Stockwatch: A 28% rally is justified here

Is the timing right for Henry Boot? The market has turned cautious, marking down shares in this FTSE Smallcap land manager from a 237p all-time high to about 225p. That's despite bumper 2014 results and Investec, the company's broker, upgrading its price target to 280p.

Sentiment strains to guess asset cycles

The five-year chart is strong albeit volatile at times. Boot is relatively diversified: construction represented 58% of 2014 revenues and 29% profit; land development 25% of revenue and 44% profit; with property investment and development 17% of revenue and 27% profit. Yet a common theme is acquiring land then improving its planning status or development use, the various activities offering scope to exact value at different stages.

This leads to perception of the shares as a macro play on asset cycles where currently there's a sense the general election and tailing-off of QE mean asset markets are potentially exposed. Recently slowing UK GDP doesn't help perception in that regard; and while the last coalition government's planning reforms released more land for new-build residential development, the next government is an unknown entity.

Management takes a radically more positive view

The message in terms of Boot's underlying operations is a vigour hard to destabilise. The UK property market is also in a relatively early-stage recovery from the last recession, so there are plenty more opportunities, hence upside ahead. The 2014 prelims state: "In our view, 2014 was the second full year of our recovery from the bottom of the property cycle."

Housebuilding has seen "balanced" market conditions which have "allowed us to sell sites with planning permission at competitive prices." 1,100 plots were sold this last year albeit 2,100 have been added to the portfolio. The commercial property market improved significantly in 2014 "with Henry Boot activity high throughout the year... we have a number of projects in progress for 2015 and opportunities beyond that are even more encouraging...the cyclical upswing is helping the development business steadily improve both activity and profitability levels..."

A contrarian might quibble, managers are soaked in operations to an extent they can’t see potential change on the horizon; but all-considered the evidence weighs positively for the longer term. The chairman’s outlook statement continues: "In the shorter term, we remain confident that prevailing economic and market conditions will allow us to deliver growing returns through 2015. In the longer term we continue to identify and acquire numerous valuable opportunities to enable us to deliver our strategic goal, well into the future."

Benefiting from cheap land and better planning

A typical factor enhancing property and house-building company profits is managers having acquired land cheaply after the 2008 financial crisis, which re-rated in value as monetary stimulus kicked in (QE boosting asset prices, the mortgage guarantee scheme improving the housing market). So this could indeed be an exceptional factor within Boot's excellent 2014 results (see table for context).

Management says its "opportunity portfolio" is now larger and more valuable than for many years, partly due to the planning system being in more robust shape than it has been for several decades after the coalition government dealt with land supply issues. Planning has tightened somewhat in the run-up to the general election; however, house builders are looking to replenish land portfolios now the housing market has enjoyed some recovery. So overall, both the demand and supply sides of the land equation look to have increased.

Valuation supports are broadly based

Net asset per share was £200.5 million, or 152p at end-2014 (or 145p on a tangible basis, the intangibles representing investment in a PFI contract to operate and maintain the A69 between Carlisle and Newcastle). Net asset value growth was a modest 3.6% due to retained profits offset by an increase in the pension deficit from £20.1 million to £28.2 million - this due to a reduced discount rate being applied to value the scheme. Unlike the aftermath of a crisis or recession, you are most unlikely to find stocks at a discount to net asset value with the property market now in strong shape; some premium is more likely as investors anticipate further earnings growth. The overall NAV still ought to help limit downside risk.

With the expansion of earnings per share since 2013, Company REFS cites annual average price/earnings (P/E) multiples nearly halving from the mid-twenties to 13 then 11 times - based on the consensus expectation for 2015/2016 earnings. Dividend growth continues nicely, and while the prospective yield is a modest 2.75%, it is expected to remain covered about three times by earnings. The cash flow profile may look disappointing, but reflects property purchases as inherent to the business. So Boot's ratings are modest according to all the "opportunities" management proclaims.

Short-term debt has reduced

The end-2014 balance sheet had short-term debt down from £46.5 million to £32.0 million, while long-term debt rose from £5.2 million to £8.8 million. Finance costs rose only 1.6% to £1.6 million, largely offset by £0.7 million, in context of nearly £28 million operating profit. Boot has still been able to continue investing as net cash from operations rose from £1.6 million absorbed to £8.7 million generated, helping investment property purchases rise from £6.4 million to £15.6 million.

Political fears possibly overdone

Housebuilders are reacting negatively to the Labour Party's plans to impose rent controls on landlords, said likely to make buy-to-let investors exit the market; however, Labour promises to help smaller house-builders. The party is also proposing to abolish stamp duty for first-time buyers on properties worth up to £300,000, expected to push house prices higher. So although the industry much prefers the Conservatives, the balance of Labour's proposals may not be enough to dent the cycle amid strong demand for new homes.

All-considered the risk/reward profile on Boot shares favours upside and while I have not seen Investec's reasoning, I concur with the sense behind a 280p target.

For more information see: henryboot.co.uk.