Interactive Investor

Housebuilders rally but is there room for more?

Having re-rated since October, how much of the housebuilding sector’s recovery is now in the price? A City bank has highlighted three stocks offering value.

19th December 2023 13:00

Graeme Evans from interactive investor

Taylor Wimpey has been named “most preferred” volume housebuilder after a City bank reviewed its recommendations following the sector’s big rebound in valuations.

UBS also likes Redrow (LSE:RDW) and Bellway (LSE:BWY) in the FTSE 250 index but believes the recovery looks to be in the price at Barratt Developments (LSE:BDEV) and Berkeley Group (LSE:BKG).

Barratt shares, for example, have jumped 40% since touching their low for the year in mid-October, just ahead of Taylor Wimpey (LSE:TW.)’s 37% progress over the same period.  

The bank said: “We think prospects for UK housebuilders are starting to improve due to declining mortgage rates, which is improving affordability and consequently demand.

“However, we see less value on offer after the recent re-rating in the sector, which now prices in a meaningful recovery in returns.”

The bank’s “neutral” position on Persimmon (LSE:PSN) and Crest Nicholson (LSE:CRST) is unchanged, with fellow FTSE 250 stock Vistry Group (LSE:VTY) the only one of eight stocks in its coverage rated at “sell”.

Even though conditions are improving, UBS expects returns to remain cyclically challenged in the short term as a result of weak sales rates, order books and higher incentive levels.

It also warns about structural risks surrounding planning reforms and under-resourced planning departments, which may restrict outlet volume recovery.

The bank added: “The key questions from here are how quickly the UK housing market can recover (in terms of sales rates and house prices) and how the policy backdrop evolves (particularly planning).”

It sees the high returns of 2014-22 as unlikely, particularly given that Help to Buy support ended in March and the industry faces challenges around planning and regulation.

Longer term, UBS regards the UK market as structurally undersupplied and with the benefit of limited financial risk.

Its analysis notes that UK housebuilders have re-rated to 1.1 times tangible net asset value (TNAV), versus the long-term average of 1.25 times and the financial crisis low of 0.75 times.

The upgrade to “buy” for Taylor Wimpey reflects a potential 13% upside in shares to 160p, as well as a sector-leading dividend yield of 7%.

Its forecast 1.05 times tangible net asset value represents a meaningful discount to the other volume housebuilders, despite making similar returns.

UBS believes that Barratt’s shares now appropriately reflect “a gradual recovery scenario” over the coming years. 

The bank expects earnings to recover over the next five to six years to £1 billion, equal to the prior peak of 2022 and compared with an expected trough of below £400 million in 2024. It has downgraded its price target from 610p to 495p as a result.

London and South East-focused regeneration specialist Berkeley is regarded as the strongest through-cycle performer in the housebuilding space.

UBS feels this has been under-appreciated for a long time, but given the recent share price upturn and in light of the outlook for relatively low returns it thinks there is less upside now. The bank’s new price target is 5,100p.

The other price estimates in UBS’ coverage see Bellway at 2,980p, Crest Nicholson at 220p, Persimmon at 1,445p, Redrow at 690p and Vistry at 845p.

It believes Bellway is well positioned for a UK housing market recovery, having made significant land investment in 2020-22. It also boasts a strong organic volume growth track record and a well-capitalised balance sheet.

Redrow is regarded as offering inexpensive exposure to the sector, with the shares trading at a 2024 multiple of 0.9 times TNAV. UBS adds: “We like Redrow's strong volume growth track record, modest adjusted gearing and reasonable proportion of cash buyers.”

The cautious stance on Persimmon reflects the downside risk that margins and returns revert to the sector average over time.

The bank said: “The key question is whether Persimmon can scale up again after suffering from meaningful site and volume compression. This will depend on the planning backdrop and perhaps also on the intake margins Persimmon demands.”

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