Directors in the news - but does it matter?

Wednesday, 7th November 2018 12:55 - by David Harbage

Trading updates today from two of the UK’s largest new home builders, Persimmon and Redrow, were accompanied by news of changes in the management board of each company. At the former, chief executive officer (CEO) Jeff Fairburn was ‘shown the door’ and leaves the company at the end of the year, while Steve Morgan, the chairman of the FTSE250 index constituent, has announced his retirement as at 31 March 2019.

The trading updates suggest both firms are performing well on a national basis, with London being the only soft spot, so investors’ focus is likely to be on what impact - if any – these senior personnel changes are likely to have on the business and the share price.

Both companies appear to be well run in operational and financial terms: gently expanding their geographic reach via new site openings, while maintaining strict financial controls (notably return on invested capital hurdles on land replenishment). Both balance sheets are ungeared (feature net cash) and City analysts expect revenue and profits to progress over the next year, as selling prices and completions edge higher. In addition, Persimmon is progressing vertical integration, beyond manufacturing bricks and tiles, by offering a broadband service to its customers.

Looking first at their operational and financial performance, Persimmon is forecast to deliver 7% earnings per share (EPS) growth in 2018 and 4% next year. Including special payments, dividends totalling 235p (covered 1.2 times by EPS) are expected this year and for 2019 – which puts the shares on an income yield of 9.8% and a price-to-earnings (PE) ratio of 8.2x calendar 2019’s broker consensus estimated EPS. Aside from its industry peers Barratt Developments, Berkeley Group and Taylor Wimpey, there are few FTSE100 companies that pay out such a high proportion of the cash they generate to their investors and are so lowly priced, by reference to their profitability. In similar vein and pace, Redrow is forecast to achieve 5.5% earnings growth in their current accounting year, which ends on 30 June 2019, delivering EPS of 90p. Choosing to distribute one third of this, a 30p dividend would puts the shares on an income yield of 5.4%, and the EPS estimate implies a PE multiple of just 6.3 – which represents 50% discount to the wider UK equity market’s earnings valuation and a 35% discount to the PE which applied before the EU referendum in June 2016.

In terms of operating performance the respective departures of the ‘main man’ in each business is unlikely to change the way they are managed by reference to their strategic direction. But how else might the departures be viewed? Persimmon clearly decided that the persistent media attention given to their CEO’s (initial £110m award, but subsequently voluntarily reduced) bonus was a negative – which reflected negatively on the company’s reputation - and a distraction, which hampered Mr Fairburn in carrying out his role. Directors of other listed house builders have also complained about the excessively generous terms of the bonus scheme setup in 2012 (in fairness, pre the government’s Help-to-Buy scheme which has boosted demand for new homes) and the subsequent publicity, which has probably adversely influenced public opinion towards the wider industry; these included Steve Morgan in February this year. As such the company’s decision will be seen by the market as positive action, to put the excessive reward issue behind it, and move forward. 

Steve Morgan, the founder and longstanding CEO of Redrow, will no doubt be missed but his retirement represents ‘business as usual’ (BAU) - normal management succession, as the existing CEO steps up to succeed him as chairman. Having said that, the author suggests investors could have two non-operational concerns. First, that Mr Morgan may accelerate plans to reduce his personal stake in the firm’s equity and, secondly, that new chairman John Tutte prompts a corporate governance issue by retaining the CEO role. In addition to donating his salary, Mr Morgan has placed over £200m worth of Redrow stock into a charitable foundation – the last major gift being in 2017 – and the charity would then no doubt be obliged to dilute this holding. However, any prospect of a reduced stake by Mr Morgan, his Foundation or any individual investor for that matter, should be viewed positively as it makes for a freer float or more liquid market, as a greater proportion of the issued shares become more likely to be readily tradable. As regards the governance issue, the company announced that a new Chief Operating Officer (COO) was being appointed, who would join the Board when Mr Morgan steps down.

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.