Which is my number-one FTSE 100 housebuilder?

After a shock announcement, Barratt Developments will overtake Taylor Wimpey as the FTSE 100’s largest builder. But should I buy either of them?

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Image source: Redrow plc

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On 7 February, the FTSE 100‘s Barratt Developments (LSE:BDEV) surprised the stock market by announcing that it plans to buy its smaller rival, Redrow.

The transaction will create the most valuable builder in the index. Presently, this title belongs to Taylor Wimpey (LSE:TW.).

But which would make the better long-term investment? Or given the current downturn in the housing market, would it be best to steer clear of both?

Option 1

The announcement by Barratt was accompanied by gloomy results for the six months ended 31 December 2023.

It’s forecasting up to 14,000 completions during the year ending 30 June 2024 (FY24) — 15% below its FY19-FY23 average.

But of most concern to me, is the big drop in its gross profit margin, to 16%. This compares to 25% during the six months to 31 December 2021.

A fall of nine percentage points translates into a massive £27k reduction in gross profit per home. Inflation is clearly wreaking havoc.

With a 57% higher average selling price (ASP), Redrow describes itself as a “premium homebuilder“.

Bigger isn’t necessarily better, but the enlarged group will cover all price points and have a wider geographical spread. This should help protect it better against a future downturn.

It’s hoped that ongoing annual cost savings of £90m will be achieved within three years.

But it’s unclear to me what’s considered to be an appropriate post-merger valuation for the group.

Barratt’s shares fell 5.7% on the day of the announcement. Redrow’s went up 15%.

The press release says the deal values the smaller company at £2.5bn but, even with the jump in its share price, its market cap is currently £2.2bn.

Until the situation becomes clearer, I wouldn’t want to invest in Barratt (or Redrow).

Option 2

Taylor Wimpey built 10,848 homes in 2023. That’s 16% less than its 2019-2023 average.

It hasn’t made any predictions for 2024. But at 31 December 2023, its order book was £1.77bn (6,999 homes). This means it has forward sales equivalent to 64% of 2023’s completions.

Although its margin has fallen, it’s not down by as much as Barratt’s. But its ASP is higher so it might take longer to return to previous sales volumes.

It’s yet to declare its final dividend for its 2023 financial year, but if it’s increased by the same amount as its interim payout, the stock’s presently yielding 6.6%.

Barratt cut its interim dividend by 56%, so it’s difficult to know what its current yield is.

Also, Taylor Wimpey appears to be better with its marketing. Its website looks more professional and is full of incentives to encourage buyers.

Option 3

The case for avoiding both companies rests on a belief that the housing market won’t recover.

But I don’t share this pessimism.

The Bank of England’s expected to start cutting the base rate soon, possibly as early as June. And the UK economy’s expected to start growing again. Both should improve the affordability of mortgages.

There’s also likely to be an election in 2024. The main parties have pledged to reform the planning system, which has slowed the building of new homes in recent years.

On reflection, if I didn’t have exposure to the UK construction industry through my shareholding in Persimmon, I’d be happy to take a position in Taylor Wimpey.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

James Beard has positions in Persimmon Plc. The Motley Fool UK has recommended Redrow Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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