Building blocks of recovery

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.

'Expert opinion' seems divided on prospects for the UK housing market which, besides a reminder that no-one has crystal ball on the economic future, poses a dilemma for investors exposed to house building shares.
 
Taylor Wimpey (TW-), the FTSE 250 listed house builder with interests both in the UK and US, is one such example. I drew attention to the shares as a high risk/reward recovery play at 15p in January and the price has twice breached 50p since I also updated at 36p in May. Currently 43p, it capitalises the group at just over £1.3 billion. How should this and other house building shares be viewed now?
 
On the negative wing, credit rating Fitch has warned of debt maturities that could lead to 'serious problems': for example Taylor Wimpey and Barratt Developments face collective debts of £7 billion of which £2.4 billion will mature in 2011 and £4.5 billion in 2012.

Fitch reckons that a significant improvement in the housing market is needed to pay this down without further asset sales or share issues. Meanwhile, the online estate agency Rightmove has just cited a 0.2% rise in house prices year-on-year between October for England and Wales, a better situation than doomsters have warned.

Most likely however, this is being caused by a tighter market with fewer properties for sale. On the demand side, mortgage availability and unemployment are key factors to judge the housing market in the medium to longer term. The worst case scenario would be a 'double-dip' recession a few economists warn of.
 
Yet investment bank Morgan Stanley has just recently argued that supply shortages will be sufficient to drive house prices higher - given that new starts have slumped to 80,000 in 2009 from 217,000 in 2007. Its analysts have proceeded to argue, shares in both Taylor Wimpey and Barratt Developments (BDEV) have about 50% upside, although this is based largely on expected improvements in net asset value.
 
I think there needs to be some kind of 'probability' score linked to fair or worse case scenarios, to make such targeting meaningful. You can't just assert '50% upside' when the economy holds so much scope for variability.

Furthermore, the stock market is already forced to rely on net asset values as the current benchmark for house builders' intrinsic value. For their shares to achieve another significant re-rating the market may want a firmer sense for earnings recovery prospects.
 
Company REFS shows a range of broker forecasts and opinion on Taylor Wimpey, with pre-tax losses of about £105 million to £160 million for 2009 being 'improved' near breakeven or up to a £60 million loss in 2010. Before the credit crunch started taking effect in 2007, Taylor Wimpey was achieving earnings per share in a 30p range although such years reflected exceptional conditions of demand and mortgage availability.

Furthermore, over 2 billion shares were issued last summer (raising £510 million net), bringing the total amount to 3.2 billion. Include the off chance of any further share issue to the current difficulty to project house builder earnings on a two-year view, and understandably the shares are treading water.
 
For an alternative investment view on the housebuilder, take a look at our iBall TV episode on Taylor Wimpey.
 
Taylor Wimpey was an interesting speculation at 15p on a rationale of coming to an agreement with its bondholders, also the housing market recovering. My stance was justifiably firm at 36p in May amid ongoing negative opinion on the housing market yet with signs of strength appearing in its statistics. More evidence of recovery is probably needed to justify share price upside in the near term.
 
First-half 2009 results showed trading improvements in both the UK and US. At end-July, UK orders were up 67% since end-December 2008 with cancellation rates down to 19% from 46% in the second half of 2008. North American orders rose 23% with cancellation rates slightly 'better' at 18%. The UK represents about 60% of the group order book, the US 38% and Spain about 2%.
 
After land and work in progress write-downs, also equity dilution, tangible net assets worked out at about 44p a share and not surprisingly, until earnings prospects become firmer, this is where the shares have consolidated.
 
In terms of value dynamics, management cites opportunities emerging to buy land at prices that should be value enhancing, to enhance the group's UK land bank of 90,000 potential plots. By comparison, the US land bank stands at near 29,000 plots. The relatively smaller market in Spain, of just over 2,000 plots, remains very weak.
 
Management has estimated net debt at about £1 billion with cash generation is expected to trim this below £900 million by the year-end. This compares with total equity of £1.4 billion and should help to bring forward new investment and cut interest costs.
 
So for the rest of the year (before trading statements ahead of 2009 prelims), shares such as Taylor Wimpey and Barratt will likely reflect shifting expectations for the housing market. They look to rate 'hold' if you already do, but investors with fresh money may prefer to watch for another update on trading. I

f you are a more active investor looking to finance buying shares elsewhere, seen as better value, then it may be appropriate to consider locking in some gains here and (part) switch.
 
Overall, on a long-term view the house builders should have further upside, but let's see more evidence.