Interactive Investor

Stockwatch: buying this small-cap share has logic

10th May 2022 12:36

Edmond Jackson from interactive investor

It’s been a gloomy 2022 for this business, but companies analyst Edmond Jackson thinks director buying, government support and political motivations make this stock worth a look.

Is it timely or premature, to follow housebuilder director buying? Despite the sector continuing to edge lower as asset-selling accelerates in the US, it is interesting to note how two directors of MJ Gleeson (LSE:GLE) have started to buy meaningfully around the 600p mark.  

In chart terms, this small-cap stock is re-visiting a 575p level it fell to in October 2020, having enjoyed a bull run from 120p in August 2012 to 964p in January 2020. Its financial summary table shows solid progress aside from the 2020 initial Covid disruption, on a circa 15% operating margin which is similar to Taylor Wimpey (LSE:TW.), although below the impressive 25% enjoyed for some years by Persimmon (LSE:PSN) (for how long that lasts). 

A better risk/reward profile focused on low-cost homes 

Gleeson specialises in high-quality low-cost homes, mainly to first-time buyers and those on lower incomes, across the Midlands and North of England. 

On the one hand, you could say care is needed given this segment of the UK population is relatively more exposed to higher living costs. On the other, a “stagflation” scenario makes Gleeson better-placed to capitalise as homebuyers adjust their expectations down, especially if mortgage lenders tighten criteria. 

Help to Buy is nowadays seen as the key driver of listed housebuilders’ prosperity after a 2017 study by Morgan Stanley demonstrated virtually all the sector’s profit uplift related to it. The scheme is formally guided to extend to March 2023 and the government’s website declares “there are no plans for further extensions”. 

But there is already speculation – quite fair, I believe – that the Tories will be under pressure to show results for their said “levelling up” in the North, after this policy helped swing votes from Labour in the 2019 general election. So Help to Buy could persist in some form and on a localised basis. Interestingly, when pressed on the matter, ministers have tended to say “no decision has been taken” than affirm next March’s deadline. 

Guessing what will happen here is a tricky call, but at Gleeson’s 10 February interim results the chief executive said: “working in cooperation with local and national government to ensure the continued delivery of low-cost affordable homes for first-time buyers, we can look forward to the next stage of the group’s development with confidence.” 

Two director buys: £60k and £30k worth of equity 

The CEO backed up his words, adding 10,000 shares at 600p on 29 April, to own 31,131 overall, when a non-executive director doubled her holding, buying 5,000 shares at 602p. 

At one stage yesterday, the stock traded at 606p but later succumbed to the US downturn, closing at 591p.  

Around this 600p level, Gleeson trades on 9x earnings for its current year to 30 June, assuming consensus for £39 million net profit delivering earnings per share (EPS) of 66.8p, a 14% advance on 2021.  

Growth is expected then to moderate to 9% for net profit near £43 million and EPS of 72.6p, implying a price/earnings (PE) ratio of 8x. 

The crux for investing in housebuilders is whether such moderate mean-reversion happens, after Help to Buy peaks out and monetary expansion during Covid lockdowns boosted house prices; or whether a more sinister reality lurks as stagflation bites. 

The UK has a fundamental deficit of homes, said to be around four million in England alone, although such an argument applied also during the 2008/09 property slump. This time around, however, stricter lending criteria should mean lenders face relatively less delinquents.  

A relatively lower yield but not so exposed to a dividend cut 

Assuming this year’s dividend rises 18% to 17.7p and a further 10% to 19.5p, the prospective yield is 3.2%, you could say it is insufficient return for risks faced by the housing market. The stock could drop to 525p and not even yield 3.5%.  

Alternatively, at around 120p, Taylor Wimpey trades on a PE of 6.4x, easing to 5.9x in respect of 31 December year ends to 2022 and 2023. The prospective yields are 8.1% rising to 10%, if forecasts turn out to be accurate. 

At 2,020p, Persimmon is on a forward PE of 7.9x, rising to 8.3x assuming around 4% earnings growth this year then down 5% in 2023. An 11.6% yield rising to 12% suggests the market is pricing in a cut ,given projected earnings cover would anyway only be around 1.0x – on recent projections – compared with nearly 2.0x for Taylor Wimpey and near 4.0x for Gleeson. 

All housebuilders face higher costs by way of materials and labour, recent rises accelerating just when demand – hence house-sale prices – will likely be tempered by higher living/mortgage costs. 

MJ Gleeson - financial summary
Year-end 30 Jun

 201620172018201920202021
Turnover (£ million)142160197250147289
Operating margin (%)19.820.618.716.44.014.9
Operating profit (£m)28.233.036.941.05.943.1
Net profit (£m)23.026.230.233.34.533.9
EPS - reported (p)43.148.355.260.48.658.1
EPS - normalised (p)43.348.555.460.48.658.1
Operating cashflow/share (p)25.735.639.715.5-26.141.5
Capital expenditure/share (p)1.72.22.53.44.36.6
Free cashflow/share (p)24.033.437.212.1-30.434.9
Dividends per share (p)14.50.032.034.50.015.0
Covered by earnings (x)3.00.01.71.80.03.9
Return on total capital (%)18.419.118.719.32.617.1
Cash (£m)23.234.141.330.376.834.3
Net debt (£m)-23.2-34.1-41.3-30.3-16.8-34.3
Net assets (£m)153171188204213245
Net assets per share (p)283317345374366420

Source: historic company REFS and company accounts

Next update will likely be resilient, but what thereafter? 

Over the last 12 months, Gleeson’s updates have either affirmed or twice upgraded financial expectations, reflecting a benign market. 

The last was the 10 February interims which upgraded full-year expectations, citing 2,000 new home completions this financial year and the land trading side due to complete further sales in the second half. “Demand for our much-needed affordable homes continues unabated,” it said.

There has tended to be a financial year-end update in mid-June to early July, last year brought forward to May due to a financial upgrade. The two directors would not just recently have been able to trade in possession of inside data, but it is fair to assume the next update reflects resilient trading. 

Mind how land sales tend to be lumpy and a buoyant market means they may be contributing a rather exceptional element of revenue/profit. Gleeson’s first half-year saw an 80:20 operating profit split between house-building and land sales.  

House-building revenues rose 12% over £150 million, helped by higher selling prices, despite a 2% fall in homes sold to 932 – although the first half of 2021 had been flattered by delayed completions from the first Covid lockdown. 

At the end of last year, Gleeson had 71 sites with potential to deliver 21,155 plots – i.e. supporting potential both for land sales and house-building. 

Management’s expectation for the rate of house price growth to slow rather than see prices fall is pretty optimistic.  

Last February, the CEO declared that due to investing in people and processes “the business is operationally and structurally very well positioned to achieve further controlled growth.” 

That Gleeson equity has since fallen by 16% from 720p shows the stock market is wary and that investment alone cannot offset a worse-case UK economic scenario. 

Ratio of house prices to average income suggests waiting 

Sceptics of the buoyant UK property market have raised eyebrows at this ratio for some time. 

Over 80 years, the difference between house prices and average annual income shows it was only the early 2000’s and more recently, when this ratio escaped a circa 4x to 7x range. Lately it has tested a record 9x reflecting ultra-low interest rates. 

If people gain wage increases to cope with inflation, and mortgage rates edge higher, then logically house prices must ease if this ratio is to mean-revert like it has done historically.  

Yet there is logic to average-in 

Bulls would say, government always seems to find a way of propping the market and a general election must be held by January 2025. 

Risk appetite is your decision, but I think Gleeson is worth flagging for how its business model looks better placed than the volume housebuilders, and two directors see long-term value. Buy.  

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.

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