Is it time to buy back into house builders or there is more pain to come?
To say it’s been a rollercoaster ride for shareholders in Barratt Developments (LSE: BDEV) would be somewhat of an understatement. The shares rose six fold from 2000 to 2007. They’ve since fallen some 95%. In fact, a few days ago Barratt was trading at 35p, less than the 36.5p in dividends it paid over the last twelve months.
Five of the seven major housebuilders have provided trading updates over the last week, with Barratt providing the final piece of the puzzle this morning. The picture across all five companies has been very similar. Completions are down by roughly a third on last year and each company has shrunk its operations to match, sadly with the loss of many thousands of jobs. Not surprisingly, dividends have been slashed or disappeared completely.
Bad though the news was, much of it was anticipated. In fact, shares of housebuilders have rebounded slightly over the last couple of days, due to relief that the figures weren’t even worse.
So far the write-downs on land and work in progress have been relatively small too. Taylor Wimpey (LSE: TW) revealed the largest write-down, wiping 11% off the value of its holdings. If house prices fall further, additional provisions will need to be made, which will hit profits and weaken already fragile balance sheets.
Some analysts are predicting write-downs of up to 30% over the next couple of years, if the pattern of the housing slowdown in the early 1990s is repeated.
A story of debt
Although all house builders have seen their share prices slide over the last year, those with the highest debts have suffered the worst losses. Of the seven major players, Barratt and Taylor Wimpey, with debts of £1.7bn each, are in the weakest position. Barratt appears to have agreed £400m of refinancing it needs in the short term, subject to final documentation, but it’s not clear how much extra interest it will be paying. Taylor Wimpey is still looking for the £500m it requires.
With less debt, but still a worrying amount relative to the size of their business, we have Persimmon (LSE: PSN) with £900m and Redrow (LSE: RDW) with £225m. With a more comfortable level of debt, for the time being, we have Bellway (LSE: BWY) with £250m and Bovis (LSE: BVS) with £94m. Berkeley (LSE: BKG) has virtually no debt. It’s regarded as the most astute reader of the housing market and it slimmed down its business in 2004 and shifted towards urban regeneration.
The decline in house sales
The root cause of the house builders’ current problems is the decline in house sales. It looks likely that we’ll see less than 100,000 completions in England this year. Sales have only dipped below this level once since 1955, and that was back in 1981. In the early 1990s, sales also declined by a third but over a period of five years. This year’s decline happened almost overnight.
With housebuilders carrying high levels of debt they’ve had no choice but to cut back. Cash flows have also been strained by a couple of other factors. Payments for land are increasingly delayed until construction begins and substantial amounts are still due for past developments. The proportion of flats being built, almost 50% of all new properties as opposed to 15% a decade ago, also makes it harder to instantly react to market changes. You can’t really leave a block of flats half built but it’s much easier to stop a development of detached homes midway through.
Where do builders go from here?
Reading between the lines of all the recent trading statements, the builders seem to think the decline in sales has levelled off. Whether this is indeed the case depends on the availability of mortgages.
There have some signs of improvement recently with a couple of lenders cutting rates but this is still a market in a state of flux. The Council of Mortgage Lenders has sub-titled their annual conference in early December as “After the storm”. Perhaps they know something we don’t.
The other key issue, of course, is what happens to house prices. There have been some falls to date but their impact on profits has been dwarfed by the decline in volumes. You can take your pick of house price predictions, ranging from a levelling off to a decline of 70%. We’re in uncharted waters here though, and no one has a clue what will happen next.
All this makes investing in housebuilders the classic binary bet. You’ll either make a packet or lose the lot.
The key is assessing the likelihood of the two outcomes. I suspect that at least some of the seven companies won’t survive in their current form so I would tend to steer clear of the most debt-laden such as Barratt and Taylor Wimpey. Their borrowings are so great that the banks are effectively in control and shareholders rarely come out smiling when this happens. Those with less debt look a bit more appealing and if I had to pick any of them, I’d go for either Persimmon or Berkeley. In all honesty, I’d rather hunt for value elsewhere.
More: Demolition Work
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