The industry is under pressure, but this well-managed company already prices in an economic downturn, and cynicism can mean missed opportunities, believes analyst Edmond Jackson.
Yesterday, and in a macro context, Morgan Stanley argued that UK equities are remarkably cheap in a global context and will rally as inflation falls later this year.
I am therefore interested to examine another housebuilder, following last week’s analysis of Crest Nicholson Holdings (LSE:CRST), that trades at a material discount to net tangible assets after the recent sell-off on fears about the effects of higher mortgage rates.
It is possible that such asset values get impaired in a “higher rates for longer” situation and the UK languishes due to weak productivity. Some might say it’s also because the country is now outside the single market of its nearest major trading partner.
This makes a latest update from MJ Gleeson (LSE:GLE) especially relevant given it has a land trading side, which as yet still reports firm demand from housebuilders. Its operations are well spread in the South, East and North of England.
At 383p, this £224 million small-cap has reverted to 2015 levels having reached highs of 964p pre-Covid and 866p in May 2021. Consensus is for net profit around £23 million in the latest year to end-June and to June 2024, which recalls the June 2016 outcome (see table below) as if the stock is in a fair-value range.
Yet discount implies attractive risk/reward
Earnings per share (EPS) are expected to more than halve to around 40p in this latest financial year, then be broadly flat in 2024, hence a price/earnings (PE) multiple below 10 times. Due to historic earnings cover for the dividend being well over three times, this is projected to ease to 2.8 times cover for a dividend just over 14p per share, implying a 3.7% yield.
Mind, however, a volatile record on free cash flow (again, see table) which is more relevant for the dividend – given investment has reduced cash to just over £5 million.
|MJ Gleeson - financial summary|
|Year-end 30 Jun||2016||2017||2018||2019||2020||2021||2022|
|Turnover (£ million)||142||160||197||250||147||289||373|
|Operating margin (%)||19.8||20.6||18.7||16.4||4.0||14.9||11.8|
|Operating profit (£m)||28.2||33.0||36.9||41.0||5.9||43.1||43.9|
|Net profit (£m)||23.0||26.2||30.2||33.3||4.5||33.9||35.1|
|EPS - reported (p)||43.1||48.3||55.2||60.4||8.6||58.1||60.1|
|EPS - normalised (p)||43.3||48.5||55.4||60.6||9.3||58.3||64.3|
|Operating cashflow/share (p)||25.7||35.6||39.7||15.5||-26.1||41.5||20.3|
|Capital expenditure/share (p)||1.7||2.2||2.5||3.4||4.3||6.6||6.3|
|Free cashflow/share (p)||24.0||33.4||37.2||12.1||-30.4||34.9||14.0|
|Dividends per share (p)||14.5||0.0||32.0||34.5||0.0||15.0||18.0|
|Covered by earnings (x)||3.0||0.0||1.7||1.8||0.0||3.9||3.3|
|Return on total capital (%)||18.4||19.1||18.7||19.3||2.6||17.1||14.9|
|Net debt (£m)||-23.2||-34.1||-41.3||-30.3||-16.8||-34.3||-33.8|
|Net assets (£m)||153||171||188||204||213||245||272|
|Net assets per share (p)||283||317||345||374||366||420||467|
|Source: historic Company REFS and company accounts|
The expectations appear fair enough amid current uncertainties. Yet a 20% discount to end-2022 net tangible assets per share of 477p, implies medium-term scope for upward mean-reversion – despite being nowhere near Crest Nicholson’s 43% discount at 188p a share.
It does at least imply support for the stock, barring a worst-case “stagflation” scenario evolving in the UK. If inflation does reduce like Morgan Stanley argues, we can expect interest rate sensitive equities to benefit. It’s why I am onto housebuilders currently despite gloom pervading the sector.
Despite his chequered record, the Bank of England governor last night proclaimed inflation will fall “markedly” over the remainder of this year, to 5%. Yes, there are risks and wage inflation will peg the headline figure in mid-single digits, but cynicism can mean missed opportunities.
Downturn in home sales yet prices helped by supply shortage
Gleeson’s year to 30 June has involved a 13% overall reduction in the number of homes sold, the trend worsening to a 22% fall in the second half as mortgage rates rose.
Yet selling prices were underpinned by a shortage of housing, which helped to offset material and labour cost increases. The average selling price rose over 11% to £186,200.
There was a significant shift in buyer demographics in the second half: first-time buyers fell from 71% of reservations like-for-like to around 50%. There was also a doubling in sales to people aged over 55 to 20%.
Rental deals projected as “a compelling opportunity”
Interestingly, there were four multi-unit sale agreements with institutions, representing investment purchases of rental properties. As yet, the proportion appears modest at 7% of 1,723 homes sold in the last financial year, although contracted reservations were over three times higher than those sold for rental.
A 30 June announcement cited two institutional investors buying 288 homes, 66 of which will be accounted for in the latest financial year, with the balance to June 2024. Consideration will be over £50 million cash, to be re-invested in working capital albeit which also helps free up cash reserves for the dividend.
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It also sounds useful in a strategic context, with potential for further similar deals – both to meet demand from renters and institutions seeking relatively secure income.
“This transaction represents a compelling opportunity in the current uncertain market environment,” said Gleeson.
Net reservation rates have improved in last six months
Net reservation rates are up marginally on a like-for-like basis from 0.62 per site per week to 0.64, although this does include the four multi-unit sale agreements.
The new financial year has a stronger forward order book of 665 plots, versus 319 at end-December 2022 and 618 at end-June 2022.
Gleeson Homes has 82 new build sites versus 87 a year ago, although 71 are actively selling versus 61 at end-June 2022.
While tricky to decipher the net effect on a housebuilder’s overall commercial trend, it implies aspects of resilience relative to higher interest rates impacting stock sentiment.
Land continues to be available at sensible prices
On the housebuilding side: owned or conditionally purchased sites have risen 3.3% to 17,375 plots on 173 sites like-for-like.
While on the land trading side, three sites were sold during the financial year, with potential to deliver 413 plots for housing development. Its portfolio currently consists of six sites with planning permission (or resolution to grant) which is twice that of a year ago, albeit only advancing the number of plots from 1,206 to 1,400.
There are a 18 further sites awaiting planning permission (up from 16) with potential for 4,285 development plots – up 20% on last year.
Gleeson said: “Whilst planning delays and economic uncertainty are causing some larger house-builders to hesitate in completing land purchases, mid-size and regional house-builders remain active buyers of high-quality consented land.”
Will first-time buyers demand persist?
I argued in my Crest Nicholson piece that first-time buyers are a vital foundation of the entire housing market, and as they’re often younger families, they’re potentially exposed to the cost-of-living crisis. Might the Tories offer any sweetener of financial help next year, ahead of the general election?
Gleeson management reckons it is well-placed to attract buyers from other builders given its “more affordable pricing and high quality” – although online reviews vary on the latter score. It can be tricky to know if such reviews inherently skew to complaints in any business.
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Cost-cutting should help mitigate sales risk. The number of regional management teams has been cut from nine to six at a one-off cost of £1.0 million, albeit achieving a £3.2 million reduction in overheads from the June 2024 year onwards.
Gleeson therefore looks well-managed to cope with challenges ahead, where so long as the UK muddles along without a serious recession, the stock at 383p arguably prices in downside.
Director and institutional share buying
Bear in mind, the company will soon or already be in a restricted period on share dealings ahead of the 14 September prelims.
Yet in April, the CEO bought £71,400 of Gleeson shares at 403p and his partner £72,100 at the same price – which is 5% higher than current price.
The managing director of Gleeson Homes also bought £47,000 worth at 437p, which was 14% higher than today’s level. In May, US investor Blackrock declared a 5.5% stake.
Such a pattern accords with the discount-to-assets and respectfully resilient operations narrative which implies long-term value.
Last September, I took a “hold” stance at 480p but consider it appropriate to upgrade and suggest averaging in. Buy.
Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.
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