This column avoided Redrow, the housebuilder, back in February given the gloominess surrounding the property market. It was a good call, with the shares having lost a fifth of their value since then.
Most of that damage has come in the past six weeks, reflecting the jump in interest rate forecasts and the effect on mortgage affordability.
The expectation had been that, by now, the housebuilders would be through the worst of the downturn and that buyers’ confidence would be on its way back towards something like “normal”. It has not played out like that and so the obvious move would be to steer clear of Redrow for a while still. Yet the share price slide could, for those brave enough to look through the near-term uncertainty, present an opportunity.
Redrow’s share price is now a third below its book value, according to analysis from Peel Hunt, implying the market thinks the land it holds and the houses it is building are not worth anywhere near what they once were. Even if that were true at this moment, it is hard to make the case that land and home values will be worth less in five years’ time. As Mark Twain said: “Buy land — they’re not making it any more.”
Aside from Crest Nicholson, of the volume housebuilders Redrow screens as the cheapest on the “share price to net asset value” metric, despite analysts’ belief that it is among the least likely to have to write down the value of its assets. A big worry for investors is the chaos that went on in the property market in the global financial crisis 15 years ago. Developers, in desperate need of cash, were selling their houses at any price. But they do not need to repeat that during the downturn, with balance sheets and debt levels much healthier than they were back then.
As of the end of January Redrow still had £107 million of cash on its balance sheet, less than half what it had a year earlier but that was before it bought back £100 million of its shares. Management have already said that they are not buying new land, which should further help to preserve cash, and even during this downturn Redrow is still expected to turn a profit in the coming year.
The consensus in the City is that Redrow will generate an underlying pre-tax profit of £367 million for the year just gone, which ran until the end of June. Profits will fall to about £208 million in its 2023-24 year. The fall will reflect a drop in output to match the lower levels of demand, with prices, so far at least, holding up much better than some had feared. That was evidenced in the latest data from Halifax, the mortgage lender, which last week said that new-build house prices remained 1.9 per cent above where they were this time last year. By contrast, values of older homes fell by 3.5 per cent on average.
Distress among big developers and homeowners is yet to show, which is probably part of the reason why prices are firmer than predicted. Unlike during the 2008 crisis, banks are still providing loans, they are just more expensive to service. That should matter less for Redrow, which builds bigger houses and sells them to second or third movers, or people looking to downsize. Its buyers tend to require smaller mortgages, if they need them at all. Last year 33 per cent of its sales were to cash buyers. If all else fails Redrow has its superior product offering to fall back on. Ask the bosses of any of its rivals which developer builds the best homes and most will have Redrow at the top or somewhere close.
Backing Redrow, or any of the housebuilders, is a risky strategy in the present environment. In the near-term should inflation, and so interest rates, come down quicker than feared, Aynsley Lammin, an analyst at Investec, would expect to see a near-term “significant re-rating”. The shares’ sharp discount to book value underpins the longer-term investment case.
ADVICE Buy
WHY Recent slump in share price presents an opportunity
Drax
Tick, tock. It’s now less than four years until the subsidies that have sustained Drax’s Yorkshire biomass plant run out, putting the fate of Britain’s biggest power station and the FTSE 250 energy group into focus (Emily Gosden writes).
Drax received £617 million of subsidies for burning biomass last year, underpinning adjusted earnings of £731 million.
Despite efforts to reduce costs, increases in the price of biomass may render the plant unviable when these payments end in March 2027. Drax hoped to win government backing for its £2 billion project to convert the plant to bioenergy with carbon capture and storage (Beccs) by 2027, securing new subsidies just as the existing payments run out.
But ministers have gone slow on that, prioritising carbon capture elsewhere and pushing Drax’s potential Beccs start date back to 2030. The government is discussing “bridging” arrangements to tide Drax over, but the Climate Change Committee — while supportive of Beccs — has said that unabated biomass plants “should not be given extended contracts to operate at high load factors beyond 2027”.
Ed Miliband, the shadow climate secretary, has indicated that Labour would review subsidies for biomass amid continued controversy, and an Ofgem investigation, into Drax’s sustainability credentials.
The delay to Drax’s Beccs project at least has a silver lining for investors: it’s using £50 million of cancelled capital spending to help fund a £150 million share buyback programme this year.
And the Yorkshire plant, while the core of Drax’s business, is not its only asset or opportunity. In Britain it operates the Cruachan pumped hydro plant and is hoping to expand it, although this, too, is subject to government backing.
Bigger opportunities lie across the pond where incentives under the Inflation Reduction Act are making the development of Beccs plants more attractive. Drax is working on a pipeline of projects in America and has inspired the City with ambitious plans to invest as much as $4 billion developing two of them this decade.
However, with the future of its big asset back at home still in doubt, it could be a rocky few years ahead.
ADVICE Hold
WHY Uncertainty over future of biggest asset
