MARKET COMMENT
Housebuilding Shares Looking Cheap

By Stuart Watson (TMFTiger)
December 17, 2003

Last week's interim report into housing supply confirmed what many people have been suspecting for some time. It suggested that the UK would benefit from a significant increase in the number of new houses built each year. So is this good news for housebuilding shares?

The market doesn't seem to think so. Shares of the major housebuilders have hardly moved at all since the report came out. Perhaps that's because the report's findings were not that unexpected and the detail of how the shortfall in new houses will be plugged is yet to be ascertained.

The report itself (particularly this section - pdf file) has some useful background information for investors. It shows that the housebuilding market is still fragmented, with the top ten housebuilders accounting for less than 40% of the 183,000 new houses built in 2002 (with the largest company having a market share of just over 7%). This suggests that there is still plenty of room for growth by acquisition, although the industry doesn't offer great economies of scale.

The report also highlights how sensitive profits can be to changes in house prices. It reckoned that a 1% change in house prices can affect profits by up to 8%. That said, it was interesting to note that profit margins remained relatively robust during the difficult period of the early 1990s, not falling below 10%. They're currently just over 15%.

Here are the vital stats for the top five UK housebuilders, as measured by market value.

Company               Share     Forward   Forward  
                      Price       P/E      Yield

Barratt (LSE: BDEV)    493.5p     5.0       3.9%
Berkeley (LSE: BKL)    831.5p     6.6       2.5%
Persimmon (LSE: PSN)   473.5p     5.8       3.7%
T Woodrow (LSE: TWOD)  244p       6.7       3.3%
Wimpey (LSE: WMPY)     332p       5.2       3.3%

So all of the top five can be bought for a P/E of under seven, implying investors think that the current level of profitability is unsustainable. However, we've already seen two upbeat statements this week, from Wimpey and Persimmon. Profit growth of almost 10% for the following year is currently being forecast for all these companies, with one exception. At Taylor Woodrow, a 25% increase is expected as the full effect of its recent acquisition of Wilson Connolly comes though. Dividend yields across the sector are still pretty stingy though, with the majority of profits being held back to buy land.

If the final report does lead to more houses being built, the majority of the increase looks likely to be at the lower end of the scale and in social housing. This won't boost builders' profits by that much. However, the builders should certainly benefit from a reduction in the red tape surrounding the planning process. The main concern, from an investing standpoint, is probably increased government intervention in the housing market. But even with this, and the risk of a house-price slowdown or fall, the sector doesn't look overly expensive.