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The key issues to consider if you own shares in any of the housebuilders
Thursday 02 Nov 2017 Author: Tom Sieber

A rally in the housebuilding sector on expectations of further state support in the Budget on 22 November is coming to a juddering halt amid sceptical analyst comment, a slowdown in mortgage approvals and data which reveals the perilous state of Government finances.

Investors have to decide if the housebuilders can continue to grow earnings and cash flow regardless, supported by an ongoing imbalance between supply and demand of housing stock.

If so, investors might start weighing these companies based on earnings per share and dividend yield rather than the traditional measure of price to net asset value (NAV).

The housebuilders are a case in point of why it can be a mistake to focus just on one valuation metric when considering an investment.

On a price-to-earnings basis, and despite a strong run, they continue to trade at a discount to the wider market at an average of just over 10 times (FTSE All-Share around 15 times) but based on price to NAV these shares are, for the most part, as expensive as they have been at any point since the financial crisis.

What are the main concerns?

In a report published on 30 October, Barclays Capital expressed concerns about the sector’s valuation, highlighting a risk that Government schemes to encourage home buying might disappoint, as well as outlining worries about skilled labour shortages.

‘One of Britain’s biggest ever post-election surveys revealed support for the Government at its lowest among the young. Ahead of the Autumn Budget, we believe one key tenet
(“inter-generational fairness”) will be front and centre,’ it says.

‘Although measures could be impactful, history suggests that they can lack teeth (solving our “broken” housing market is not easy) and we believe expectations may have run ahead of themselves.

‘This, together with strong share price performance – our housebuilder index is up 46% year-to-date (versus the FTSE 250 up 10%) – leads us to downgrade Persimmon (PSN) and Berkeley (BKG) (from equal weight to underweight) and Redrow (RDW), Bellway (BWY) and Taylor Wimpey (TW.) (from overweight to equal weight).’

Key concerns

Investors owning housebuilders’ shares should think about what Brexit may eventually mean for demand, plus consider if house prices are getting too high (and therefore out of reach) for many potential buyers, even when factoring in help from various Government schemes.

An expected first increase in interest rates in more than 10 years at today’s Bank of England meeting (2 Nov) is another factor to consider, as the increased cost of mortgages could potentially reduce demand for new build properties.

A volatile sector

Shareholders in this sector have endured considerable volatility in the last 10 years as the financial crisis and the Brexit vote wiped billions off market valuations.

Housebuilders’ balance sheets are in much better shape to survive a downturn this time round. However, earnings and cash flow remain sensitive to fluctuations in the wider property market and the ability to sustain profitability at current levels could be constrained by increasing labour and raw material costs.

History suggests it would be a mistake to expect the current favourable conditions in the sector to continue indefinitely. (TS)

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