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Barratt: safe as houses?

Tom Stevenson

Tom Stevenson - Investment Director

Important information: The value of investments and the income from them, can go down as well as up, so you may get back less than you invest.

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I’ve been writing about investment for long enough to remember Barratt Developments coming back from a near death experience nearly 30 years ago. Co-founder Lawrie Barratt was brought out of retirement to rescue the company, which had been badly hit by the recession that savaged the housing market in the early 1990s, pushing many homeowners into negative equity.

A glance at the long-term share price chart shows that it has not exactly been plain sailing since then. Housebuilding is a volatile business, requiring land to be bought in advance, well before it is clear what end demand will look like. The potential to read the cycle wrong is significant and builders (and their shareholders) tend to lurch from feast to famine.

Barratt’s half-year figures today showed a company enjoying the feast end of this spectrum. The sector has been the beneficiary of years of government stimulus thanks to the Help to Buy scheme which will continue to support home-buyers fully until next year and in a more diluted form for another two years after that.

All the main measures of the health of a housebuilder are moving in the right direction. House completions were 9% higher in the period, the company is delivering a decent profit margin and generating plenty of cash to pay a dividend and promise one-off extra returns to shareholders later this year and next.

On the face of it, therefore, the shares look good value, even after nearly doubling over the past year. They are priced at about 11 times expected earnings and promise a yield of more than 5% on the basis of the consensus forecast of ordinary and special dividends this year which the company helpfully lays out in its interim report.

Valuing a housebuilder is not easy, however, which goes some way to explaining why the shares have given investors such a roller-coaster ride over the years. There are plenty of moving parts, all of which have the potential to blow companies off track.

Here are five things to consider when deciding whether the case for investing in Barratt is really built on firm foundations:

Demand: in the long run, there is a shortage of housing in the UK after years of building too few homes. Shelter is a human need that will never go away. In the shorter-term, demand is rationed by price and confidence so builders must hope that the Prime Minister’s optimism for the British economy is infectious.

Costs: regulation, especially around energy efficiency, and the labour-intensive nature of building a house mean that managing costs is key. Barratt has done well on this front, tinkering with house designs to reduce costs, and putting in place fixed-price supply deals. As Britain’s leading housebuilder it is well placed to drive a hard bargain.

Policy support: the Government’s election manifesto promised to keep the Help to Buy scheme going for first-time buyers for another three years. This is good news, but it does underline the fact that the sector’s fortunes are to a degree out of its control. It is reliant on politicians’ natural self-serving desire to prop up house prices. Companies that lack control over their own destiny tend to be less highly-valued by investors.

The economic cycle: housing is a cyclical business. When a company’s product is such a high-ticket item, its profit margin is the difference between two very large numbers. Miscalculating the price paid for the biggest single input - the land a house is built on - can blow away a builder’s earnings. The time lag between buying the land and selling the house makes this very hard to judge. Again, this argues for a lower rating than a more predictable business.

Valuation: all of which means that even an attractive looking valuation multiple of just 11 times earnings may be less compelling than it might at first seem. Especially at the end of a period of extreme government largesse when interest rates are as low as they are likely to go.

The volatility of housebuilders’ share prices makes them attractive to hobbyist investors. Time your purchase right and big gains are possible. So, too, however, are big losses. The long-term outlook for house prices and the profits of housebuilders remain positive. But don’t expect it to be a smooth ride.

More on Barratt Developments

Five year performance

(%) As at 4 Feb 2015-2016 2016-2017 2017-2018 2018-2019 2019-2020
Barratt Developments 34.3 -11.5 22.1 3.9 62.0

Past performance is not a reliable indicator of future returns

Source: FE, as at 4.2.20, total returns in local currency

Important information: Investors should note that the views expressed may no longer be current and may have already been acted upon. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.

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