Shares of MJ Gleeson (LSE: GLE) are up over 3% to a new all-time high of 779p after the housebuilder released a positive trading statement today. The specialist in low-cost homes in the North of England and strategic land in the South said the forward order book of the former division at the end of November was up more than 30% on last year, while demand at the latter division continues to be strong.
Gleeson’s shares have more than 10-bagged since their financial-crisis low in December 2008. However, despite this performance and an apparently benign outlook, there are three reasons I’d sell the stock today.
Why I’d sell
First and foremost among the three reasons is valuation. A forward price-to-earnings (P/E) of 14.7 may not seem particularly demanding for this fast-growing business. However, a price-to-book (P/B) ratio of 2.5, an operating margin of over 20% and return on capital employed of over 25% have reached the sort of levels we see at the peak of the housing cycle. Investors who have enjoyed a 10-bagging return from Gleeson bought the stock at the bottom of the cycle when the P/B was just 0.2, profit margins and return on capital were negative and the P/E off the scale.
In addition to the current top-of-the-cycle valuation (and at a time when consumer debt is at historically unprecedented levels), I’m concerned that housebuilders’ bumper profits and dividends are starting to attract unfavourable political scrutiny. The government’s Help to Buy scheme has done little to close the gap between housing starts and new household formations.
Finally, we’re seeing some huge share sales by shrewd veteran directors at a number of housebuilders. On this front, Gleeson notified the market on 8 November of a 1.5m sale at 726p a share, followed by a further 1.5m at 725p on 23 November, which together netted close to £22m. The sales were made by North Atlantic Smaller Companies Investment Trust and Oryx International Growth Fund, both part of Harwood Capital. Gleeson non-executive director Christopher Mills is the founder of Harwood and the investment manager of both funds.
Cyclical recovery
Tullow Oil (LSE: TLW) is the opposite of Gleeson. Over the period the housebuilder has 10-bagged, Tullow’s shares have fallen almost 70%. Furthermore, the fall to 179p is even more dramatic when taken from a high of over 1,500p in 2012, before the oil price crash.
Today, Tullow is in a similar position in many respects to that of Gleeson in December 2008. The oil company’s profit margins and return on capital are currently negative and the P/E is off the scale. Its P/B of 1.2 isn’t at the discount Gleeson displayed in its darkest days but it’s far below the housebuilder’s current 2.5.
With the oil price having turned upwards, Tullow looks to be at the start of a cyclical recovery. In a trading update last month, the company increased its production guidance for the current year, reduced capex guidance and said it expects to deliver free cash flow of $0.4bn.
Net debt stood at $3.6bn at the end of October (down from $3.8bn at the end of June) and Tullow has refinanced $2.5bn of reserve based lending credit facilities with its supportive banks. I expect debt to continue falling fairly rapidly, as free cash flow rises on an improving oil price, increasing production and operational cost savings. On this basis, I rate the stock a ‘buy’.
