Housebuilders are being truly tested for the first time in 15 years. Without windfall government support schemes and ultra-low borrowing rates that have sent profits soaring for the big players, margins have been crushed and share prices sent into freefall.
Now, former kingpin Persimmon could be on course for ejection from London’s top index when the FTSE indices reshuffle next week. It would be the first time the group has been out of the FTSE 100 since 2013, the same year George Osborne, when he was chancellor, handed the help-to-buy scheme to the industry.
Between the launch of the scheme and the shares’ peak, Persimmon’s market value swelled from around £3.2 billion to more than £10 billion. Those gains have been lost entirely. It means that the total return delivered over that period is beneath peers such as Berkeley, Barratt Developments, Redrow or Taylor Wimpey, despite dividends trumping most rivals. But Persimmon isn’t the clear value play.
The macro challenges are clear. The rapid rise in mortgage rates has stifled demand and completions this year are expected to be at least 9,000 — around 40 per cent lower than last year. Sales rates in the five weeks since its latest update at the end of June, were 0.41 per sales outlet a week, down from 0.59 across the first six months of the year. Analysts at Numis cut their volume assumptions for next year from 10 per cent growth, to just 3 per cent. Numis expects margins to come in at just shy of 14 per cent, half the 2021 level.
Operating margins over the past decade have been fattened by an acceleration in completion volumes, rising sales prices and benign build cost inflation. Even if higher building materials and labour costs are likely to ease, demand and average selling prices are dependent on affordability constraints. The market doesn’t expect any cuts in interest rates until at least the end of next year.
Housebuilders deserve to be valued more cheaply than they have been over the past decade. Based upon its projected earnings, Persimmon doesn’t look like a bargain at all, with its shares trading at a multiple of 12, a slight premium to the long-running average.
That translates to an 8 per cent discount to the forecast value of its assets at the end of this year, which puts the group at an 11 per cent premium to the rest of the sector. Historically, that’s been justified by its ability to generate superior margins and returns on equity, a consequence of its large bank of strategic land, acquired without planning permission and therefore at a cheaper rate.
A snarled-up planning system, together with new reforms that remove the ability to overrule local opposition to developments, presents an obstacle to returns, analysts at Peel Hunt think. Why? One, it means it may have to buy more land already with planning permission, and two, it might have to tie-up more capital in land and work in progress, particularly as it attempts to rebuild its number of sales outlets.
A fall in the rate of land buying in the two years before the pandemic, together with the high demand that ensued thanks to Rishi Sunak’s stamp duty break when he was chancellor, meant Persimmon entered last year with a lower level of outlets than was historically the case.
Not surprisingly, a previously generous capital returns policy was terminated at the end of last year. A dividend of 60p a share is forecast for this year. Granted that would represent a potential yield of around 6 per cent on the current share price, but that’s still less than what’s expected from the likes of Barratt, Taylor Wimpey or Redrow.
Less cash to dole out to shareholders is just another reason Persimmon has lost its edge.
ADVICE Avoid
WHY There are better-value ways to play the fall in housebuilder valuations
Finsbury Growth and Income
Investors in Finsbury Growth and Income need patience. After a decade of near-undisturbed gains, the trust managed by star stock picker Nick Train, has stalled over the past three years. A discount has been entrenched within the shares, although one that has narrowed to just over 4 per cent.
The London market is a tough place to be for managers like Train, who run UK equity strategies. Companies listed here trade at discounts to their historic averages and even more cheaply compared with international peers.
There is value on offer, even if the Finsbury trust hardly focuses on the sort of bargain basement, old-economy stocks that dominate the FTSE. The publishing company Relx, London Stock Exchange Group and Diageo account for around a third of net assets.
There are tentative signs that the FTSE 250 investment trust may be turning a corner. The value of its assets has edged back ahead of the FTSE All-Share, the yardstick it attempts to beat, since the start of this year. Even if the lead is modest, at 7.2 per cent versus the 5.3 per cent delivered by the benchmark, it’s still far better than a loss of almost the same amount that was recorded by the trust last year.
There are potential catalysts for improvement at some longtime holdings. Changes at the top for Unilever and Burberry, two of the trust’s more inconsistent performers, could bring greater strategic shake-ups that kickstart returns. Others still look problematic. Take Fevertree, the posh tonic maker, and Cazoo, a position inherited as part of the take-private of Daily Mail and General Trust, part owner of the online car retailer.
Durability is the chief quality of the trust’s largest holdings. Prizing qualities such as high margins, low debt and consistent profitability are worthy measures for picking stocks that have a chance of delivering good compound returns in the long term. Over the past ten years, the value of the trust’s assets has risen 134 per cent, almost double the index.
For investors that can tolerate bumps in the road, there could be a good chance of solid compound returns over the long term.
ADVICE Buy
WHY The shares could deliver compound returns over the longer term
