We have long been worried about house prices here at MoneyWeek. But last May, we finally got worried enough to run a four-page feature (by James Ferguson) explaining why the house price bubble had pretty much run its course. Six weeks later, the rate of house price growth started to slow and it's been falling pretty much ever since. It's going to keep falling, says Ferguson. Given that transactions are down 25% on last year, the stock of unsold property is up 29% on last year and asking prices are falling (down 1% lastmonth, according to Rightmove), "it seems inevitable that next month's growth number will be negative," says Ferguson. House prices will then have dropped on a year-on-year basis for the first time in ten years. Ferguson remains convinced that this is a trend that will only get worse. Extrapolate from today's numbers, he says, and they imply that, by March next year, prices will have fallen by double digits in year-on-year terms.
Look at recent economic statistics and it is hard to disagree with him. As Nick Mathiason points out in The Observer, "never have British consumers been as overextended as they are today". Interest rates may be relatively low, but capital repayments on homes, loans and credit cards mean debts as a proportion of income are higher than they were in the late Eighties, and in the first quarter of this year individual insolvencies rose 23.7%. There's bad news in the corporate sector too, with profits warnings all over the place and winding-up petitions rising 10% in the first quarter of the year. Unemployment has now been rising for five months and economists at ABN Amro think it could go up by 500,000 in 18 months. Unemployment hardly helps household finances, says Mathiason, "and if there is one thing that sparks a housing meltdown, it's a forced seller".
So what does all this mean for housebuilding stocks? MoneyWeek has been wary of these for some time, despite last year's record profits and bumper dividends, and we suggested that readers dump them back in December last year. We were a bit early at the time, but in recent weeks the shares have started to come off, persuading many analysts that now is a good time not to sell but to buy them. Brian Durrant, writing in The Fleet Street Letter, points out that the housebuilding sector is a "different animal" now than it was in the late 1980s, and the firms that survived the turmoil then have learnt from that "sobering" experience. "The number of housebuilders has more than halved since 1989. Bigger companies with lower gearing are controlling a higher proportion of the market, while tight planning restrictions have left market supply constrained." Better still, say the bulls, the house builders are very cheap. Most now trade on p/es between six and seven times, around half the FTSE 100 average.
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The problem with this argument is not that housebuilders aren't cheap, but that they're cheap for a reason. Housebuilding is a cyclical business and shares in cyclical businesses always look cheap at the top of the cycle because the e' in the p/e equation represents peak earnings. But in this kind of sector, earnings can fall very fast as sales prices decline (while the builders may not be as geared as they once were, they're still geared, which means that profits fall exponentially as sales prices fall). These shares may look cheap now, but history tells us they can get a lot cheaper. In 1989, Wimpey traded on a p/e not far off the one it's on now. But its shares still fell 75% in the following 12 months.
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Back in 1989, says James Ferguson, the stockmarket also paid a very low multiple for housebuilders. Persimmon and Wilson Bowden traded on only four times and Belway and Westbury on just three times. But even that turned out to be generous. The squeeze on their margins as prices fell meant that most of the high-volume players ended up in the red and that their share prices plummeted.
Will things be as bad this time round? There are many who say they won't, but the signs aren't good. Last summer, Wimpey indicated that it did not intend to chase sales volumes, but that it would concentrate on maintaining its margins, says the FT. It managed the volumes bit in the first half (they fell 17.5% hardly good news in itself), but margin maintenance has "eluded" it. Interim profits will now be well below last year's first half. Barratt Developments looks no better.
Bad news too from Bovis. Sales of Bovis homes fell in the first half of the year, in spite of the firm doubling its output of social dwellings. Malcolm Harris, the chief executive, said reservations in the first half were down 3% and added that the main problem was the slowness of the second-hand market. Sale prices also fell by 1.6% in the first half of this year. With news flow like this coming out and the fact that it will almost certainly get worse, why hold housebuilders?
