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Member Since: Wed, 6th Aug 2008

Number of Share Chat Posts (all time): 3,328
Number of Share Chat Posts (last 30 days): 118

Last Posted: Wed 13:58

Post Distribution over the last 30 days

17 Nov '15

Dividend realignment

After FY2016, we are realigning our expectations for the group’s dividend distributions. The
forecast for FY2016 is unchanged at 13.6p per share but, given the timing of the capital raise,
it is expected that the new shares will qualify for both the interim (xd likely in mid-December)
and final payments. Therefore, total dividend costs would rise by 22% for the current year.

For years FY2017F-19 we are re-casting our dividend expectations.

FY2017F – given the previous expectation of a step back on PBT, we forecast a level of
dividend that was halfway between the then forecast FY2016 and FY2018F payments, both
of which were determined by using an earnings cover of 3x. Therefore, cover dropped
Although headline numbers have
not changed, we have effectively
upgraded for FY2018F and

Moderate near-term EPS dilution is more than offset by long-term benefits

Dividends have been re-aligned with earnings materially below 3x in FY2017F in what was a fairly arbitrarily determined level of dividend.
Reflecting the change in the earnings profile with the earlier recognition due to the IPRS
sales, we have re-based our forecast to reflect the dilution of the new capital while at the
same time raising the expected earnings cover to around 2¼ x. The net result is that we are
now forecasting a full year distribution of 15.7p (previously 16.4p) but, as with FY2016F, the
total distribution will be materially higher. This dividend is higher than would be paid by
maintaining earnings cover on the revised dividends.

FY2018F and FY2019F – we are now forecasting that dividend cover in these two periods
will rebuild towards 3x rather than jumping straight to that level. The net result is that we are
now forecasting distributions of 16.1p and 16.8p (previously 19.2p and 20.3p). Again, the
total cash distribution will be materially higher than before the capital raise and higher than
would have been paid based on the revised EPS. As the capital raise is set to deliver the
17 Nov '15

By whichever approach is adopted, we can still see a fair value estimate for Telford Homes
materially higher than today’s 377p share price. Although there has been dilution to EPS for
FY2018F and FY2019F, this is really just the scene-setter for better growth in later years. A
logical approach might appear to be that, as earnings have stepped down in the forecast
window, the estimate of fair value should follow suit. This, however, chooses to ignore the
longer-term benefits the cause of the dilution (the enlarged capital base) brings.

We see that either of the approaches delivers a fair estimate at least in line with our
previous estimate of 490p, although it is possible, using the model based on later years’
earnings, to see a higher fair value at around 520p. By either approach the shares are
undervalued at today’s levels and continue to offer substantial value in a house building
sector that has otherwise largely run out of value.
Valuing Telford on the same basis
as the volume builders is no longer

A longer growth phase justifies a
higher rating, in our view

We stick with an earnings-based
valuation but raise the fair value PE
to reflect a more sustained growth

We maintain our fair value estimate
at 490p, although the derivation
has changed
17 Nov '15


Hitherto, we have valued Telford using the same model that we apply to the volume house
builders – essentially a P/E valuation based on a notional cyclical peak at the end of
calendar 2018. While it is possible that the currently favourable climate will remain positive
for longer than this, we still believe that this has proved to be a reliable valuation basis for
the volume sector. It has been able to describe very well the recent hit point and correction
in the share prices of the volume builders.

Increasingly, however, we have formed the view that this valuation approach may not be
ideal for Telford Homes as its market dynamics, its capital structure, development profile,
visibility, core drivers and length of growth phase are all radically different from the more
traditional single-house development model. As highlighted earlier, we struggle to see the
equivalent of a near-term cyclical peak or a fading/reversal of core external factors as we
can for the volume sector.

While we would not seek to argue that Telford Homes has converted fully into a long-term
growth stock, we do believe that applying what amounts to a peak-cycle valuation based
around 2018 EPS is no longer valid. If we are to use the same basis model of trying to
assess the period when growth will flatten, we should perhaps be looking at 2021 or 2022
(or later) here. Although we are not formally forecasting out to these periods, we have
modelled indicative numbers to this point, and beyond. We would estimate that for FY2021
EPS would be above 60p and above 65p for FY2022, although as mentioned earlier (with
the levels of capital then to be employed in the business) these could prove to be
conservative estimates.

So, while not fully convinced that this period would actually describe either a plateauing or
topping out of profits; we believe that rolling our existing valuation methodology through but
using earnings from later years does provide a more solid basis for the valuation. Carving
things up a different way and seeking greater consistency, an alternative would be to
recognise the more enduring growth phase for Telford and apply a materially higher P/E ratio
into the existing model. We previously used a P/E of 7.75x for the notional 2018 peak but we
believe that, for longer growth plus the potential for faster growth than currently assumed, a
P/E ratio applied to calendarised 2018 EPS of above 10x can be readily supported.

By whichever approach is adopted, we can still see a fair value estimate for Telford Homes
materially higher than today’s 377p share price. Although there has been dilution to EPS for
FY2018F and FY2019F, this is really just the scene-setter for better growth in later years. A
logical approach might appear to be that, as earnings have stepped down in the forecast
window, the estimate of fair value should follow suit. This, however, chooses to ignore the
17 Nov '15


We still believe that house builders
should be valued on an earnings

As we have argued many times before we do not believe that an asset-based valuation is
the correct approach when valuing a UK house builder. House builders’ assets are actually
working capital rather than fixed assets and cannot, standing alone, generate value for
shareholders. The assets (primarily land) must be converted and sold before shareholders
can benefit. Therefore, house builders are transparently trading stocks and should be valued
on their ability to generate earnings and dividend through that trading activity.

However, we must acknowledge that many observers do use a price-to-book approach.
When considering the Economic Value Added (EVA) it is important to note the following for

. Volume house builders’ returns can be flattered by the high levels of ‘land creditors’
within their total capital which most management teams choose to ignore when
calculating their ROCE.
. Telford operates with a very different capital structure from the volume sector,
preferring to operate with higher levels of balance sheet leverage.
. Telford runs with materially longer lead times for delivery of its homes and as such will
always have more tied up in working capital than the volume sector. Whereas a site-
based, single-house developer has a build cycle of 16-20 weeks, the larger schemes
now undertaken by Telford can see working capital committed for 2-3 years.
. Telford presents a materially lower WACC due to its higher leverage so, while some of
the volume house builders might headline a higher return on capital, Telford is up to
350bps lower on its cost of capital, making for a closer alignment in EVA computations.

Referencing the valuation grid in Figure 12 above, it might appear that on a price-to-book
basis, Telford Homes is already trading at a fair value relative to the closer peers, the
smaller and faster-growing house builders. However, we expect NAV growth for both the
larger and smaller volume operators to slow materially after 2018/19 as returns on capital
plateau. In contrast we believe that Telford will be able to continue to show a double-digit
rate of NAV growth right through to the currently visible limits of the development pipeline at
around FY2024. Again, as mentioned before, we see the indicative profit levels driving the
NAV as being conservatively set so in practice the growth in the NAV could run out more
strongly than now forecast.
17 Nov '15


Again referencing Figure 12, it can appear that Telford is offering a yield in line with the
immediate peer group of smaller and faster-growing house builders. While we see dividends
as being less important where EPS growth is set to be stronger, nonetheless we can see
Telford’s yield pushing on to good levels beyond our forecast window. As with EPS, we can
see growth running on longer here than we could reasonably expect elsewhere in the sector,
with dividends following suit. Initially we have continued to model that Telford would
distribute one-third of post-tax profits but, as the group plans to de-gear a little in later years,
there is scope for dividend cover potentially to reduce. Even assuming that cover levels are
unchanged, we can see the yield against the current share price pushing towards and past
6% within the current lifespan of the development pipeline.

Relative share price performance

Share performance relative to the house building sector had been relatively weak since May

. Observers assessed that the group faced a number of macro headwinds in the London
new homes market. The likes of BTL tax changes, overseas investor appetite and
residential valuations generally in London did drag on the share price.
. The volume sector surged very strongly post the 2015 general election.
. The market absorbed the news of the planning delay at Caledonian Road and the
resulting alteration of the profile of profit delivery.

More recently, the trends have been hard to determine against the sector because of the
equity issue being digested at Telford and the increased cautious view of the volume end of
the sector by sell-side observers. Nonetheless, as the chart in Figure 13 shows, the
momentum in relative performance looks to have reversed and, since the beginning of
September, Telford has outperformed the sector generally by around 8%.

We believe that the volume end of the sector most likely has further corrections to make but
we believe that, as the benefits of Telford’s decision to invest in order to grow become more
widely appreciated, this relative outperformance can continue.
Telford’s yield may only appear to
be in line today but we see
dividends growing for longer

We see a stronger performance
relative to the UK house builders
going forward

The views expressed in this document accurately reflect the research analyst’s personal views about any and all of the subject securities and the company on the date of this
document. Any opinion or estimate expressed in this document is subject to change without notice. Shore Capital may act upon or use the information or a conclusion contained in
this document before it is distributed to other persons. None of Shore Capital Stockbrokers Limited or any member of Shore Capital, or any of its or their directors, officers,
employees or agents accept any responsibility o
16 Nov '15

Still an under-valued stock: We have historically valued Telford on the same
basis as the volume national builders but this increasingly feels wrong. We see
unparalleled visibility, a clear long-term strategy, a solid focus on growth and, in
our view, still highly favourable local market dynamics. We still see fair value here
at 490p and believe that the stock is under-valued on both earnings and NAV
bases in a sector that otherwise appears stretched.

Equities Research Company Update 16 November 2015
Research analyst
Robin Hardy

Telford Homes+

Fresh capital for capital growth
Telford Homes has raised £50m of new capital that will be used to expand,
accelerate and prolong growth. The capital base is expanded and with
continuing confidence in Telford’s local markets in London, we see greatly
enhanced prospects. The development pipeline already extends out to FY2024F
and contains up to £1.5bn of gross development value (GDV), 6.5x current year
revenue, and via the new funds we expect the pipeline to expand further from
FY2017F. This, along with close to £700m of forward sales, gives Telford by far
the greatest earnings visibility in the sector. Coupling the now substantial capital
base with still strong market opportunities for securing new sites and continued
strong buyer demand, we see great value here with fair value still at 490p. The
rating shows an FY2019F PER of 7.5x and P/NAV of 1.14x meaning this stock
presents material upside in a sector otherwise struggling to show any.

Long visibility, sustainable growth and FY2017F forecasts raised: The pipeline
of sites to bring through to development already stands at c.£1.5bn, having been
boosted by c.£500m via the £23m United House acquisition. Now that £50m of
additional resource is available to the group, we can see this expanding even
further as Telford looks to identify sites within the next 12 months and to commit
the new capital fully within two years. Supported by the new equity, we have
raised our PBT forecast for FY2017F from £25.1m to £31.9m
A still bullish market climate in Telford’s London: The media seeks to portray
high risk in London residential but we still see great opportunity for developers in
more affordable areas. Demand still heavily outweighs supply, population growth
is unabated, we see buyers gravitating towards markets offering greater relative
value and there is no practical evidence that buyer demand has diminished.
Widening the sales channel while also de-risking: Telford has opened a new
sales channel: the institutionally funded private rental sector (IPRS). We see this
becoming an important part of the London housing market, helping to bridge the
supply gap; it is good for a developer to align with this new market segment, in our
view. IPRS allows a site to run with minimal capital, no debt, full sales visibility
and earlier profit recognition while delivering overa
16 Nov '15

while a 4.75 buy target when we were 4.90 5 months ago was a bit irritating now we are 3.80 post dilution it is positively helpful. Peel have always been conservative and we have overrun their 12 month target before.

Where are the rest of the brokers?
16 Nov '15

16-Nov-15 Peel Hunt Limited Buy 475.00 Reiteration

06-Nov-15 Deutsche Equal-weight 474.80 Reiteration

27-Nov-14 Peel Hunt Limited Buy 410.00 prev 410.00 Reiteration
16 Nov '15

Reiteration of 485 after a dilution much welcome

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