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Hidden value in housebuilders By Ceri Jones
House building may not be known for its raciness, but these are exciting times for the sector. The big news is the merger between George Wimpey (WMPY) and Taylor Woodrow (TWOD). And the decision Provided Persimmon (PSN) does not step in and bid for Taylor Woodrow - chairman John White is not known for paying over the odds - the merged entity will become number one in the sector. It would then steal the top spot from Persimmon, securing a place in the FTSE 100 in the process. Land Securities' move is a big departure for Britain's biggest commercial developer. It plans to develop the housing element of its 1,450-acre Ebbsfleet site in north Kent, rather than entering into a joint venture with a builder. The aim is to keep hold of the profits from the disused quarry site regeneration which will create some 13,000 homes close to the Bluewater shopping centre, which 17 minutes from London. Takeover candidates Following the M&A publicity, unearthing hidden value in the sector will now be more difficult. Redrow (RDW), Bellway (BWY), and Bovis (BVS) are all in the frame as takeover or merger candidates and have risen accordingly. The first two head the speculation list as their profit margins are in the mid-to-late teens, while Bovis, despite its recent troubles particularly in its northern division, has margins in the early to mid-20s which offer less potential for improvement. Redrow CEO Paul Pedley may know something we don't, as he sold £3.25 million of shares at 648p on 27 March. Oakdene Homes (OKD), which expanded its South East operations with the acquisition of Kent-based homebuilder Chequer Homes in December, has also been touted as a likely takeover target. On a PE of 12.5, its broker is projecting earnings per share growth of 27% for 2006 and 69% for 2007.
With planning as it now is in the UK, the logic is all about muscle. The bigger groups can buy more and larger sites and hold on to them for longer before development, picking the moment for maximum advantage. The Budget has also added to the confusion with the Planning Gain Supplement, which will be levied on the uplift in a property's value once planning permission has been granted. Companies have to negotiate deals now with the potential threat of a new tax in 2009, which could have a significant impact on future large scale or phased developments to be completed after 2009. Geography is always an issue, and larger companies can avoid reliance on one particular locality. Persimmon is particularly well spread, while Bovis for example is more concentrated around the South East. Less well understood is the sales culture at these businesses. Each year, as Christmas approaches, sites discount heavily to meet their annual targets. The bigger a company's balance sheet, the less pressure is on it to drive sales volumes at the expense of profit margins. Even with takeover activity in full swing, the sector is still on relatively low valuations, although as a whole it has risen in 42 of the last 60 months. The big fear is always the direction of house prices and the potential for a meltdown, which is heavily dependent on interest rates. UK house price growth slowed in March, a sign higher borrowing costs are subduing the residential market. Demographic drivers support this business as families continue to fragment (the very real shortage of plots will continue to push up their price). Growing housebuilders An example of the sector's low valuations is Anglo-Irish house builder Abbey (ABBY), currently rated a buy by analysts, which trades on a PE of 10. The £230 million market cap tiddler recently reported pre-tax profits at the interim stage up a touch to €22.58 million from €22.32 million a year ago. It said market conditions in England have been steady throughout the period while the Irish market continued to be firm. Another interesting play is rapidly growing house builder Galliford Try (GFRD) which acquired smaller rival Linden Homes for £245 million in March, and is now embarking on a six-month timetable for the reorganisation. It is restructuring its operations around three brands: Linden Homes, Midas Homes, and Stamford Homes. Galliford Try's acquisition of Linden is the latest in a line that includes Chartdale and Morrison Construction which were both bought early last year. An alternative way to leverage the market is planning permission specialist Henry Boot (BHY), where profits have risen 35% in 12 months on booming land values. The shares have already doubled in the past two years leading the company to issue a four-for-one split, but so long as the talk about reforming the UK's planning regime remains just chat rather than action, Boot's planning skills may continue to add value. Eco-friendly developments Expertise in eco-friendly development is also likely to have growing impact on bottom lines, which will accelerate as government incentives kick in. A high environmental approval rating via the official Building Research Establishment (BRE) test centre can add 10% or more to the value of a home, but the additional cost of constructing an eco-friendly home generally falls short of the 5% mark. Last year, Taylor Woodrow and Redrow both put only 9% of their new homes through the BRE testing system. Traditionally the preserve of specialists, certain volume house builders are pushing forward in the eco-friendly arena. Crest Nicholson (CRST) and private concern Countryside have growing track records with developments such as Accordia in Cambridge and Portishead near Bristol.
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