London-focused housebuilder Berkeley Group Holdings (LSE: BKG) saw its share price fall 5% this morning. In a trading update the firm said it was on track to hit profit forecasts but wouldn’t be expanding its building programme.
Berkeley said that market conditions for buy-to-let investors and home movers are being affected by high transaction costs and limits on mortgage borrowing. These, coupled with “the time and complexity of getting on site following planning approval,” mean that the firm isn’t able to increase production.
Instead, it’s sticking to a plan that’s expected to produce “at least £3.3 billion of pre-tax profits for the period from 1 May 2016 to 30 April 2021”.
I’d keep buying
These shares look tempting to me following today’s decline. I can see several reasons why they could soon return to growth.
A sector-leading firm: Tony Pidgley, Berkeley’s founder and chairman, has been running this firm since 1976. The trailing 12-month operating margin of 30% is the highest in the sector, and Mr Pidgley has repeatedly shown himself to be a good judge of market conditions.
Profits: Pre-tax profit guidance for 2016-21 was upgraded by 10% to £3.3bn in December. Profits will peak this year, but broker earnings forecasts for 2018/19 have risen by 6% over the last three months. Further upgrades are possible.
Cash: Net cash was £632.8m at the end of October. It should be higher at the end of the year. The company plans to return a further £1bn (£7 per share) to shareholders by the end of September 2021. That’s equivalent to 18% of the current share price.
The shares offer a forecast yield of about 5% plus the prospect of further buybacks. On 7.6 times forecast earnings, I’d be happy to buy.
My top pick
However, I already own shares in another housebuilder, Redrow (LSE: RDW). This FTSE 250 firm is also chaired by its founder, Steve Morgan, who regained control of the firm in the wake of the financial crisis.
Redrow homes are more affordable than those of Berkeley, with an average selling price of £330,000 versus £719,000. The group was slower to recover after the financial crisis, but is now delivering the financial returns and surplus cash we’ve seen elsewhere in the sector.
Here are three reasons why I continue to rate Redrow as a buy today.
Profits: Net profit rose by 27% to £143m during the first half of the current year. Analysts expect a full-year figure of £291.7m, a 15% increase on 2016/17. Profits are expected to rise by a further 9.5% in 2018/19.
Rising margins: Redrow’s operating margin rose to 19.7% during the first half, while return on capital employed hit 25%. These are good figures that place it above several major rivals.
Cash generation: The group’s free cash flow has improved rapidly over the last 18 months, resulting in dividend growth of 70% in 2016/17 and a forecast increase of 39% for the current year. The stock now offers a forward yield of almost 4%.
I believe this company should continue to deliver improving results while market conditions remain stable. With the stock trading on just 7.5 times forecast earnings, my buy rating remains in place.
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Roland Head owns shares of Redrow. The Motley Fool UK has recommended Redrow. 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.