One man who is the chief executive of a housebuilder puts it like this: "You make good profits for years, always increasing them, and still no joy." Every other boss of a publicly owned housebuilder is similarly puzzled and frustrated over why the City still snubs the sector, despite another results season in which bumper profits have been announced. "It makes you wonder what we have to do to get the City to notice us."
This complaint has a lot of justice in it – at least at first glance. Ratings are the City's way of ranking companies by their expected future earnings, and the better the City's opinion of a firm, the higher the rating. The average rating of a company on the London stock exchange is 17, however, the housebuilding sector has a rating of between seven and eight, despite the fact that returns to shareholders have never been higher. For example, Wimpey's pre-tax profit was 20% higher last year and Wilson Bowden's rose 15%, yet their ratings are, respectively, 8.5 and 8.7. Crest Nicholson's pre-tax profit, which rose 10% last year, has increased five-fold from £10m to £53m in the past six years, yet its rating is one of the lowest of all – 6.9.
Not surprisingly, the sector is lobbying the City for a rethink. Alan Cherry, chairman of Countryside Properties, says: "I think it should happen, and now it's a question of when. But it's no good us saying it, although we all believe it. The City needs to believe it and do it."
You may have detected a hint of a weakness in the housebuilders' case in that last quote – a slight suggestion of the former alcoholic attempting to convince everyone that he really has changed. No more housing crashes, shock E E losses and land value write-downs; that's all behind us. Leslie Kent, an analyst at stockbroker Seymour Pierce, puts the City's response to the accusation that it has got its sums wrong. He concedes the fact that the sector has performed well recently, but says it still has a long way to go to convince investors that it is a safe bet in the long term. "There is a case for rerating, but I don't think it will happen in the short term because of the history," he says. "Housebuilders have disappointed too many times in the past and they've still got more to prove."
In other words: once you have taken account of the degree of risk, the stock market is rating the sector accurately.
Housebuilders, for their part, concede that investors have been burned before, but maintain that this is should not stop the City being objective about the long-term outlook. As the House Builders Federation mentions every other sentence, Britain is on the cusp of a serious housing crisis. The UK builds about 140,000 houses a year, but needs 200,000. This shortage, caused by planning delays and a dearth of suitable sites, is creating a huge demand for housing, which means that housebuilders are making greater margins on their product. Add in cheap money and the surprising resilience of the domestic economy and the result is a massive hike in house prices – up 16% last year – which the firms are cashing in on.
Tony Pidgley, managing director of Berkeley Group, says: "It all bodes well in terms of affordability and supply of new houses. It's very hard to see that there's anything wrong with the industry, but the City must take the view that it's a cyclical business and things will eventually turn."
At this point the debate enters extremely wide economic waters: the business cycle of growth and recessions has been with us for hundreds of years, so is there any reason to believe it is now over? Those who support rerating say the strong results of recent years show, at the very least, that the boom-bang-smash-crash economy of the 1980s and early 1990s is over. Martin Donohue, chief executive of Westbury, observes: "We are paying for our past sins. The City still thinks that despite nine years of good profits it doesn't mean that we aren't going to bite them in the bum again. This is not a five-minute wonder. The cycle will always be there, but the peaks and troughs are not as extreme and the good results prove that. We can be trusted."
Housebuilders just don’t deliver the cash other types of companies do. They manage to take from the City as much they give out in dividends
Stephen Rawlinson, analyst, KBC Peel Hunt
The City's response to this is that even if housebuilders are safe from a 1990s-style property slump, the nature of their business is such that they will never deliver the kind of profit that other sectors can.
Consider a cruel irony. The margin of the average housebuilder will typically be five times higher than the margin of the average contractor, but the contracting sector has a rating of 10-16, about twice that of housebuilders. What is more, the ratings of both sectors have been growing: housebuilding has gone up about two points ("from crap to very bad", as Donohue puts it), whereas contracting has undergone a more thoroughgoing revaluation as more and more 30-year PFI contracts are signed.
One underlying reason for this is cold, hard cash. The City says that, despite the housebuilders' huge profits, they are by their nature cash-hungry animals. Money cascades through contractors, but the whole growth potential of housebuilders is linked to their landbank. This means that they have to keep back a large proportion of their money to buy land, rather than distributing it to shareholders as dividends. Stephen Rawlinson, an analyst for KBC Peel Hunt, says: "Against the rest of the market, construction is poorly rated, but is it underrated? That's a subjective argument. Housebuilders just don't deliver the cash other types of companies do. They manage to take from the City as much they give out in dividends. This is a major reason why they will always be rated low."
Housebuilders are also permanently exposed to fluctuations in interest rates and the price of land. At the moment, the value of their landbanks is rising, but if prices collapse as they did in the early 1990s, firms will be left with land worth millions of pounds less than they paid for it – which will inevitably hit the balance sheets.
Another argument for low ratings of housebuilders is that the companies themselves are not big enough to attract large shareholders. Only a few of the sector's firms have market capitalisations of more than £1bn, and even this is still small by stock market standards. For example, if a fund manger buys £10m worth of shares in a smaller housebuilder (small change for these people), they automatically become a major shareholder, which makes it harder for them to sell their stake without affecting the firm's share price. It's far easier for them to buy £10m in BP or Vodafone, where they won't be a major shareholder and will enjoy far more freedom.
The consolidation deals of the last 15 months have gone a small way towards to addressing this complaint, with Persimmon, Taylor Woodrow, Wilson Connolly, Redrow and Wimpey all snapping up rivals. In turn, these companies' ratings have improved.
But the City still wants more deals to be done and is exerting pressure on companies for these to happen. Donohue admits many housebuilders are still too small: "It's a long haul, especially for the mid-cap and small-cap firms. The bigger firms are attracting more and more interest. I would say, as one without it, that scale does matter."
Leslie Kent, analyst, stockbroker Seymour Pierce
Alan Cherry, chairman, Countryside Properties
Tony Pidgley, managing director, Berkeley Group
Martin Donohue, chief executive, Westbury
How to work out a ratingRatings are calculated by dividing a company’s share price by its earnings per share to get a price/earnings ratio, or p/e, ratio. If a company’s share price is 100p and has earnings per share of 5p then its p/e ratio or rating will be 20. A company’s share price reflects what the City thinks of its future earnings potential. When a share price goes up – on the expectation of higher earnings – the p/e ratio will also rise. In general, a high p/e ratio suggests a high growth company whereas a low p/e ratio means a low growth company.
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