Interactive Investor

Three bargains in bricks and mortar

26th July 2016 13:44

Harriet Mann from interactive investor

For a sector partially demolished by Brexit uncertainty, analysts remain confident a turn in the current cycle will not be anything like as severe as the aftermath of 2008. Downgrades this time reflect just a "modest" 10% fall in volumes and prices.

Given price targets were too optimistic ahead of the EU referendum, one analyst has decided now is a convenient time to bring sky-high expectations more in line with reality, although they still expect 40% upside and blockbuster dividend yields sector-wide.

Despite claiming a downturn would be "moderate", Deutsche Bank has slashed its 2017 cash profit estimates by 50% and pre-tax profit guidance by 60%. This risk to profit should weaken from 2018, as the sector benefits from cost-cutting and cheaper land, although pre-tax profit is still expected to fall 40% and 30% in 2018 and 2019.

"Whether this proves to be a correct assumption or not only time will tell - but it enables us to explore valuation in such a downside scenario and participate in the debate," explains analyst Glynis Johnson.

Deutsche Bank still reckons dividends can be maintained, confident the sector yields an attractive 5.2%. Even with reduced forecasts, Taylor Wimpey leads the way with a 9% yield thanks to its special dividend commitment.

"However, for many of those with dividend policies based on P&L pay-out ratios, our forecasts suggest significantly excess cash accumulation, which could provide scope for significant higher returns to shareholders, with Barratt proving a strong example, with net cash in FY 2018 equivalent to a 16% yield," adds Johnson.

Identified as a driver of economic growth, government policy has prioritised housebuilding since 2007, with plans to build one million new homes from 2015-2020 reiterated post- referendum.

This commitment provides serious upside to the sector after decades of chronic undersupply. There's a chance the Help to Buy equity loan scheme could also be increased to 30%, too, which Johnson reckons will provide meaningful support to volumes.

Value opportunities

There is still opportunity to capture value in the sector, however. Collapsing after the referendum 'Leave' result, the housebuilders now trade on a price/net asset value (NAV) ratio of 1.4 times, although there is significant range within the sector - from 1-2.1 times. After downgrades, return on equity is expected to trough at 15% in 2017, indicating a 50% premium to cost of capital.

"We believe this suggests there remains significant value in the sector, particularly for those trading in the lower ranges of the peer group. Our pick in this category is Bovis," says Johnson.

The analyst has her eye on the three big housebuilders she thinks offer good scope for return.

Barratt Developments

Reducing their target price by 13%, Johnson's team now reckon Barratt is worth 575p, which offers 40% upside to its current 410p price. It's yielding 7%, too.

Bovis Homes

Suffering a double-digit target price downgrade, Bovis could still be worth 55% more at 1,190p and there's a 5% yield for 2016.

Taylor Wimpey

Now worth 147p, Taylor Wimpey has 48% potential upside with its new 218p target price and offers with a 7.4% prospective yield, which grows to a sector-leading 9.1% in 2017 and 10% in 2018.

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.

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