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Stockwatch: four stocks to back a UK building boom

With minsters confidently citing housebuilding and infrastructure as key means to invigorate UK growth, is this a new investment trend to back? Analyst Edmond Jackson thinks so.

9th July 2024 12:25

by Edmond Jackson from interactive investor

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    While it was always a key policy objective for Labour, it took until confirmation of a strong majority government for housebuilding equities to respond from last Friday. With housebuilders, the rally has typically only been around 3% for the majors, more so in small-caps, if only taking both back to levels of last springtime.

    In infrastructure, key shares are edging to multi-year highs but remain on modest single-figure price/earnings (PE) multiples.

    So, with minsters confidently citing housebuilding and infrastructure as key means to invigorate UK growth, is this effectively a new secular investment trend to back? Bosses of Barratt Developments (LSE:BDEV) and Berkeley Group Holdings (The) (LSE:BKG) have responded positively, as if this is a breakthrough effectively for private companies to piggy-back public spending.

    I think the stock market is being wise to avoid a knee-jerk reaction up. Labours plan, effectively for around 65,000 extra homes built per year, within their objective for 1.5 million homes over five years, is going to require forceful action versus councils, and there will be local andgreen lobby resistance. The Conservatives wanted to build more houses but met the dilemma of alienating their own supporters.

    In the short term, builders should get some bonus from existing stalled building sites being accelerated, and also brownfield sites and Labours de-defining Green Belt boundaries pinpointing grey areas within.

    Affordability remains just one issue among others

    Affordability of homes is the chief reason housebuilders profits are projected to shift materially lower than they were in the years before interest rates hiked. Initially, Labour needs to prioritise build/buy to rent where Vistry Group (LSE:VTY) is showing it can capitalise.

    More positively, Vistrys trading update today cites forward sales up 21% on last year, so the market is picking up. I have rated this stock buy since 832p in July 2022.

    But mind how, if Labour does achieve its objective to deliver more homes, this will temper house price rises which are one key element in housebuilders profits.

    There are snakes in the grass besides ladders of opportunity.

    What will be the public/private balance under Labour, will it move towards some kind of nationalised housebuilding and where would the funding come from? All this may be revealed at an autumn budget.

    Despite Labours contempt for shareholder dividends, I doubt they will hit housebuilders with a windfall tax, given it would promptly assert an anti-businessapproach when Labour needs private builders on its side.

    Lack of skilled workers is another factor: if wages have to rise further to attract people into the industry, it counters the Bank of Englands objective to grind inflation assuredly down to 2%. For younger people, however, checking house price growth (via greater supply) is the most serious aspect of inflation to deal with.

    Does this justify upgrading housebuilders from 'hold' to conviction 'buy'?

    Shares in MJ Gleeson (LSE:GLE) are up 11% to 590p since the election, the best gainer given its strategic focus on low-cost homes and a near £350 million small cap status relative to the volume builders such as Persimmon (LSE:PSN) up barely 3% as a £4.7 billion FTSE 100 company. I had previously upgraded my stance on Gleeson to buy at 383p a year ago.

    Despite a forward PE near 17x and yield of 2% with around 3x earnings cover, Gleeson remains well down on its all-time high above 950p in early 2020, after which it slumped to around 350p by late 2022 and in chart terms is in a recovery trend:

    gle_2024-07-09_12-07-48.png

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

    It adds to intrigue over a trading update due this Thursday 11 July and, if there is a builder I would upgrade to buy”, it is probably Gleeson given it is in the right space to co-operate well with Labour and of small size to leverage gains.

    Vistry I continue to like after a £580 million deal was struck last month with Blackstone and Regis for 1,750 new homes in the South East. That its stock is as yet unable to respond positively to todays trading update implies patience may be needed for a break-out over 1,300p but meantime it offers a 4.5% yield:

    vty_2024-07-09_12-08-26.png

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

    We can expect all housebuilders to adapt their narratives to Labours agenda, for example the boss of Berkeley Group welcoming new government proposals saying 87% of its homes were delivered were on brownfield land in the last financial year. Around 4,800p, Berkeley's prospective yield is around 5% albeit with cover around 1.4x.

    If you have no exposure to housebuilders then a case exists to consider buying into the sector, where plenty should benefit. If you already hold, then continue to rather than go overweight. We have yet to see for example, what Labour will do on corporation tax.

    Infrastructure solutions stocks still face low-margin dilemma

    Whereas operating margins for housebuilders Persimmon and Taylor Wimpey (LSE:TW.) are in low-teen percentages, infrastructure groups such as Costain Group (LSE:COST) and Kier Group (LSE:KIE) have only in the last year or so recovered margins of around 2% (after losses during Covid).

    The chief risk with low-margin contractors on high revenues (Kier expected to achieve over £4 billion in its latest financial year, Costain £1.2 billion) is financial results potentially being disrupted if just one major project hits trouble. Yet with the stocks on modest single-figure PEs, they have enjoyed recovery trends as managers have asserted better controls.

    These companies are broadly set to get further support from Labours agenda. We need to see the policy details and how financed, but infrastructure spend is a classic priority for centre-left governments.

    I have been positive on both these stocks as recovery plays: Costain for deep value at 50p in March 2023 and Kier likewise as a buy at 90p exactly a year ago after declaring a string of contract wins. Serving highways, rail, infrastructure and nuclear, a public sector bias may well be helping Kier versus private firms deferring commitments during uncertainty.

    In both cases, a forward PE of 6x has only needed to improve to around 7x for share prices to advance, by 80% for Costain and 65% for Kier hence their currently passing momentum investors screening criteria.

    Kier Group - financial summary
    year ended 30 Jun2014201520162017201820192020202120222023
    Turnover (£ million)2,9073,2763,9984,1124,2203,9663,4233,2613,1443,381
    Operating margin (%)1.01.7-0.31.13.1-5.2-5.91.31.42.4
    Operating profit (£m)29.057.3-10.245.3129-205-20143.745.181.5
    Net profit (£m)10.04.4-17.610.787.3-210-273-0.312.741.1
    Reported EPS (p)15.839.3-25.312.875.5-126-90.911.62.89.3
    Normalised EPS (p)56.158.072.965.381.798.780.851.717.818.3
    Earnings per share growth (%)-10.53.425.74.725.120.9-18.2-35.9-65.63.1
    Operating cashflow/share (p)-8.5168172130111-53.5-37.922.816.341.6
    Capex/share (p)78.058.753.952.154.120.34.13.01.51.5
    Free cashflow/share (p)-86.510911877.657.3-73.8-42.019.814.840.1
    Dividend per share (p)56.554.263.456.758.04.20.00.00.00.0
    Covered by earnings (x)0.30.7-0.40.21.3-30.00.00.00.00.0
    Net debt (£m)210181143146213195510171163124
    Net assets/share (p)54560358743951727412797.8124115
    Source: historic Company REFS and company accounts

    Costains interim results are due in August, after the 16 May AGM cited in-line trading with a high-quality forward work position that aligns with our strategic plans both for transportation and natural resources.

    Kier is also due to report soon: last year there was a 20 July trading update in respect of annual results to 30 June (announced September). The March interims had asserted revenue up 23% and operating profit up 15% on a 3.4% margin, albeit the order book up more modestly at 6%.

    Reinstating a dividend in context also of a 44% reduction in net debt, helped confidence that Kier is at a positive watershed.

    My instinct is both stocks remaining buy as government doubles down on infrastructure development. You do, however, need to respect inherent risks with low-margin contractors.

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

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