13 February 2018

Blog: UK House Builders and Cash

By Scott Fulton | 13th February 2018

Political and market considerations will be front of mind as the UK house builders update on trading and report results in the next six weeks (see Figure 1 below).

Figure 1: House Builders’ Financial CalendarIf the market reactions to Redrow’s interims (7th February 2017) and Bellway’s trading update (8th February 2017) are anything to go by, the builders will have to indicate considerable growth to avoid further share price weakness.

Figure 2: Share Price PerformanceRedrow and Bellway reported a strong trading background and further improvements in returns; profit and cash. Despite this, both saw share price weakness, albeit that Redrow experienced initial strength before giving this up in later trading. In the last week, Bellway has seen its share price fall by almost 5.0%.

We suspect that other announcements could meet the same fate. The UK equity market appears to be “risk-off” for housing and will apply a lower multiple to growth because it no longer believes that this is sustainable in the medium term. However, a floor may be established through greater understanding of house builders’ cash flow.

Figure 3: House Builders’ ValuationThis has been a consistent feature of house builders’ financial performance for at least the last two years. It reflects the lack of competition in the land market and the larger builders’ ability to manage its land costs through creditors and options. At present, most of the builders shown in Figure 3 have little or no gearing on a reported basis and several would remain cash positive even when allowing for land creditors.

If the market is slowing – and there are signs that it is – then these builders may seek to reduce land buying. Currently, most replace land used as a minimum with several, including Redrow and Bellway, seeking to extend land banks. If this is not required owing to slower sales growth, they could under-replace land used, generating significant amounts of cash.

This could underpin the already high levels of dividend payment, relative to share price, producing further returns for shareholders. In turn, this suggests that the current average yield of over 5.0% in the current year is increasingly safe; i.e. covered by earnings and free cash flow.

As the market struggles with the apparent lack of direction from Government on UK housing, investors would do well to consider the builders’ cash flow as much as their sales prospects.