Housebuilding stocks succumbed to the market volatility in the aftermath of the EU Referendum vote, however their foundations remain unshaken. There is a chronic undersupply of housing in the UK, housebuilders are well-capitalised and there are a number of schemes in place to keep the sector building.
Housebuilding stocks ended last week on a high, dominating the London Stock Exchange’s list of top 10 risers. Bovis Homes surged 12%, while Bellway was up 9%, Crest Nicholson up 8%, Taylor Wimpy up 7%, Berkeley up 7%, Barratt Developments up almost 7% and Persimmon up over 6%.
However, these modest gains leave share prices a far from the highs seen before the UK decided to quit the EU. For this reason, analysts at UBS believe housebuilding stocks represent good value. They said that while the whole sector is cheap, Bellway, Berkeley and Persimmon offer the most attractive risk/reward.
UBS said that, in contrast to 2008, the sector is well positioned to absorb a downturn:
- Balance sheets are strong with a sector net cash position and only £2 billion of land creditors vs total leverage of £6 billion in 2008;
- No visible signs of distress in the financial system, hence there is no reason to expect any sharp reduction in mortgage lending;
- Help to Buy remains in place which should assist new build transactions;
- The land market running up to H116 was benign, meaning land bank margins are at record levels compared with the compressed levels of 2008.
According to UBS, changes to unemployment rates and shifts in consumer confidence will likely determine trading conditions. Analysts expect FCF generation to remain strong as land prices adjust and companies reduce land buying and switch focus to cash generation.
“The c40% share price fall of the sector post EU referendum is overdone, and suggests an attractive entry point over its forecast horizon,” UBS analysts said in an economic note. “We recognise the range of potential outcomes remains wide, but believe the market is relatively close to pricing in 10% house price deflation and a 25% volume drop, which we estimate implies a further 10% share price downside.
“Our new base case of -5% price and -15% volume cuts estimates by c40% and PTs by 35%, on average; but we see average upside potential from here of c40% across the sector on a 12-month view. Until clarity improves we believe volatility is likely to remain high, but we see upside potential in the sector.
“We expect dividends to be maintained in our base case scenario; with the sector on an average 9% yield, which is 1.5x covered by FCF and 1.4x by EPS in 2017E on our new forecasts,” analysts said. “Our upside scenario, which assumes no material deflation and slight volume growth implies c70% share-price upside, on average; and our downside scenario (a further 10% volume drop to -25% and -10% price deflation) suggests a further 10% downside to the sector.”
IMAGE CREDIT: Rafael Matsunaga