Interactive Investor

Stockwatch: Further upside here after outstanding year

24th October 2017 09:46

Edmond Jackson from interactive investor

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Can property, construction and land investment group Henry Boot go from strength to strength and its share price higher?

A latest update affirms: "trading has continued to be very strong across all our business segments, in particular, within property development and land promotion.... given the accelerated completion of transactions in September and October, also successful delivery of major development schemes through the second half of the year, we anticipate performance for the year to end-December 2017 will be materially ahead of the board's expectations."

Expect upgrades, therefore, to the consensus pre-tax profit expectation of £45.1 million, while the update guides also that "expectations for 2018 remain unchanged". With some contracts concluded ahead of schedule in 2017, this effectively implies positive momentum carrying forward too.

The stock has risen 8% to 335p, capitalising the group at about £445 million, a key question being, does it represent a "momentum buy" or "sell into strength" given the effect very low interest rates are having on asset values and development activity? A November rate rise might only restore pre-EU referendum rates, henceforth inflation be key.

An outstanding year

The update continues: "2017 has proved to be an outstanding (my italics) year where almost every deal we hoped to complete has done so." Thus, where might the underlying trend approximate: to a still superior growth rate or a consolidation?

When I drew attention to the stock at 206p in August 2016, it was along a rationale that Brexit-inspired fears for house-building/property stocks appeared misplaced; firms were reporting strong progress and expectations; but even so the Bank of England had cut interest rates once again which was medium-term bullish for asset values/activity.

This I believe is the chief reason for Boot's outstanding progress: a maturing of the situation in August last year when interim profits/earnings rose nearly 50% boosted by strategic land sales and with "the larger commercial development schemes we have been preparing for some time, now finally on site."

Premiums to net tangible asset values

A dilemma with many housebuilder related stocks is a current tendency to trade on multiples of net tangible asset values (NTAV) after the "Help to Buy" mortgage subsidy has boosted profits with house price inflation. It compares typically with big discounts after the 2008 financial crisis.

The risk for long-term investors is that when earnings/dividends ease, a fat premium to NTAV implies an air pocket. Who knows for how long the current upturn will last, while housebuilding remains a top government priority yet affordability is tough.

By way of comparison, Persimmon is sometimes cited as the prime beneficiary of Help to Buy and its stock trades on 3.5 times NTAV, despite a superficially attractive forward price/earnings (PE) of 11.5 and 5% yield covered 1.75 times.

According to its end-June 2017 balance sheet, Henry Boot's NTAV has improved to 180p per share, i.e. its stock is on a multiple of 1.9, while the forward PE should now be lower than the 13 times implied by September forecasts, the dividend yield 2.4% covered 3.25 times.

The company does hold its strategic land purchases as inventory, at the lower of cost or net realisable value, hence its asset values don't benefit from unrealised gains. Quite whether that's enough to justify the premium to NTAV: anyway, the market seems content to rate mainly on an earnings basis as profits flow.

Henry Boot - financial summary           Consensus Estimates
year ended 31 Dec 2012 2013 2014 2015 2016 2017 2018
               
Turnover (£ million) 103 154 147 176 307    
IFRS3 pre-tax profit (£m) 13.4 18.4 28.3 32.4 39.5    
Normalised pre-tax profit (£m) 13.0 18.2 27.9 32.3 39.2 45.1 46.4
Operating margin (%) 13.7 12.3 18.6 17.8 12.7    
IFRS3 earnings/share (p) 6.9 8.5 16.2 17.3 21.3    
Normalised earnings/share (p) 6.7 8.4 15.9 17.5 21.1 25.2 26.0
Earnings per share growth (%) 3.9 25.6 90.5 9.9 20.5 19.6 3.1
Price/earnings multiple (x)         15.8 13.2 12.8
Annual average historic P/E (x)   26 24.0 13.8 11.7 12.4  
Cash flow/share (p) -6.1 -1.0 6.9 0.7 16.0    
Capex/share (p) 0.2 0.3 -8.1 -10.2 1.5    
Dividend per share (p) 4.4 4.9 5.3 5.8 6.3 7.8 8.0
Yield (%)         1.9 2.3 2.4
Covered by earnings (x) 1.5 1.8 3.0 3.0 3.4 3.2 3.3
Net tangible assets per share (p) 131 140 145 162 172    
               
Source: Company REFS              

Property investment/development contributes 45% of profit

On a pre-tax basis and before central costs, the main driver for Henry Boot is diversified commercial property - warehouse schemes, the Aberdeen Exhibition and Conference Centre, office development in the South East, also residential units at a former Terry's chocolate factory in York.

All this effectively implies the stock is a medium-term play on the UK economy without a lot of consumer sensitivity. After trading "really well" in the first half, "we are currently delivering schemes with a gross development value of over £700 million and have over £500 million in the pipeline."

Mind this side has proportionally more debt than the others, clipping 21.5% off its operating profit, although like-for-like interim pre-tax profit leapt 266% to £10.9 million. Such vigour is a chief reason for the update guiding profits higher.

Land trading side is bullish going into 2018

This is the other aspect behind the latest profits re-rating. The group is exposed to housebuilding principally via its Hallam Land business: the interims show it accounts for 34.2% of pre-tax profit, albeit down from £12.9 million to £8.2 million like-for-like.

Back in August, it was said that 2017 financial objectives were already in the bag, also four sale contracts had been exchanged to complete in 2018 and is in advanced discussions with housebuilders on a further six. The October update doesn't advance on this except to cite 14 disposals concluded in 2017.

On such a narrative you'd "hold/buy for further upside" assuming the story can continue positively. Besides low mortgage rates likely to persist, and councils under government pressure to loosen planning restrictions, Henry Boot's interim statement added a fair point.

It said: "one outcome of the general election result will be a period of stability in the planning system with all parties seeing house-building as important to the wider economy, with little appetite to make significant legislative changes."

Construction broadly flat, slightly better for 2018

This side has continued to perform in line with expectations despite some challenges, and in August had secured 60% of 2018 planned activity versus 50% of 2017's, like-for-like. Its interim pre-tax profit contribution remained about flat, though, at £4.9 million or 20% of the total.

Works include a Barnsley town centre for the council and a 45-bed care unit for Leeds city council. The group's Sheffield headquarters likewise quite begs the question how resilient the Northern British economy will prove but plenty looks good for now.

Directors maintaining their equity exposure

Post-interims, the chief executive sold 10,000 shares at 300p, albeit "to satisfy certain tax obligations arising on the exercise of long term incentive plan (LTIP) shares", to own 610,000 shares; and the finance director bought 4,841 shares at 303p in early October and added 10,000 shares via an options exercise at 191p, to own 39,500 shares.

Frankly, the executive/non-executive directors' holdings are quite modest, reflecting professional hires, whereas Jamie Boot, who chairs the board, owns 4.43% of the company. Anyway, the upshot is directors opting to retain their equity rather than sell into strength.

The conclusion is, therefore, quite a fine line: adherents to a "margin of safety" may prefer to avoid any such property/housebuilder stocks on substantial premiums to NTAV, or if holding then not to push your luck too far.

Yet, it's notable how the finance director judges it prudent to raise exposure amid strong commercial momentum. For vigilant traders, Henry Boot remains worth buying as a more imaginative play than the likes of Persimmon.

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