The housebuilder’s profits are booming, but there’s still a bit more to go for, says Phil Oakley.
Britain’s housing market is in rude health. In London and the southeast of England it is positively booming. So it’s not surprising that housebuilding companies, such as Bovis, are reporting stonking increases in their profits and dividends.
The government’s Help To Buy scheme (which provides taxpayer guarantees on mortgages to encourage banks to lend) is effectively underwriting a significant chunk of demand for builders of new houses, and this does not look like it will end anytime soon.
However, the shares of housebuilding companies, like the market they operate in, have a tendency to move from boom to bust. The recessions of the early 1990s and late 2000s wrought havoc with their profits and finances. Shareholders were frequently asked to cough up more money to put them back on an even keel.
These painful experiences should have taught investors in housebuilders some valuable lessons. They are not shares to buy and forget about, where you can simply sit back and reinvest your dividends and see your wealth compound. On the contrary – these are trading stocks.
Although the managers of these companies say they can effectively manage the ups and downs of the housing-market cycle, history suggests that despite their best intentions, they can’t.
Yes, they may be able to stop their companies from going bust – but you should expect that the future has a good chance of being somewhat similar to the past and that profits will move up and down a lot. So from time to time, investors in housebuilders need to get involved in a guessing game.
You have to work out when to buy and when to sell. So is there any money left to be made here? Or should you steer well clear of the shares?
Housebuilders’ profits depend on two key variables. One is the selling price of the houses they build. The other is the price they pay for the land they build them on.
Opinions on the outlook for house prices are ten a penny. Trying to predict them is not easy. All I’d say is that, relative to wages and rents, they don’t look particularly affordable. If they were, then schemes such as Help To Buy wouldn’t be needed.
Builders do have some influence over the prices they receive – for example, they can sell more higher-priced family houses, instead of flats, as Bovis is doing. However, other than that, they have to rely on the general strength, or otherwise, of the overall market.
But where housebuilders can add real value is in where they build, and how much they pay for land. If you need a reason to be bullish on the outlook for Bovis and its shares, then its land-buying skills could hold the key to higher profits and returns on capital employed (ROCE). This, in turn, could lead to higher dividends and a higher share price.
Bovis has a land bank of 17,702 plots, all of which have planning consent. It has added 4,600 new plots this year. When working out what to pay for land, builders work backwards from the expected selling price of the properties they aim to build on that land.
Bovis reckons that on its newly acquired land, it will get a ROCE of between 25% and 30%, which would be very impressive.
Then there’s the company’s strategic land bank of 19,608 plots, which do not yet have planning permission. This can be bought far more cheaply than consented land, with the hope of a big rise in value when, and if, planning permission is eventually granted.
A full three-quarters of Bovis’ land is in the southeast of England, where demand is high – especially for family houses.
Bovis is confident that it can ramp up the rate at which it builds new houses from around 3,650 properties in 2015, to between 5,000 and 6,000 in a few years from now.
As long as house prices remain relatively steady, then this big increase in building will feed through to a large jump in Bovis’ revenues. Not only that, but with the prices the company has paid for land already known, Bovis expects to see profit margins and ROCE increase significantly.
During the last year, Bovis’ ROCE has been 13.4%. It expects this to rise to 16% by the end of this year, and to reach at least 20% by the end of 2016.
If Bovis can do this, then its profits and dividends are going to be a lot higher than they are at the moment. The dividend payout for this year will almost triple to 35p per share, and will be at least that level in 2015 as well, which gives the shares a decent yield.
If the market remains healthy, then investors can also expect to see bonus payouts on top of the regular dividend.
Is there anything left to play for?
This all sounds very encouraging – but how much of this rosy outlook is priced in to the shares? It looks to me as though there may still be a bit more to go for.
The share price is up by just over 6% this year, after making very strong gains in 2013. City analysts expect Bovis to deliver after-tax profits of just over £100m this year – that’s about 25% below its peak profits during the last cycle, after adjusting for inflation.
People are rightly wary about the sustainability of Bovis’ profits. And it’s true that a multiple of 1.3 times its net asset value (NAV) is no bargain. But if Bovis can ramp up production in a benign market, then its profit momentum may attract fresh buyers. The bull market in houses and housebuilders’ shares may still have some way to run.
Verdict: a speculative buy
Bovis (LSE: BVS)
Share price: 852p
Market cap: £1.13bn
Net assets (June 2014): £835m
Net debt (Jun 2014): £45.3m
P/e (prospective): 11.1 times
Yield (prospective): 2.56%
Price to NAV: 1.3 times
Interest cover: 14.3 times
Dividend cover: 3.4 times
Target price: 990p
D Ritchie (CEO): 120,971
J Hill (CFO): 37,058
I Tyler (Chair): 0