Stockwatch: Buy this share on the dips

A drop in the share price of FTSE 100-listed housebuilder Taylor Wimpey -down from 135p to 123.5p, around a latest trading update - can imply it is running out of steam. A news context of house price rises moderating, the general election approaching and the shares' modest multiple depending on ambitious forecasts, might combine for a sense to lock in gains. Yet January often sees housebuilding shares peak in the short term, after their prior-year business summaries. There are reasons to consider why the current industry cycle has plenty further upside - i.e. share price dips offer buying opportunities.

"Company starts 2015 in an excellent position"

The update has PR blandishments e.g. a lower rate of house price growth serving to "create a healthy and more sustainable housing market" than hurt company margins, and "a reduced risk of UK interest rate increases in the near term." Fair enough, but mind a point of scepticism about serial UK housing booms followed by quasi busts, that housing is nowadays priced high relative to wages.

By August 2014, average home values had risen over five times annual earnings compared with a peak of about 5.75 in summer 2007 then slide below 4.5 in 2009. From 1980, however, the long-run average is more like 4 times - the relatively recent de-coupling being associated with more aggressive lending and looser monetary policy.

Housebuilding cycles may, therefore, be dictated more by changes in credit terms: the (mortgage) lending boom that peaked in 2007/08, then Help to Buy from 2012 - effectively taxpayer-subsidised, cheap credit. Sceptics therefore wonder what will be the fall-out when interest rates rise to a "normal" level. As if marking an adjustment in the market already, lower mortgage approvals in the fourth quarter of 2014 have led to expectations of lower like-for-like housing transactions in the first half of 2015. But "the new normal" has been ratcheted down and European deflationary risks are keeping rates low.

UK general election could defer home purchases

A chaos is already apparent, five months before the event, with Tories and Labour squabbling over the incidental matter of TV debates. Opinion polls vary weekly as to the election outcome with possibly another to resolve a hung parliament. This uncertainty could hurt the traditional spring home-buying season, this year, although no political party will do much radical.

Encouraging home ownership is now "consensus" and Labour's proposed mansion tax doesn't affect this area of the market. But in the mid-market it still only needs some people to sit on their hands for a chain effect to start, so the current selling of housebuilders' shares has a rationale: a period of consolidation may be underway. Equally this could create a busier post-election period for home sales, boosting shares again.

Longer-term demand prospects remain attractive

Ongoing social trends of marriage breakdown, more single households and net immigration - versus shortage of housing stock - put housebuilders in an overall good position. Despite controversy over immigration the UK seems unlikely to take the economic risk of leaving the EU, and with the eurozone stagnating net immigration is likely to continue for the foreseeable future. Barring a wider deflationary catastrophe, housebuilders could see their recovery from the 2009 trough extending for a cyclical upturn much longer than most.

Taylor Wimpey reminds us in its update, 2015 is only the first year in ambitious targets to 2017, described in a 13 May 2014 presentation as a "sweet spot period for financial performance." This helps explain the high consensus forecast (see table) for nearly 34% earnings growth this year after 43% projected for 2014 - meaning a very low price/earnings multiple of about 12 falling to 9 times, relative to strong earnings momentum. Naturally the market wants to see more evidence, also considering the aspect of cheap credit fuelling growth. But the rating is modest enough to allow some shortfall, if this medium-term scenario is at all realistic.

Dividend re-rating could also drive the stock

The consensus for a rise in the payout to 8.8p a share for 2015 is based on three brokers targeting 8.5p to 9.1p last November/December, as if some guidance from management was involved. Mind, this is a radical improvement considering the company only returned to the dividend list in 2012 and its 2013 payout was very modest also. But if the dividend can be anywhere near this target and sustainable, the stock would re-rate in order to price it more competitively - say for a yield nearer 4-5% than the 7% implied. So the dynamics how yield can affect capital value here, are also interesting to follow.

Certainly it is time for the company to prioritise shareholder distributions alongside land acquisition: the trading update cited net cash of about £113 million at end-2014, up from expectations of about £100 million only two months previously. "This is largely as a result of outperformance in underlying trading, whilst at the same time continuing to invest in our landbank as we approached our optimal scale."

The end-June balance sheet had only £100 million longer-term bank loans and £147.6 million pension fund obligations relative to £2,559.3 million net assets, so the company is not exposed with high debt should the cycle weaken anytime. Despite scant intangibles, net assets per share of 72.2p clearly puts more emphasis on proving the earnings and dividend forecasts.

Shaping up as a "recovery-to-growth" play

Taylor Wimpey has made spectacular progress since I drew attention repeatedly in 2009, initially at 15p in January before a 1 for 1 open share offer at 25p addressed debts and enabled investment. Sharp falls in house prices and mortgage rates were also triggering demand back then, and the stock traded at a big discount to underlying assets.

Yet from being a plain recovery play it's possible to stand back and see long-term growth opportunities for mid-tier housebuilders, despite some cautionary factors presently triggering profit-taking. Not to make the mistake of thinking an inherently cyclical business deserves a growth rating, however, the balance of probability suggests there is growth momentum hence plenty more upside.

For more information see taylorwimpey.co.uk

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.