When will housebuilders become cheap enough to reassure shareholders? Barratt Developments is now valued at a 16 per cent discount to the gloomy asset value forecast by analysts at the end of June this year. Investors have piled out of the sector over the past 12 months in advance of darker economic conditions.
A steady slide in demand over the second half of last year is hardly surprising, which might explain a muted reaction from investors. Barratt’s average weekly sales rate had halved in the final three months of the year, compared with as recently as August, as the chaotic fallout from the September mini-budget caused lenders to pull mortgage products and sharply increase borrowing rates.
That fall in reservations makes Barratt even more reliant on the spring bounce in demand materialising. If weekly average sales rates increase by the same degree as usual, from a rate of 0.3 homes per outlet to roughly to 0.5, then the housebuilder remains on course to hit consensus completions of 17,475 units this year. But if it does not, then that number could fall to somewhere between 16,000 and 16,500, which would represent an annual decline of up to 11 per cent on last year.
An easing in mortgage rates in recent weeks and improving availability could provide some support to affordability and demand. Analysts at Peel Hunt think pre-tax profits will fall from last year’s record but, at £950 million, remain above the £920 million recorded in 2021.
Putting an accurate figure on where profits will land during the next financial year is much harder. One thing seems certain: volumes will fall again and margins will be squeezed, sending profits lower. For one, Barratt will be without the boost provided by the boom in demand from government stamp duty breaks. The value of the order book has declined by almost a third to £2.5 billion and the proportion of forward sales even for this financial year has fallen to 77 per cent of expected completions, down from 89 per cent this time last year.
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Just how badly profits are hit will depend on the extent of the fall in sales prices later this year. A decline seems nailed on. At the top level, the average for its private homes was 14 per cent higher over the last six months. However, Barratt has increased the incentives offered for homebuyers and broader industry data shows that prices peaked in August. House prices fell for the fourth consecutive month in December, according to the mortgage lender Halifax.
Analysts have already pencilled in some big falls in prices for Barratt over the next 12 months. Jefferies forecasts an average selling price of £316,000 for the financial year ending June 2024, which would represent a 16 per cent decline on the average recorded by Barratt over the past six months.
Based on earnings forecasts for this year, the shares trade at six times earnings. However, against the market’s expectations for the 12 months to June next year, that forward earnings multiple rises to just under 11 times forward earnings. That is above a ten-year average of about nine.
Another question is how strong Barratt’s balance sheet is. The answer, at present, is very. The group is sitting on a net cash pile of almost £1 billion. Note that land approvals were negative in the latter half of the last six months, and a slowdown in the rate of approvals and land buying should result in an inflow of cash next year.
The big curveball would be any writedowns on the value of the housebuilder’s land or other assets. Last year, the value of greenfield land rose to its highest level since the last financial crisis in 2008, according to Savills, the property services group.
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Barratt’s shares might have fallen by about 45 per cent but that does not make them a bargain. Like peers, the housebuilder deserves its paltry price.
ADVICE: Hold
WHY: The fall in the value of the shares is justified by a likely drop in earnings next year
Merchants Trust
The top ten holdings of Merchants Trust might seem unimaginative: FTSE 100 stalwarts Shell, British American Tobacco and GSK are the first three names in that list. But shareholders are unlikely to care. Shares in the FTSE 250 investment trust trade near a record high. The value of its assets rose 10.5 per cent over the 12 months ended November, versus a 6.5 per cent gain for the FTSE All-Share, the yardstick it tries to beat.
The UK-focused trust aims for a high and rising income, as well as a capital return. A rally in value stocks after years of underperformance versus racy US growth companies is one explanation for the gains. For Merchants, holdings in energy majors, defence giant BAE Systems (the FTSE 100’s biggest riser last year) and more defensive tobacco stocks pushed up returns.
The heady rise in the trust’s share price has not taken away the stock’s income status, which offered a dividend yield of about 4.8 per cent. Merchants has increased its dividend for 40 consecutive years. The odds of it continuing that record this year look good. Earnings generated by Merchant’s holdings rose sharply in the first half of the financial year, to within a hair’s breadth of the pre-pandemic level. Matching earnings generated in the second half of last year, would leave the annual total exceeding the 27.3p a share dividend paid out in respect of last year.
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Where next for returns? Stocks more closely geared to the broader economy are where Simon Gergel, of Allianz Global Investors, sees the best opportunity. Recent purchases include NatWest, a play on rising interest rates and improved returns, and building materials supplier Grafton, which could benefit from higher infrastructure spending over the longer-term. Cyclical stocks bring higher risk. But there could be gains to be made from buying companies with solid balance sheets and a record of strong cashflows at the current, weak valuations.
Corporate earnings prospects are even less predictable than usual in the near-term. Merchants’ record over five and ten years should be the main allure for investors. Over the former time horizon, the shares are up 53 per cent versus an 18 per cent rise in the benchmark.
ADVICE Buy
WHY Trust has a solid record of beating the FTSE All-Share
