Interactive Investor

Edmond Jackson's Stockwatch: Rekindle your passion for this housebuilder

19th September 2014 00:00

Edmond Jackson from interactive investor

Why did shares in housebuilding and construction group Galliford Try fall in response to excellent 2013/14 annual results? Does it represent caution - UK housebuilding shares have had a great run and uncertainties over interest rates and politics are henceforth likely to weigh? Might it be a portentous sign of a tired bull market generally, how cyclicals are weakening?

Galliford has dropped nearly a pound this month to 1,225p currently, having turned volatile after a strong bull run from 2011.

From last April to July the price fell from 1,360p to 1,060p then recovered, possibly in anticipation of good results. Notice from the table how the consensus estimate is for another big profits jump during 2015/16, which, if reasonable implies a prospective price/earnings (P/E) under 10 and dividend yield near 6%. Yet investors are not swallowing this, being wary not to push luck with the surprise upturn for UK housebuilders, mindful how the projections could represent exuberance among managers and analysts. I have similarly noted with regard to Barratt Developments, some in the industry reckon pent-up demand after the 2008 financial crisis and recession could extend the current cycle to 2018.

The latest results have a flavour of "as good as it gets" in this industry with double-digit rises all round: pre-tax profit up 28% to £95.2 million on revenue up 21% to £1.768 billion; earnings per share up 32% to 94.6p and a notable 43% jump in the dividend to 53.0p with the board confident to reduce earnings cover from about 2 below 1.8 times. Return on net assets has risen by 25% to 20.8% and this September has seen a clutch of building and development contracts worth near £1.3 billion in terms of revenue and development potential. While it is hard to estimate when their results will be accounted for, the 2015/16 projections have reason.

Operating margins continue to rise

Galliford Try - financial summary
Consensus estimate
Year ended 30 June2010201120122013201420152016
Turnover (£m)12221284150414671768  
IFRS3 pre-tax proft (£m)19.241.763.174.195.2  
Normalised pre-tax profit (£m)21.634.760.373.3 111133
Normalised earnings/share (p)18.53156.368.892.6106127
Earnings/share growth rate (%)-67.667.58.722.334.614.719.8
Price/earnings multiple (x)    13.111.49.5
Cash flow per share (p)-35.3-27.620.40.6   
Capex per share (p)2.37.69.66.3   
Dividend per share (p)10.913.720.533406170
Yield (%)   2.73.355.8
Covered by earnings (x)22.32.82.12.361.71.8
Net tangible assets per share (p)368405430456   
Source: Company REFS.

Obviously the government's Help to Buy scheme announced at the March 2013 budget has been a major stimulus, not even Galliford's chief executive could anticipate. Exactly two years ago he said in an interview: "We're in the middle of a housing crunch" although Galliford was already distinguished as the only firm building 20% more houses than during the 2007/08 peak of the previous cycle. "I don't see any house price inflation for at least three years, probably longer" he added.

Macro influences can blur awareness of the company's strategy, born of the 2009 downturn, to become one of Britain's biggest housebuilders under the Linden Homes brand. A record 13,900 plots focused on the prosperous South East puts the group in a strong position and its growth has been achieved with modest financial gearing, end-June net debt being only £5.1 million. Housebuilding operating margins continue to rise, lately 15.1%. which was ahead of expectations for the financial year, and management looks for 18% in the current year.

Positive factors persist

I initially drew attention at about 600p in April 2012 when earnings were recovering smartly and implied a P/E multiple of about 10, reducing to 9 times - relative to other housebuilders' P/E's in the mid-teens, "so unless there is a stall in the housing market...there is scope for Galliford's multiple to improve." I also liked a risk/reward profile supported by Galliford's southern bias (where employment and wages have been firmer), low exposure to first-time buyers, a strong balance sheet and 5% prospective yield.

These factors persist, the only real difference now is possibly being "mid" the current housebuilding cycle - or "late" if there are political/interest rate upsets over the next six to 12 months. In a similar way that various housebuilding shares started rising from early 2011, mind the stockmarket's tendency to anticipate.

Notice a definite theme of stocks consolidating - even falling on good trading reports - e.g. Thomas Cook Group, Thorntons, Topps Tiles just recently. This trend appears manifest especially among cyclical and recovery plays, as if investors are wary that margin improvements may be reaching limits and the UK consumer recovery has yet again involved borrowing. While it's not yet possible to identify any conspiracy of factors for a downturn, investors have enjoyed very good runs in such stocks and are inclined to lock in gains; meanwhile potential buyers wonder how to approach the volatility.

Curdled situation

Writing hours ahead of potentially momentous UK political change and divorce from Scotland, there's an obvious current risk affecting shares generally; otherwise and as discussed in my macro pieces a theme of "muddling through" continues - e.g. lately the Ukraine crisis and US Fed winding down its bond purchases - than any jolts to the financial system. Weaker Chinese economic numbers have raised concerns, however serious they prove.

The key question affecting sentiment towards quality cyclicals such as Galliford, is whether a modest/weak growth scenario combines with ongoing loose monetary policy (i.e. interest rate rises being very slow and small when they come) for a classic Goldilocks scenario in shares: neither too hot to cause inflation and upsets, nor weak enough to cause recession. The currently curdled situation is making investors pause and lock in gains; but in the absence of a genuine shock, if companies like Galliford continue to post strong results then buyers will return.

For more information see gallifordtry.co.uk.

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