UK HOMEBUILDERS ARE IN A CYCLICAL DOWNTURN - WHICH TO BUY?

Duration: 8:47 1154 transcript words EN summary

Video summary

UK homebuilding stocks have faced a severe cyclical downturn, with major players like Vistry dropping 77% over the last eighteen months and Taylor Wimpey falling 66% from their peaks. While companies such as Barrett Retro and Bellway have also suffered significant declines of nearly 40% to 57%, the sector is currently characterized by subdued sales figures, increasing costs, and reduced gross profits that are impacting net earnings and shareholder payouts. Unlike the extreme leverage and risk seen during the financial crisis, these firms are now navigating a sluggish market environment where investors have priced in several years of slow growth, leading to lower buyback programs and adjusted dividend policies that reflect current uncertainty. Despite these challenges, many companies maintain strong balance sheets with low debt levels and even net cash positions, offering a margin of safety as their stock prices trade significantly below their tangible net asset value per share. For instance, Bellway trades at a discount to its net assets while maintaining an adjusted gearing ratio of just 6.4%, and Berkeley Group utilizes buybacks to return capital given the low cost of debt issuance. This defensive posture allows investors to acquire shares well under book value, though the potential for excess cash generation is currently limited by the slowing business environment. The strategy involves accepting lower current returns in exchange for the possibility of substantial upside if market conditions improve and margins return to historical highs. The outlook for the sector varies by company strategy, with some focusing on growth through sales expansion despite the downturn, while others adopt a more defensive stance by reducing payouts to preserve capital. Analysts suggest that if affordability issues resolve over the next year or two, tangible equity could recover, potentially driving returns above 10% for companies like Perimon that are still operating effectively despite depressed numbers. The investment thesis relies on the belief that this downturn is temporary; those who can weather the storm and accept the downside risk may be positioned to benefit significantly when the cycle turns, whereas firms with higher leverage or weaker fundamentals face greater danger in a prolonged slump. Ultimately, investing in UK homebuilders requires acknowledging the cyclical nature of the industry and the uncertainty surrounding how long the current downturn will last. While some view the situation as comparable to Japan's economic struggles, others argue that the risk-reward profile remains favorable if companies avoid fire sales for liquidity and maintain their core operations. The key decision for investors is whether they are willing to hold through the volatility to capture the upside when the market rebounds, or if they prefer the safety of more established value opportunities elsewhere. As always in investing, there is no crystal ball, but following these companies closely and understanding their individual strategies will be essential as the sector attempts to navigate this challenging period toward a potential recovery.

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Good day, fellow investors. If you go around the world and search for pockets of value, UK homebuilding stocks have been hit pretty hard. Vistry down 77% over the last year and a half, something more. The largest there, Perimon down significantly from the peak a few years ago. Barrett Retro, same story there. 57% down over the last 5 years. Berkeley 29% down a little bit less but stable. Bellway 40%. Taylor Wimp is 66% down since like ever. But this is homebuilding. It's a cyclical sport. So it has ugly times, great times. And if we are back to ugly times, it might give us some kind of returns for those who are willing to take the bet that times might improve going forward. If we go to the stock presentations, look a little bit at the companies, we see a little bit of subdued numbers last reporting period. So sales are we can say flat with then increasing costs or fire sales gross profits are down a little bit that brings down net profits that brings down payouts but it's nothing crazy as it was during the financial crisis when most of these companies were much more levered and risky. Now they're just in a downturn and for now the market is pricing a sluggish few years ahead. If we look at the company, they're doing some buybacks that are lowered compared to the past. The dividend is lowered but the balance sheet is still there. And if you look at the tangible net asset value per share, it is significantly higher at 117 pence than the stock price here. So as a margin of safety, one could say you are buying something below tangible book value. Of course, it's not just book value. It is also cash flows. What can you get on that book value? The business is slowing down. Therefore, lower payouts, lower excess cash and that has to be repriced into the share price. We are seeing a new shareholder reward policy. So, not 7.5% of net assets, but now 4% of net assets. And with lower payouts, the price also goes down as investors don't know how long will this last. But that's exactly the uncertainty you might want to look at as a value investor because it is better to buy something at the same price now when the ordinary dividend is lower and the potential is that it goes back to where it was then buy it here and then see it go down and see also the stock price go down 50%. There is not much debt there. Net cash position. So that looks okay. Adjusted gearing 6.4%. And if you look at what the business did over the last decade since the great financial crisis, the net profits were there but the payouts were very little. As they were building their land bank, they were building their equity. And you can see here the total equity. The key question is when will it return to the previous splendor? What's the upside or when will the upturn come? That is of course the million-doll question. However, this is more defensive given the low debt, given the lower payout. If they cut the payout more, it will go even lower. However, if margins return to historical highs, market booms, even if some would say that would be a miracle in the UK home cycle, but if there is a s shortage, it might work. If you're happy with the current return, accept the risk on the downside, accept the upside, it might be interesting. Four pennies is already something 5%. If that is held, it's a nice bonus to wait it out. But again if that is health bell way okay growth they are going for growth going for the sales accepting the business downturn as a temporary thing and trying to get out stronger later. Strong balance sheet there. Net asset value 3,000 per share. Again the same discount here compared to the net asset value. operating cash generation a little bit negative. They're just keeping business as usual, keep going and if they nail that cyclical downturn and it gets better, they will be at the forefront of the growth. Next, Berkelet is a bit different as a business, the fancy part of homebuilders. I think they are reducing land creditor over time they are returning to shareholders but if you look at the guidance the pre-tax profit divided by the four years it is let's say in line with everything else that we have seen priced there in the market and that is return to shareholders via buybacks and smallish dividends. the focus on buybacks as there is a discount some debt issuing very low coupon. So if we go to the next one, ugly situation here. If you get the rebound, you will do well. They are going on the buyback share of things because they say things are cheap. Net assets are 7 billion compared to the market capitalization and they are buying a pound for 50 p. That's the goal. Perimon also down. They are keeping their business just turning ahead working okay a little bit down on the numbers but still looks good. The outlook is still there. Analysts say that if affordability and everything works well over the next year or two tangible equity to recover grow the returns should be higher than 10%. So when we sum up on the homebuilders, some are more levered bets, some have buybacks, some have dividends, some are just depressed as you don't see the upside because they are more defensive, some are keeping the growing. So each have their own business strategy in this scenario. All we can know is that there is a downturn. If the downturn passes, some will benefit more, some will benefit less. those that went defensive. But that is investing. We don't have a crystal ball. We can discuss it. We can start following it. I always need a few quarters learning, writing up, catching up, reading your comments like I did on the Vistry video we made a few days ago. And really great comments. UK is a dying economy like Japan. inside they're selling funding government funding not having a loss if they wouldn't have done the fire sales for liquidity the upside is greater than the downside the risk and reward and I'm putting it on the covered situation in my research platform much better than some other situations that look like value but are very risky like the vonovias for example but still this is the UK You always need to mind the gap. What's going on? Are you taking this value? Are you ready to double down if it turns even more negative for the UK in the next year or two? I'm looking forward to your comments.