Lots to pick over in mixed update from Barratt Developments

After some time in the doldrums the housebuilding sector is showing signs of springing to life, and Barratt Developments (LSE:BDEV) is certainly in the mix to capture any such benefit.

Its planned acquisition of Redrow (LSE:RDW) is a particular statement of intent, and the deal is expected to clear next month subject to approval from the Competition and Markets Authority.

• Invest with ii: What is a Managed ISA? | Open a Managed ISA | Transfer an ISA

The deal comes with annual cost synergies of £90 million expected by year three, with associated costs of the acquisition in the interim of £73 million. A combined land pipeline of 92,345 plots would give the new combined entity significant firepower as and when economic constraints abate. A combined net cash position of £874 million (at the time of the deal announcement) also allows room for further expansion as and when the opportunities arise. Complementary geographical footprints add a further intriguing dimension to the deal.

In the meantime, the rationale for the deal remains in sharp focus at a time when the market could be turning, with the toxic cocktail of housebuilder headwinds washing through. Squeezed mortgage affordability and availability have resulted in waning customer demand, while broader concerns over general economic growth, consumer confidence and spending have all darkened the picture.

At the same time, the removal of the Help to Buy scheme removed an important plank from first-time buyers, while legacy costs for remedial building work continue to come at a significant cost, totalling some £192 million, according to this trading update for the year ended 30 June 2024.

Pressure on margins has also been an issue, with some demand being teased from elevated levels of sales incentives and an increasing use of part exchange to see deals through.

• Sign up to our free newsletter for share, fund and trust ideas, and the latest news and analysis
• Stockwatch: four stocks to back a UK building boom
• The Income Investor: two FTSE 100 stocks where dividends count

Even so, Barratts has kept a firm hand on the tiller in terms of the factors within its control through a combination of controlling build activity, managing costs and a highly selective attitude to new land buying. In addition, moderating build cost inflation will also ease some of the pressure on margins, with the group expecting broadly flat inflation next year as compared to this year’s 5% level.

While still some way off pre-pandemic levels, there are signs that a corner is being turned. Net private reservations rose by 5.5% over the period, with first-time buyers accounting for 27% of the number, in a promising increase from 25% previously.

Visibility of earnings is helped by a completion rate of 73% in a forward order book totalling £1.91 billion, albeit lower than the previous year’s £2.22 billion. Home completions fell by 18.6% in the period to 14,004, with a cautious level of between 13,000 and 13,500 predicted for next year. However, adjusted pre-tax profit for this year is now expected to be slightly ahead of the previously guided range.

Average selling prices across the portfolio fell to £307,000 from a previous £320,000, although the underlying reduction in house prices was partly offset for Barratts by a higher proportion of London homes in its order book compared to the previous year.

The group’s balance sheet remains in rude health even without the addition of Redrow, with net cash at the year end of £865 million, while Barratts previously took the prudent step of shaving its dividend payment, although even after the cut a projected yield of 5.7% is attractive in the current environment. 

Meanwhile, the new government’s apparent urgency and focus on the sector, including a reform of the planning system, has more recently added a froth to the housebuilders which had been lacking. However, the prospects amount to more than any government intervention.

Aside from the proposed Redrow acquisition, Barratts has upped its land activity particularly in the final quarter of the year having identified some profitable prospects. Expectations for lower interest rates in the shorter term and the availability of more competitive mortgage rates has resulted in an uptick since the start of the calendar year, both in terms of buyer sentiment and also reservation rates. 

This potential inflection point for the sector would come at a good time for Barratts. Indeed, given the nation’s obsession with house ownership and a longstanding shortage of supply, an improving backdrop could mean buyers feel more confident in making a purchase.

• What Labour’s landslide means for investors
• Time for unloved UK stocks to shine again
• The Analyst: Dzmitry Lipski’s investment insights

It remains to be seen whether the current tailwinds fall into place at exactly the same time, but this would provide an overdue boost. In the meantime, even though Barratts has seen a share price increase of 22% over the last year, as compared to a gain of 12% for the wider FTSE 100, over the last three years the price remains down by 30% reflecting the scale of the challenging backdrop which remains.

The current consensus of the shares as a 'hold' is evidence that investors need some convincing that the sector is turning a corner, as indeed does the initial share price reaction to the update, although these increasing signs of recovery could tip the balance over the next few months if Barratts maintains this progress.

Annual results are scheduled for publication on 4 September.