E3, Greenwich SE8 and Matchmakers Wharf E9, Hendon, Wanstead and Woodford. More recent initiatives include entry into new boroughs, notably Camden and Lambeth (the latter via a 24 storey tower).

In terms of TEF’s customer mix, as much as 50% of open market transactions may be attributed to investment buyers (London rent yield is circa 6%) - with two-thirds of these probably being overseas – and the other half acquired by traditional owner occupiers. Unlike Berkeley, the company has not signed up to the latest government schemes to attract first time buyers, with management suggesting that the location of its homes deliberately attracts prospective purchasers with relatively high deposits. As at its year-end, TEF boasted a pipeline of 1,949 units with planning permission (plus 20 without), as compared to 1,904 a year ago; the company believe that this is capable of generation £100 million gross profit over the next four years. In the past year or so, the cost of build has remained fairly static as, although labour expense rose, the price of core materials has fallen.

By contrast with other segments of manufacturing industry (such as engineering), house building is relatively homogeneous - with the prime exception for UK listed companies surrounding the extent of any overseas or commercial contracting work. However, a bias to London, which was also reflected in Bovis Homes’s trading update on Monday, is a clear differentiating factor - by reference to local economic conditions, a near absence of green field development and a more complex, slower planning permission environment (typically reflected in the cost of land being a lower proportion of the eventual selling price) – all of which can be expected to continue in the foreseeable future.

When looking at the stock market’s valuation of house builders, by reference to forecast earnings (looking a year out), a rather surprising picture emerges – if investors perceive that market conditions, particular by reference to the prognosis for house price inflation, is considerably more benign in London. While national businesses are priced on a price/earnings ratio of between 11.1 and 12.7 (Barratt Developments 11.1x, Bovis Homes 12.7x, Persimmon 11.9x, Taylor Wimpey 11.1x) for the calendar year 2013, London-oriented Berkeley Group and TEF are valued on less demanding multiples of 9.1 and 7.0 forecast earnings, for their trading years ending April and March 2014 respectively. Placing a discount on the earnings-based valuation of TEF relative to Berkeley appears wholly appropriate, given its less distinguished track record; but the junior company has managed its recovery path through the downturn as well as its larger national peers Barratt Developments and Taylor Wimpey. Looking at net asset value, TEF stock currently stand at a discount of 25% (NAV was 133.7p at its year end) – something it shares with most of its listed peers, although Berkeley’s premium rating (latest advice of NAV: 839p) makes it an exception in this regard.

While average prices across the UK typically fell by 1.5% in the year to the end of June 2012, according to the Nationwide’s house price index, house values have appreciated in London – often by up to 10%. The price of new homes has held up well (and not just in London), relative to the overall stock, but making a call on a house builder represents a combination of various factors – many of which, as described in last week’s blog, are a call on the macro-economy (job security, mortgage rate sensitive) and are often consumer-oriented. Clearly London’s attraction to overseas buyers will also depend on the relative, currency-translated, merit of the local marketplace versus other comparable investment destinations.

As a smaller company, TEF undoubtedly represents a higher risk-reward investment on the housing market, and this is exacerbated by the company’s lack of a full listing on the London stock exchange (which demands greater disclosure than the AIM). A move to correct that could prompt a reduction in the stock’s apparent discount rating. Paying down debt to more manageable levels would also improve investor sentiment, and clearly any significant appreciation in net asset value per share and gearing levels will improve the terms upon which TEF can borrow (or renew its existing bank loans) to progress its longer term prospects.

Recent director purchasing, in the first week of July, is encouraging and, while “not a stock for widows and orphans” according to the old parlance of stockbrokers, TEF may have appeal to investors seeking to invest in a reasonably transparent (if only to the extent to having clear drivers which will influence the worth of its future profits and assets) business. Finally, one factor which TEF shares with the other relative minnow in its industry sector Kentz (discussed within 25 May’s blog), is that larger businesses could be attracted to the prospect of enhancing their own earnings, by making a complimentary acquisition of a business which appears to be undervalued by comparison with its peers.

The Writer's views are their own, not a representation of London South East's. No advice is inferred or given. If you require financial advice, please seek an Independent Financial Adviser.