Following on from the look at Barratt Developments, I have put together a table looking at the main operating and financial metrics of the other major UK housebuilders. The only notable absence is Taylor Wimpey which has significant North American and Spanish operations making comparison with the other companies difficult. There are some facets of the data that we should briefly note. First, whilst much of the data on land bank is comparable, the definition is not consistent across companies. Bellway and Redrow give two figures for land bank and although I think they are comparable it isn’t clear as not every company discloses how they define their land bank. Second, we should keep in mind that what might be defined by most as “capital expenditures” for housebuilders is taken in the working capital line of the cash flow statement. I have included free cash flow data but it isn’t comparable to other companies. I am first going to point out the interesting aspects of the data and individual companies and then I will update my view on the sector and individual companies.
The company that is instantly distinguishable along almost every metric is BKG, The Berkeley Group. First, BKG has a huge average selling price (ASP). To quantify this, as margins for BDEV were maybe around £25k per plot in the last fiscal year, having an ASP which is around £100k over competitors is huge. The reason for this is that BKG is concentrated on London (it does a lot of urban regeneration projects) which just doesn’t really compare to the housing market in the rest of the UK at all. Unsurprisingly, BKG has massive margins and large profits. What is also interesting is that the company is investing heavily, has the largest land bank run rate (i.e it has the most property in inventory relative to the sales it made in the last fiscal year), and has an excellent financial position.
BKG is worth 71% more than BDEV despite the fact that BDEV has a land bank almost double the size. Clearly, sentiment on the London housing market is quite strong. One way to find out if the current market cap is roughly right is to attempt a shorter version of the BDEV model outlined in the previous post. We multiply land bank by the ASP and take off the EBITDA margin leaving us with the Implied Gross Profit figure (the last line of the second group). One way to interpret this number is to take this as a percentage of enterprise value and compare it across competitors (alone it is probably quite a useless number). BKG has the highest IGP/EV which is good as we want the most IGP for our investment however, we should recognize that this is due to having a much larger than average land bank. So given the large capital expenditures, the company may find itself in quite a tough spot if the London market reverses however, there seems to be little sign this will happen and the GM it is making is really extraordinary for the industry. Despite this, the current price doesn’t appear to obviously attractive and, as I don’t know much about the London housing market, I will leave it.
If we are take the lessons from BKG we can say that the main thing we are looking for in a housebuilder is a large, strong land bank in regions where solid margins can be achieved. Also important is a strong financial position as the current opportunities for capital investment seem quite lucrative (this is just anecdotal but 20% GMs appear possible on recent plot purchases).
Dealing with the financial position last, we can see that BDEV, RDW (Redrow), and PSN (Persimmon) are in the worst position going by the Net Debt/EBITDA metric. BVS (Bovis) is quite significantly ahead. Interestingly, BVS has gross margins that are significantly higher than competitors and the data on FCF suggests it is taking advantage of this by making some significant investments. Unfortunately, its good gross margins are made worthless by its huge admin costs. Redrow also scores poorly on this point with admin costs that are significantly higher as a percentage of gross profits relative to peers.
Looking to the land bank and inventory, one notable figure is BDEV’s inventory/EV metric. Again, this metric is useless as an absolute measure but we can see that BDEV’s inventory is being valued differently, relative to its peers. The high inventory/EV could signal potential undervaluation (you are getting more inventory per unit of market cap) or it could be that the market is questioning how BDEV is marking its inventory. The value of BDEV’s inventory was something that came up in my previous post and, to put it briefly, it was difficult to replicate £3.2bn without making some quite optimistic assumptions. However, it is also worth noting that BDEV is providing more value in terms of implied gross profit when controlling for the land bank run rate. Despite this, the upside from this isn’t enough considering the financial position.
We can make the same criticism of RDW which has net debt/EBITDA near BDEV but just doesn’t have any upside in terms of having a good implied gross profit when controlling for the size of the inventory. The financial position of BVS is best in the sector however, it appears the market has placed a significant premium on this safety as, although we are getting a lot of inventory for our money, the profit that the company will make from this isn’t priced well. In particular, given the company’s gross margins, the EBITDA margins are really terrible.
This leaves PSN and BWY which I believe are probably the best, relative to the other companies examined here. Of the two, BWY is the most interesting as it doesn’t have much inventory left, has good margins, and has a good financial position. It is strange that the best investment is a company that has the least exposure to the sector but in this case it should allow BWY to improve margins going forward. PSN is in the position of being better than BVS or RDW but in a worse position than BWY. PSN has more inventory, more debt, and worse margins.
So what I have hoped to highlight is that BWY is probably the best placed company in this sector. This is not to say that other companies do not offer value but I think BWY offers the lowest risk way of playing a recovery in the housing market with the highest possible reward. BKG and BDEV are also quite interesting companies however, the risk profile they offer is slightly different. With BKG, the upside is clear but if the company does not meet expectations and those large investments don’t work out it could be messy. With BDEV, messy is what is priced in but if the housing market recovers the upside is huge. BDEV and BKG are really the polar opposites in terms of payoffs whilst BWY is somewhere in the middle. One thing to highlight though is that this doesn’t take into account any other assets that the companies might hold and it doesn’t take into account any possible one-time effects on the KPIs, particularly plots sold. It is quite tough to think about how to value these inventories both absolutely and relatively so it may prove that my logic used here is completely wrong. Factors like the private/social housing mix and the house/apartment mix are important. Either way, we have to consider a slightly broader perspective in thinking about whether the sector is actually a good investment.
My previous view of the sector was, to put it briefly, that the supply/demand situation was favourable with a serious supply shortfall emerging but bank lending was probably the most serious obstacle in the way of recovery. I was fairly sceptical of government policies to remedy this as they appeared to be skewed against housebuilders. The mortgage indemnity scheme makes the housebuilders take the vast majority of the credit risk on 95% LTV loans whilst the banks don’t appear to take any. My previous contention was that the credit risk didn’t seem like a particularly good investment and given the state of balance sheets I don’t see how companies like RDW or BDEV are going to take advantage of the scheme. My previous analysis was that the takeup wasn’t going to be good because it was skewed against the housebuilders. I don’t think this is quite correct as the housebuilders really are desperate. However, the separation of lender and credit risk is also a pretty worrying aspect of this scheme. I haven’t seen any detailed description of how the scheme is going to work but it seems that the banks lend to who they want to and housebuilder contribution is limited to depositing into the fund. Regardless, this will change the industry in the spring, when loans are going to be made, and the housebuilders that already have a poor financial position will find it more difficult to participate.
So at the moment the industry is in a really tricky place. People need houses but they can’t get loans to buy them and starts are nowhere near the level needed to meet the growth of demand. Predicting what will happen with government involvement is tricky but given the low-level of starts it is very unlikely that they will fail to do something. The mortgage indemnity scheme is perhaps a good example of the latest compromises being forced by the government’s fiscal position. Given that the government’s fiscal position is not going to improve soon then this more aggressive use of private sector balance sheets could be the core of the government’s strategy. Either way, this scheme is important and will emphasize the advantage of those housebuilders in a strong financial position.