Sunshine today - storms or rainbow ahead?

Thursday, 10th May 2018 14:34 - by David Harbage

Prompted by a trading update from Barratt Developments this morning, please find and post the following brief comment on the above website:

‘Sunshine today - storms or rainbow ahead’

Based on the lunchtime ‘no change’ in interest rates from the Bank of England and today’s trading announcement from Barratt Developments covering the period from 1 January to 6 May 2018, the immediate outlook for the UK’s major house builders appears very sunny, but could there be storms ahead - or perhaps a rainbow? 

Barratt reported that trading is strong across all its regions, in line with the board’s targets and that forward sales were 2.5% higher than this time last year. Drilling into those sales, affordable housing has seen a 15.4% hike while private sales are marginally ahead.  Profitability could take a knock from that shift in mix, but the company is set to deliver  a 6% increase in earnings per share (EPS) in its accounting year which ends 30 June 2018 - according to the consensus of 15 brokers with published forecasts - with a similar rise in EPS pencilled in for the following trading period. 

The big question for new home builders surrounds 2019 and beyond, because the stockmarket is pricing in a near 20% fall in earnings across the industry - as 5-10% reductions in average selling prices (saw evidence of deflation in the overall market yesterday, albeit based on estate agent survey evidence, primarily in London and in homes worth £1m plus), allied to volume decreases of the same magnitude are anticipated by some commentators.

Essentially, the negative sentiment surrounding the London market (relative to the provinces) is likely to extend further afield in the second-hand market, but the recent encouraging performance of the share prices of London-focused builders Berkeley Group and Telford Homes is testament to the forward-looking nature of markets and could be a portent for the national new home developers. History tells us that markets will typically look beyond current difficulties (or 'rosy patches', as applies to Barratt’s encouraging report) to price in a longer term perspective and even as news may appear at its worst (think of Middle East conflicts), they can perceive an easing in uncertainty and negative sentiment.

The health of most of the FTSE350 index constituent builders' balance sheets is impressive, demonstrated again by Barratt's advice of its net cash (£550m, ahead of management’s previous guidance) today, and will help weather any softening in customer appetite. The company's purchase of land (20,000+ this year, secured at prices that exceed their profitability-hurdle rates), ahead of consumption levels (again matched by Barratt’s peers) is indicative of its medium term confidence - especially as Barratt which has a particularly quick turn on its developments and capital. 

The group also announced that its new range of homes feature more modern methods of construction (featuring timber framed, large format block or light gauge steel frames) leading to faster build at lower cost. The resultant widening of margins could lead to upward revisions in earnings forecasts for the current year and beyond. 

Dividend pay-outs are perhaps the biggest boost to confidence - although investors will appreciate that the FTSE100 builders are expressing theirs in special or exceptional terms - and Barratt is expected to pay-out 43.3p this year and 44.8p next to shareholders, representing a dividend yield of 8.0% covered 1.5 times by earnings. The writer believes that sustainable attractive income yields could yet be the catalyst to a re-rating of the sector’s listed businesses - even as the peak in profitability draws closer.

Investor sentiment remains fragile but, just as 90% of financial pundits were anticipating - in March - an interest rate rise today, considered financial wisdom is far from fallible and the environ of ‘lower for longer’ in the rate cycle could yet underpin support for cyclical firms like Barratt.