Stockwatch: A cheap share if 'Remain' wins

Can Crest Nicholson break out from a year trading sideways to a rating that more properly reflects its earnings and dividend growth? Focused on high quality homes in southern England, the mid-cap housebuilder has delivered strong interim results.

Pre-tax profit jumped 25% to £72.6 million on turnover up 22% to £408.1 million. While its gross margin slipped from 27.6% to 27.1%, reflecting project mix, administration costs rose modestly in context such that the operating margin held at 19.1%.

For income-seekers, the interim dividend is up 42% to 9.1p a share as the board seeks to reduce dividend cover from about three to two times by 2017, implying a prospective yield of about 6%, with the stock currently at 575p.

If worries over the housing market are overdone then this rise in yield may also help capital upside as the market realises the dividend is less risky.

Presently, the market is being quite fair given Crest's brief dividend record since flotation at 220p in February 2013 - the company was previously taken over by its lenders in the global financial meltdown.

On consensus forecasts (see table below) the price/earnings (PE) multiple drops from 12 to 8 times. Such a profile is quite typical of house-building stocks, which have consolidated as doubts crept in now the cost of the average UK home represents nine times average income.

Indeed, one estate agency boss has called the top of the market.

FTSE 100 stocks such as Barrett Developments and Taylor Wimpey similarly trade on single-figure forward PEs and sport yields around 7%, albeit with earnings cover of 1.5 to 1.75 times.

Rising costs have also been a concern, and currently the European Union (EU) referendum. Yet those undecided voters are more likely to vote conservatively in the face of economic fears, and house-building stocks enjoy a boost from a late tilt to 'Remain'.

Southern England focus implies a preferred play

Crest's operating region enjoys greater prosperity than the North, avoiding overpriced "prime central London". The company is also of a size - near £1.5 billion - making it easier to achieve growth than the FTSE 100 behemoths, with less risk than smaller builders inherently exposed to change. This makes it an intelligent compromise to play improving sentiment towards house-builders with a 'Remain' vote, although underlying progress anyway affirms value.

After housing legal completions rose 7% in the six months to end-April, forward sales at mid-June are up 19% on last year, contrasting with the estate agents' pessimism on house prices. Crest's chief executive contends: "Moderating sales price and build cost inflation, combined with rises in real incomes, will help to maintain affordability and support a stable housing market."

The government's Help to Buy scheme remains important, and is why I originally drew attention to Crest at 315p at the end of August 2013. I also liked its southern exposure, negligible debt and modest PE.

The outlook statement respects risks with availability of skilled labour and clearance of planning as "key constraints on volume delivery", yet management expresses overall confidence for its full-year result. The house-building cycle has been boosted and prolonged by low interest rates - artificially so, in the case of Help to Buy - so the investment case rests on Crest's progress defying scepticism.

On target for £1 billion revenue by October

Management adds it is on target to deliver not only £1 billion revenue by this October year-end, but also £1.4 billion by 2019: manifest confidence in the market's continuing strength.

Land planning is critical to this and in the current financial year contracts have been exchanged on 10 sites, enabling potentially 1,147 housing units with a gross development value of £472 million. Furthermore, a similar number of plots have terms agreed and are passing through solicitors.

So Crest's land bank is broadly supportive of the growth targets also, if planning consents follow. This has been granted for Crest's first sub-urban Private Rented Sector (PRS) scheme near Gatwick Airport, and it will be interesting to watch whether "build to rent" becomes a new leg for growth.

In recent years this sector has grown to represent 16.5% of UK households as investors buy property for letting purposes (the Faygate scheme near Gatwick being developed for M&G). Some forecasters reckon that in 15 to 20 years more people will rent in the UK than own homes, as affordability evades the 25-35 age group - especially urban professionals. So Crest likely needs exposure for a balanced approach.

Net gearing is a negligible 3.7%, with £174.9 million of mainly longer-term loans largely offset by £148.8 million cash, up from £113.8 million. Crest's balance sheet can, therefore, support further funding or debt for development as required.

What are the Brexit risks?

Crest anticipates a possible three-to-six-month pause in land investment in the event of a Brexit, although the stockmarket would fret of a general slowdown in the housing market, as buyers wait to see what happens on interest rates and sellers sitting on their hands also.

Scare stories, such as an emergency rise in interest rates to defend sterling, appear just that, for the Bank of England will be well aware of the potential effect on borrowers. And George Soros still occasionally takes credit for the favour he did us in 1992, forcing sterling out of the European exchange rate mechanism to devalue it, which (he claims) was instrumental in ending the early 1990s recession.

There could be inflationary risk from more costly imports, the Bank would need to monitor and possibly respond to. But if you believe George Osborne's prediction of Brexit hitting house prices then this could also have an overall beneficial effect - in the interests of first-time buyers - after the excesses created by cheap money.

Crest directors appear to remain comfortable owning substantial shareholdings, e.g. the chief executive with about £23 million exposure, the chairman £20 million and the finance director £6 million. There has been no trading since the restricted period has ended.

So if you believe - as I continue to - 'Remain' will prevail, the stock is currently a "buy", but considering its underlying strengths and modest rating, potentially one also in a 'Leave'-inspired sell-off.

For more information see the website.

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.