UK housebuilders mostly came into the coronavirus crisis after several years of paying big dividends and with their coffers still bulging with cash.
But after the government put most of the country on lockdown last month, with builders encouraged to close their construction sites and sales offices, revenues have completely dried up.
This week and next, attention will turn to two of the country’s largest residential builders and how much cushion their balance sheets provide with the housing market on total lockdown.
All eyes in the upcoming updates will be on “cash, cancellations and… progress towards re-opening sites”, said Liberum analyst Joe Brent in a note to clients on Tuesday.
Comparing cash piles
Looking at the balance sheets of all the housebuilders in the FTSE 350, Persimmon has one of the best liquidity buffers of around £910mln, according to its last update, of which £610mln was from its own cash and £300mln of committed bank facilities.
Taylor Wimpey said in mid-March that it had gross cash of £807mln, of which net cash was £165mln, with £550mln drawn down from its revolving bank facility.
The weakest positions, according to research by Liberum’s Brent, are at Vistry Group PLC (LON:VTY), the former Bovis Homes, which after last year’s social housing acquisition has net debt of £435mln, offset by a £750mln bank facility.
Also in a net debt position are Redrow PLC (LON:RDW), where borrowings of £116mln are balanced out by £650mln of bank facilities, and Crest Nicholson PLC (LON:CRST), with £65mln of net debt and £550mln of bank facilities.
Sitting in the middle are Barratt Developments PLC (LON:BDEV), with bank facilities making up most of its total liquidity of £1.15bn; Bellway PLC (LON:BWY) where its total liquidity of £550mln contains only £5mln of net cash; and MJ Gleeson PLC (LON:GLE), which has £23mln of cash and £70mln of available bank borrowings.
Roughly £13bn worth of forward sales, or around 45% of 2020’s expected revenues, “provides some comfort”, said analyst Clyde Lewis at broker Peel Hunt in a note in late March.
Potential economic shocks
Construction is likely to be one of the first industries released from lockdown, some analysts have said, albeit with additional social distancing measures in place.
“At this stage we see no obvious reasons (apart from general economic weakness) why UK construction activity will not match previous expectations,” said Lewis. “Government tax and spend policies will be key in determining how quick the bounce is.”
However, that general economic weakness will obviously be quite a substantial factor.
The initial shock to the UK economy is expected to be much more severe than the financial crisis, with the Office for Budget Responsibility recently publishing an “illustrative scenario” — not a forecast, they stressed — where UK gross domestic product could possibly shrink 35% in the second quarter of this year.
Economists do not expect UK unemployment to rise by as much as in the global financial crisis, though the consensus is for around 10% in the second quarter, according to the Statista website, falling to 7% in the fourth quarter. Another consensus calculates unemployment will be 6.1%.
Peel Hunt’s Lewis said housebuilders have relatively low operational gearing due to low fixed costs and “are more exposed to price declines”, with a 1% cut in house prices costing circa 5.2% of average profits.
If unemployment rises to 6%, Liberum’s Brent expects a real house price fall of 7% – much smaller than the 16% fall in the previous crisis, where the mortgage market shut down, which is not expected to be repeated, with mortgage rates and availability considerably different.
“We have looked back at the last three significant periods of rising unemployment,” Brent said. “We believe that this episode will see milder adjustment in house prices than in the [global financial crisis], because that decline was exaggerated by the mortgage market halving almost overnight.
“Today is also different from the late 1980s, as that bust followed a very strong boom. We argue for a relatively mild house price fall this time, with a similar relationship between unemployment and house prices as seen in the early 1980s.”
How long a lockdown can builders take?
With visibility on revenue and profits akin to an economic pea-souper in the short-term, the durability of many consumer-focused sectors is overwhelmingly dependant on the length of the coronavirus lockdown and how the economy reacts.
The City’s spreadsheet-jockeys have all been wrestling with their calculations and financial models for how the situation could unfold.
If the lockdown is not lifted until the end of June, meaning the home building companies make no sales for three months, the sector’s balance sheets generally look strong enough to cope, according to UBS in a note in late March.
Peel Hunt’s Lewis calculated that housebuilders will lose two months’ worth of sales activity and see only “modest” house price declines, which due to the time of year is likely to represent around a 20% drop in private sales and translate to roughly a 30% drop in profits.
JP Morgan Cazenove’s recent estimates incorporated a 30% decline in housing completions for 2020, although this was felt to be a conservative estimate, leading to a 40% cut to the sector’s earnings on average.
Muddying the waters or perhaps providing some encouragement that some sales were still going through the system, Barratt revealed last week that since the lockdown on 23 March and 12 April it had sold almost 1,350 homes.
Share prices and valuations
Shares in the housebuilding sector have de-rated from 1.9 times book value before the outbreak to a current position where market capitalisations are on average less than 1.3 times the value of their assets.
This means financial markets are pricing in a real house price decline of around 9.5%, Liberum calculates.
As such, if the housing markets enjoy a “soft landing”, with house prices down around 7%, Liberum sees value investing in the housebuilders.
However, a scenario where house prices fall by more than 10% in real terms would lead to further “downside” for the sector shares, the analysts calculate.
A worse scenario, akin to the wake of the financial crisis where real house prices collapse by 16%, would squeeze the theoretical fair value to around 0.6 times book value, Liberum said, leading to further share price downside to the builders of around 50%.
Liberum’s picks are Persimmon, Gleeson and Bellway, with “good risk/reward” seen in Crest Nicholson and Vistry.
Similarly Citigroup’s sector specialists last week said with the shares at such depressed levels the risk-reward in the sector “looks attractive”.
Citi’s top pick was Persimmon, followed by the fellow ‘buy’ rated names Taylor Wimpey, Barratt, Redrow and Bellway.