There’s strong demand for new homes, underpinned by the Help to Buy scheme and a competitive mortgage market. Big builders can be bought at earnings multiples as low as 8.6 and with dividend yields as high as 10.4%. Investing in our trio seems like a no-brainer.
However, I’m far from convinced it’s wise. Indeed, after a decade of unprecedented economic stimulus, I see think that 2020 could be disastrous for these stocks.
The Labour Party hates companies making ‘unreasonable’ profits, especially from supplying the basic human needs of water, food, warmth and shelter. In recent years, big housebuilders have been the standout flaunters of the kind of supranormal profits, extravagant boardroom bonuses and lavish dividends that Labour despises.
Furthermore, it blames the big builders for a dysfunctional UK housing market. I would expect its policies to put Barratt, Persimmon and Taylor Wimpey on a punitive diet of thin profit-and-dividend gruel — at best. And I’d expect their shares to crash in the event of a Labour general election victory.
Housebuilders’ profits have skyrocketed since the introduction of Help to Buy in 2013. The scheme is set to end in 2023, but from 2021 will only be available to first-time buyers and with regional caps on the price tags builders can put on Help to Buy homes.
Help to Buy has faced criticism from across the political spectrum, and while a U-turn on policy seems unlikely, I think an early end to the scheme would smash Barratt, Persimmon and Taylor Wimpey’s share prices. Even as things are, in 2020, I’d anticipate their shares coming under pressure, as the market looks increasingly to the profit-sapping prospect of the reduced dose of Help to Buy steroids in 2021.
A ‘desire’ for home ownership shouldn’t be equated with ‘demand’ in the economic model of supply and demand. This can be easily illustrated. If banks were to stop underwriting new mortgages tomorrow, the desire for home ownership wouldn’t change, but demand would fall off a cliff. The only demand for companies like Barratt, Persimmon and Taylor Wimpey would be from a small number of cash buyers.
In an economic downturn, banks inevitably see a rise in bad debts, and become more risk-averse, tightening their lending criteria (including approving fewer mortgages). A disorderly Brexit or damaging continuing period of uncertainty are still not off the agenda, and could yet catalyse a contraction in the UK economy. Furthermore, even if the divorce from Europe goes smoothly, history tells us we’re moving into a period in which a recession is becoming increasingly overdue.
Blink of an eye
Earnings coverage of housebuilders’ dividends is already way below the widely-regarded safety level of 2 — and is as low as 1.1 in the case of Persimmon and Taylor Wimpey.
The trouble with housebuilders, when the economic cycle turns against them, is that falling profits and write-downs of inventories happen so fast, and are of such a magnitude, that strong balance sheets become weak balance sheets — and dividends disappear — in the blink of an eye.
For all of the above risks and reasons, I see Barratt, Persimmon and Taylor Wimpey as stocks to avoid today.
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G A Chester has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.