How Telford Homes plans to kickstart profit growth

At 12% below net asset value, it's believed the shares fail to reflect "positive changes" at Telford.

In a housebuilding sector dominated by chunky yields and fears over consumer confidence, the repositioning of Telford Homes (LSE:TEF) represents an interesting investment case as the AIM-listed company pursues a strategic refocus towards build-to-rent.

Supported by partnerships with the likes of Invesco and M&G, Telford believes there's scope for build-to-rent to account for 70% of the homes in its development pipeline. Its less risky than private housing and with more Londoners renting there's good reason to think that purpose built rental housing is a promising way forward for Telford in the capital.

In February, Telford announced plans to accelerate its focus on build-to-rent so that half of its pipeline is made up of such schemes by the end of this year. This should help profits to start growing again after the 2020 financial year, although in the meantime there will be a squeeze on profitability not helped by project delays and a lacklustre individual sales market.

After February's update and profits warning, shares tumbled 17% to below 300p, where they've been languishing ever since. Today's annual profits of £40.1 million were in line with revised guidance, but well short of the £50 million the company was striving for during 2018.

While build-to-rent is lower margin, house broker Shore Capital today noted the longer-term benefits of superior growth, lower risk, lower capital intensity and lower gearing.

Shore's Robin Hardy added:

"The build-to-rent segment remains strong and is still attracting high levels of interest from a diverse range of investors from the UK and overseas."

With the shares trading at 12% below net asset value, Shore believes the market is failing to reflect "positive changes now well in hand". The broker has a fair value estimate of 355p. 

Source: TradingView Past performance is not a guide to future performance

As build-to-rent leads to a stronger balance sheet, Hardy said there was the potential for more generous dividends for shareholders. Today's dividend was maintained at 17p for a yield of 5.6%, which is where Shore thinks it will stay until profits start growing again.

Build-to-rent developments contributed revenues of £108.7 million in the year to March 31, a rise of 61% as group turnover lifted 12% to a record £354.3 million. Sales from open market schemes were down 5% to £231 million but the margin on these developments was 28.3%, compared with the build to rent margin at 13.2%.

Gearing reduced to 37% from 52.2% a year earlier, reflecting the increased proportion of less capital intensive developments.

CEO Jon Di-Stefano said the company's new business model aimed to exploit a long-term structural imbalance between housing supply and housing need in London.

He added: "Our recently announced partnerships with Invesco and M&G signal our reputation as a trusted build to rent partner, and as such are a significant step as we continue to develop our profile at the forefront of this burgeoning sector."

Analysts at Peel Hunt are also supportive of the strategy, with a target price of 350p based on the current price/earnings multiple for this year and next of 11.8x and 9.2x respectively. They believe there's potential for profits to recover to £40 million by the 2022 financial year, compared with £24 million in this financial year.