If there’s one thing I hope I can keep up during my future in blogging, it’s coming up with hilariously witty titles like the one above. I’ve a strange feeling it might’ve been done before by every analyst who’s ever covered the housebuilding sector, but I’m going to use it nonetheless!
Barratt is a previously beleaguered housebuilder battered by the typical woes of the sector – its extreme cyclicality evident from the share price, which fell over 10 times (in loosely adjusted terms), and which is now starting a slow and staggering rise.
I like housebuilders, which is why I’ve dedicated my first ever analytical blog post to them, and I like Barratt the most out of the bunch. I also think they’re strange equities for value investors though, as their metrics are fairly split – Barratt is trading at a tempting 0.52 of tangible book value; and large chunks of the book , it should be noted, were impaired in the peak of the crisis when land values were at their lowest. While I’d be hesitant to actively add any value on to the book for this without knowing more specifics, it does give an investor more faith that it isn’t based on old valuations.
Against this deep value backdrop, though, is the kind of seesaw earnings that value investors hate. Part of the problem, I think, is very nature of the industry. The make up of the housing market, with products that are fairly difficult to differentiate and the almost non-depreciatory, means that supply and demand can swing hugely based on that horrible phrase – consumer confidence. Of course, unless you’ve been living in a cave these last few years, you might’ve noticed a few small changes in the psyche of the consumer since the boom.
I sincerely hope I’m not being contrarian for the sake of being contrarian, but I do seem to be reading the signals a different way to most. Mortgage lending and transaction levels are at historic lows. This seems to be a major bear argument – that we’re teetering on the edge of the abyss. But mortgage lending has been in the doldrums for the last couple of years, and prices have stabilised. For me, this isn’t a downside – this is the exact opposite. If this level of mortgage lending has stabilised house prices, there is only one way we can go from here – as lending can’t reasonably be expected to dip any further except in an economically apocalyptic scenario. Perhaps it can and I’m misreading the signals – but I think this is a fairly stable floor (give or take 5%).
Still, I didn’t intend this to be a post about house prices, and so I’ll focus on the business. Operating profit, as we see, remains positive throughout the downturn, though not quite as positive as their solid £400m per year pre-crisis. Earnings take a huge battering, reflecting the impact impairment and finance costs have had on their headline figures. Future impairment looks unlikely – and with the completion of Barratt’s refinancing, finance costs are slowly dropping. The feed-through of land through the production cycle is also important for housebuilders, and this is another positive for headline earnings numbers over the next few years. In the dip, Barratt was still essentially selling houses with a high base cost at depressed prices. As they’ve acquired land through the downturn and change their mix of builds, gross margin can reasonably be expected to increase even if house prices were to stay flat in the near future.
But the thing I probably like most about Barratt as a housebuilder is its flexibility. This probably isn’t a word that immediately jumps to mind when referring to large organisations building that most static of goods, but hear me out. The chart above right shows Barratt’s cashflow through the downturn and beforehand. This, I think, juxtaposed with the chart above left, tells the story – that they can, to some degree, decide their own cashflow and operations. In 2009, for instance, they generated a rather impressive £795.5 from ‘decrease in inventories’ – essentially selling houses while slowing land purchases and the starting of future work. This, combined with their rights issue, helped to shore them up and is part of what leaves them in such a strong current balance sheet position – £366.9m of net debt vs. 2.9bn of assets reported in their last annual report. Their recent refinancing also shifted some of the burden away from term debt to revolving credit facilities, putting them in a flexible financial situation, too. Should the need arise, Barratt can borrow and purchase land for future operations – they can adapt fairly fluidly as the market shifts.
This is also evidenced by what they’re building. Fairly obvious, you might think, but there has been a marked shift away from flats and social housing to private houses – and the impact of this on profits is no small matter. Average selling prices have increased to £185,200, up from £169,600 in 2007, the peak of the boom. The 2010 annual reports have a gem of a table on this, showing land approvals since mid-2009. By value, 66% of these are in the south of England, which has held up far better in the crisis. 77% are houses. Over a period that’s marked ~15% fall in nominal house prices, that’s an impressive statistic.
I could go on, but I think this is the main point – flexibility – I think Barratt has the operational flexibility to dodge the worse parts of the bumpy housing market. The housing market is a difficult one, and while I’m more positive than most, I’m still open to the opportunity of a prolonged correction or even a faster drop. The thing is, even in such a scenario, I think Barratt will hold up fairly well. After all, the over-extension that led them to the rights issue was caused by a greedy acquisition at the height of the boom – and that situation won’t be repeating itself for some time. They’d batten down the hatches, focus on high value sites in the south of England, and ride out the wave. Should the housing market surprise on the upside? Well, it’s unlikely they’ll be trading at any sort of discount to the value of their land in that case, as they’ll be able to consistently add value to their raw material.
I think it may take some patience for Barratt to rebound, but I think the potential rebound could be significant. Surprises will come and go, but I think Barratt is definitely on a long-term upward trajectory, and that’s why it’ll make the first mid/large-cap cornerstone of my portfolio.