Stockwatch: 7% yield backed by insider buying

Is a circa 7% yield realistic here, and poised to support mid-cap builder Galliford Try? The one-year chart looks pretty dire, but the five-year context shows a retreat to a strong trend-line since the UK housing market recovery.

A consensus of brokers expects the dividend payout to continue rising strongly, such that at about 1,300p a share the prospective yield soars to 7.5% for Galliford's financial year to June 2017. It's not alone, e.g. Barratt Developments offers 7.3% on a similar timescale and Taylor Wimpey 7.1%, covered at least 1.5 times if forecasts are fair. So is market pricing rational, to exact such yields for the industry risks, or overdone?

House price inflation issues

While the government's Help to Buy scheme for first-time buyers has been extended to 2021, the stockmarket has become wary of stricter controls on lending to let air from any house-price bubble. They coincide with rising build costs, especially for labour amid skills shortages, such that housebuilders' margins may be exposed.

That at least is the fear. But interest rates appear unlikely to rise by much in the medium term, and "nimby" discontent over the acceleration of South-East councils' house-building approvals shows momentum is established. The EU Referendum is cited as a risk factor if Brexit was to reduce immigrants' demand for housing; yet it's unclear what extent Britain would re-gain control of its borders and the strength of the economy hence demand for skills are likely a more significant effect on immigration.

Rising stamp duty has tempered the higher end of the housing market, and an additional 3% charge on second homes is liable to cause disruption in the buy-to-let market - potentially another factor to weigh on house prices. But with ten buyers per home battling it out - as of last November - and a chronic lack of affordable housing, there is plenty for builders to get on with.

Deputy chairman invests nearly £60,000

Appointed also as the senior independent non-executive director a year ago, Peter Ventress has made an initial purchase of 4,250 shares at 1,399p - which sceptics might say after a 7% drop to 1,300p - shows directors are not necessarily good judges of the stockmarket. They are also expected to buy equity anyway, not benefiting from options like executive directors. Yet Galliford's fundamentals imply a decent chance of beating the industry risks, while its current valuation suggests the rewards out-weigh. When I initially drew attention four years ago at 600p it was significantly due to a southern England bias where employment and wages are firmer. The table shows a strong record of earnings and dividend growth, albeit lumpy in terms of cash flow, which hasn't always covered the dividend despite modest capital expenditure.

The last results for the six months to end-December 2015 show good progress with pre-tax profit up 24% to £52.9 million on revenue (inclusive of joint ventures) up 12% to £1,264.9 million, with interim earnings per share (EPS) similarly up 24% to 52.2p and the dividend up 18% to 26.0p. The 2007 acquisition of Linden Homes has driven the house-building side whose operating margin has jumped from 15.1% to 17.0% like-for-like - i.e. no sign as yet of pressures. Sales have jumped 17% to a record £793 million and the landbank has 12,800 plots. House-building also includes Galliford Try Partnerships where interim revenue slipped 4.7% to £150.2 million on a low margin of 3.0% despite some improvement.

In its 2014/15 financial year the group derived 87% of profit from house-building versus 10% from construction (despite it representing 55% of turnover), the remaining 3% profit from public-private partnership investments. The last interims cited construction revenue up 22% to £738.6 million on a 1.2% margin, and a £3.7 billion order book. As of end-February, management cited an encouraging start to its second half-year as reason to hike the dividend, so the deputy chairman's share-buy has genuine reasons.

Brokers target upside of 15% to 50%+ before dividends

March has heralded a £40 million office development in Reading and the construction side is also making progress in the North and South London via public sector frameworks.

Amid firm progress, it's understandable how analysts are more confident than the market with targets ranging from 1,495p by Numis (albeit recently downgraded from 1,619p) to Peel Hunt (company broker) looking for 1,980p, while Jeffries targets 1,962p. The higher end implies a forward price/earnings (PE) multiple in the mid to low-teens, albeit a still-supportive 5% yield.

Technically, the stock is rising off the lower end of a recent zig-zag trend, a latest drop coming after 12 April news of defects in Scottish schools built over 10 years ago by Miller Construction which Galliford bought in 2014. More significantly, in terms of overall trading, in 2015 there was a 13 May update covering the year to date, hence there is potential meat for bulls in 2016 within the next month.

Balance sheet able to withstand shock downturn

A high yield also implies debt risks, but they look plenty manageable. Admittedly, total debt rose 12.3% to £179.4 million over 2015, also as short-term debt was re-arranged into long-term. A reduction in trade payables largely explains end-2015 cash down to £83.7 million from £123.8 million, meaning net debt has actually risen from £35.9 million to £95.7 million. Net gearing was a modest 16.8% at end-2015, the interim net finance charge covered nearly 10 times by operating profit.

Within the balance sheet, a rise in accruals and especially development land payables (see note 13) meant "other non-current liabilities" jumped 40% to £200.7 million. But, overall, the balance sheet looks able to withstand a downturn in trading.

So, while Galliford Try isn't unique in the house-building sector - high yields are now established - it's a good example how cautious pricing implies upside.

For more information see: www.gallifordtry.co.uk/