Interactive Investor

Stockwatch: Lock in FTSE 100 share's 6.5% yield

12th February 2016 11:20

by Edmond Jackson from interactive investor

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Are fears for the London housing market overblown? It exemplifies a main dilemma: figuring which dividends are genuinely secure. You see some yields rising to over 5% as share prices fall, covered 1-2 times by forecast earnings, but what if the business cycle is turning down generally? Strong balance sheets provide some respite, yet it takes a determined board to make distributions uncovered by earnings.

One such situation is Berkeley Group, the London and Southern England house and flat-builder. This year its FTSE 100 shares have fallen 16.5% from 3,700p to 3,090p, with three hedge funds taking down-bets later in January and in early February - presumably along a rationale the London housing market is over-priced.

But, on 10 February, the stock rose smartly to 3,250p before settling just below 3,200p; on that day, at least, enough buyers disregarded short-sellers to focus on a circa-6.5% yield, in a belief a 200p per share dividend is likely and supports the stock.

In renewed market falls, the price has hit 3,000p, recovering to 3,100p, which on a chart view puts the stock back around a support level pertaining since last May. Whether it sustains or loses this is likely the key to near-term sentiment - otherwise, in simple chart terms, perception moves to the 2,500p level last May.

Don't be put off by a "heavy" share price; this is a good sign, that Berkeley has only 137 million shares in issue despite being a £4.2 billion company. It implies a history of commercial success and prudent financial management without regularly diluting shareholders.

More than any other housebuilder, Berkeley's board emphasises returns of capital. The 4 December interims proclaimed an "enhanced shareholder returns programme". All things considered, payouts from 2011 to 2021 are to be increased by £500 million from 1,300p to 1,634p per share.

This is based on the "strength of our recent performance and visibility over future profitability and cash generation from our land bank and forward sales". To price the stock below 3,000p - implicitly a 6.7% yield - therefore represents the market looking beyond this medium-term scenario, to reckon on worse ahead.

London homes most overvalued in the world?

The short-selling rationale takes the view advanced by UBS last autumn, i.e. that London house prices are in a bubble - now exposed to foreign buyers selling up, an excess of new flat developments, and the chancellor's steeper stamp duty regime. London has become one of the most expensive cities in the world, based on home prices-to-incomes and price-to-rent ratios; the expense of buying a flat is now comparable to renting it for 30 years.

Is a 6%-plus yield satisfactory enough for what may lie ahead?Furthermore, loose monetary policy has distorted asset markets, including housing, with stockmarkets de-rating in the realisation all this hasn't helped the real economy - hence, in a matter of time, this will spread to other assets that are overvalued on fundamentals. There may also be a cynical factor: overseas buyers using London housing as a means to evade tax or launder money, "embezzled funds" which a downturn can temporarily knock out.

So yes, there is significant risk, and the equilibrium price for Berkeley Homes rather depends on what yield investors judge is appropriate for engaging this stock.

Against this uncertainty, it's not possible to determine from the accounts exactly what portion is represented by "London" or, moreover, what element by "prime central London" - which is more likely over-priced. The suburbs have benefited price-wise and in terms of building, as people buy larger homes there. But exactly where does the "London" sprawl end? It's a relative concept (linked also to travel logistics), so is impossible to decipher in accounts.

South is best-positioned longer-term

The long-term bullish point is this area being the most affluent in a services-dominated economy, with London its chief outlook point internationally. Short-term, investors also need to consider the risk of "Brexit" and what the likely extent of potential disruption is.

Even a relatively short time-scale reflects housing's cyclicality Once past this issue, demand for homes in London and the South East will still be relatively superior, such that a housebuilder's stock will rate a 'buy' - the hedge funds proving mere noise in a transition phase. That time could conceivably be now - you cannot tell - but only if a 6%-plus yield is satisfactory enough, according to your risk tolerance, for what may lie ahead.

Dividend under-written near-term

A 200p per share dividend (as forecast in respect of the current and next financial year) requires £274 million cash, where the last year to end-April 2015 saw £509.2 million net cash generated from operations, up from £303.2 million in the 2013/14 year.

The table shows those years as exceptional, however, with 2011 and 2012 seriously cash flow negative - when no dividends were being paid. So even this relatively short time-scale (in the table) reflects housing's cyclicality in a builder's financial statements - another reason the market is exacting a 6.5% prospective yield.

Berkeley isn't easy to interpret, but does at least have significant risk priced in Last December's interims showed net cash flow from operations down markedly, from £102.2 million to £1.3 million, versus dividends of about £122 million being paid in such six-month periods. Balance sheet cash rose from £153.5 million to £263.1 million, so the dividend is secure in the short-term.

However, this context emphasises the need for 2016/17 profit forecasts to jump to over £730 million to be realistic. For example, Cannacord Genuity published a 'buy' note on 3 February, backing this scenario and looking for earnings per share of 412p - i.e. 9% above consensus and representing a forward price/earnings multiple of about eight times.

Management's outlook is PR-correct, for example: "Today's normal market conditions provide Berkeley with the operating environment in which it can differentiate its performance," with the addition that it is "well-placed to meet its targets for the next three years". But that doesn't commit management to anything; such language can change with events.

Stock priced for rising risks

So, Berkeley is not easy to interpret, but does at least have significant risk priced in. Possibly, the chief macro risk is a continued devaluation of sterling amid Brexit fears and a realisation that George Osborne's targets are being shredded. This could boost inflation against largely static wages, leading to an element of mortgage defaults. In a worst-case scenario, Berkeley could borrow to meet its dividend commitments - the balance sheet is ungeared - although the market would see through this.

The stock is therefore a 'buy' for those able to see through the present risks, to long-term strength in the "London" housing market. Mind that there are medium-term risks, both to forecasts and the sustainability of a 200p dividend, with economic and political disruption.

For more information see their website.

Berkeley Group Holdings - financial summaryConsensus estimates
year ended 30 Apr2011201220132014201520162017
Turnover (£ million)7431041137316212120
IFRS3 pre-tax profit (£m)136215271380540
Normalised pre-tax profit (£m)136184271381540465731
IFRS3 earnings/share (p)70.3113140188277
Normalised earnings/share (p)7188.4141189277231379
Earnings per share growth (%)20.924.459.63446.6-16.663.9
Price/earnings multiple (x)
Cash flow/share (p)-177-12487.9230385
Capex/share (p)1.31.656.33
Dividend per share (p)15149180200200
Yield (%)
Covered by earnings (x)
Net tangible assets per share (p)69582596810521186
Source: Company REFS

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