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Why I believe the Barratt share price could soon return to 650p

Today’s trading statement from FTSE 100 housebuilder Barratt Developments (LSE: BDEV) confirmed my view that these shares could soon return to 650p, a level last seen in January.

The 7.4% forward yield continues to be supported by net cash, which is now expected to be “around £550m” at the end of June. That’s 10% ahead of previous guidance. Management has confirmed that the firm remains on track to return £1.9bn of cash to shareholders during the five years to November 2019.

Making houses more profitable

So far this year, Barratt has sold an average of 302 houses a week, compared to 299 during the same period last year.

However, the company says that engineering and design changes to its housing range “should increasingly benefit” the firm’s profit margins. The new designs are already being constructed on 85 sites, with more planned.

Today’s sales figures suggest to me that pricing remains stable. Total forward sales are 2.5% higher at £3,286.7m, compared to the same point last year.

Despite concerns that higher costs could reduce profit margins, this doesn’t yet seem to be a problem. The group’s operating margin rose from 17.8% to 17.9% during the first half of the year and management says it is “on track in implementing our margin improvement initiatives.”

I’d still buy

It seems possible that the UK housing market may have peaked. But demand for new houses appears to remain very strong.

I expect Barratt’s performance to be sustainable while the UK economy remains stable. With the stock trading on less than 9 times earnings and offering a cash-backed 7.4% dividend yield, I’d rate these shares as an income buy.

An alternative choice?

If the outlook is bright for housebuilders, what about other housing-related stocks? One of the companies I rate most highly in this sector is kitchen supplier Howden Joinery Group (LSE: HWDN).

This company sells directly to the trade, meaning that it supplies over 400,000 small builders and other tradesmen from its network of about 650 branches. Although some of these customers are building new houses, many of them are fitting new kitchens to existing homes. So the company’s exposure to the housing market and the economy is slightly different to that of housebuilders.

Are further gains likely?

Howden shares have doubled in value over the last five years. One reason is that this is a very profitable business. The group’s return on capital employed (ROCE) was 41% last year. This means that the firm generated £41 of operating profit for every £100 invested in its operations. That’s an outstanding figure.

A high ROCE generally results in strong cash generation, and that’s certainly the case here. Howden’s net cash balance has risen £95.4m to £241.1m since 2012. Over this time, the firm has also bought back nearly 5% of its shares and increased the dividend from 3p to 11.1p per share.

Too late to buy?

Earnings are now expected to climb 7% to 31.9p per share this year, while the dividend is expected to rise to 11.9p. These forecasts put the stock on a 2018 P/E of 16.1, with a prospective yield of 2.3%.

Although I think this is a fair price for a high quality business, the risk of a slowdown in consumer spending means that these shares aren’t without risk. I’d rate the stock as a hold at current levels, but would be happy to buy on any dips.

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Roland Head has no position in any of the shares mentioned. The Motley Fool UK has recommended Howden Joinery Group. 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.