Interactive Investor

Stockwatch: Persimmon versus Vistry - who wins?

12th July 2022 10:34

Edmond Jackson from interactive investor

Companies analyst Edmond Jackson thinks this is one of the biggest disconnects in valuations and reporting that he’s ever seen. Here, he investigates whether one of these housebuilders is truly unique, like its management claims.

Signals continue to evolve about how either stock market ratings or managers of leading UK housebuilders are massively wrong. 

This looks like one of the biggest disconnects I have seen in valuations and reporting, hence it is interesting to compare £1.8 billion Vistry Group (LSE:VTY) against £5.7 billion Persimmon (LSE:PSN).   

Two big beasts defy economic warnings 

Capital Economics started this week by warning that house prices are detached from reality and will fall by 5% to 10% in the UK, possibly up to 20% in Canada. I think that is overdue anyway and hardly a disaster. 

Persimmon shares have settled nearly 5% down at around 1,785p, despite a 7 July update raising first-half-year profit modestly above its expectations “reflecting strong demand and positive pricing conditions. Our forward sales position is robust.”  

As I noted on 17 May, Persimmon has a cushion by way of high operating margins and return on capital employed (ROCE) - consistently in a mid to high 20% region.  A forward price/earnings (PE) ratio barely over 7x and a dividend yield over 13% - but only just covered by projected earnings – says consensus forecasts are wrong. 

Yet Vistry shares are up 2% at 832p after a bullish update. Management asserts it has significantly beaten its expectations amid “strong demand across all areas of the business, and our forward sales positions have further strengthened.” 

Despite cost pressures, Vistry expects significant margin progression in 2022, with adjusted profit at the top end of market forecasts. That was hard for the market to dismiss.  

Mind, the progress has not been quantified and budget could have been conservative. But the updates do show managers are on the ball. It would appear worse is needed to happen than a 5% to 10% easing of house prices to justify current stock ratings in the longer run.  

What extent of mean reversion in the ratio of house prices to income is likely? 

Construction generally is exposed to cyclical downturn in business spending, yet a strong desire for home ownership will persist even if affordability is temporarily compromised.  

A bearish factor, however, is government no longer being able to afford Help to Buy, which finally expires in March 2023. Five years ago, Morgan Stanley did comprehensive analysis showing the scheme had chiefly boosted housebuilders’ profits. 

Stricter mortgage lending criteria adds to a likelihood, the ratio of UK house prices to average income will finally mean-revert after an exceptional rally helped by loose monetary policy.

Vistry offers more realistic yield, also asset-backing  

Consensus has expected net profit to soar 24% to £316 million this year and then flatten. This would imply around 22% growth in normalised earnings per share (EPS) to 144p, hence a forward PE of 5.8x. 

The dividend yield would be 9% based on consensus for a 24% rise in the pay-out to around 75p a share, in respect of both 2022 and 2023. Earnings cover would however be nearly 2x – i.e. twice that for Persimmon, hence more scope to maintain or modestly cut the pay-out should profits fall.  

Relative to net tangible assets (NTA) Persimmon is on £3,449 million or 1,080p a share – a 65% premium. Sceptics might say, that reflects an element of distortion from Help to Buy and exceptionally beneficial monetary policy – both now changing. 

Vistry has £1,715 million NTA, or 783p a share, hence a 6% premium in market price, which conservative investors might favour over Persimmon. 

Barring a prolonged recession, I think both stocks will likely be higher on a two-year view; the question is what happens in the meantime. 

Vistry - financial summary
year-end 31 Dec 2016 2017 2018 2019 2020 2021
Turnover (£ million) 1,055 1,028 1,061 1,131 1,812 2,359
Operating margin (%) 15.2 11.8 16.4 15.8 5.1 12.1
Operating profit (£m) 160 121 174 179 91.7 285
Net profit (£m) 121 91.3 137 138 76.8 254
EPS - reported (p) 84.2 63.5 95.0 97.7 34.7 114
EPS - normalised (p) 84.2 67.3 94.7 107 43.1 118
Operating cashflow/share (p) 43.1 109 90.9 153 82.2 120
Capital expenditure/share (p) 1.2 1.0 1.3 0.4 1.2 0.7
Free cashflow/share (p) 41.9 108 89.6 153 81.0 119
Dividends per share (p) 42.1 44.4 53.3 19.2 20.0 60.0
Covered by earnings (x) 2.0 1.4 1.8 5.1 1.7 1.9
Return on total capital (%) 13.5 10.3 13.6 12.7 3.4 10.0
Cash (£m) 38.6 170 163 362 341 399
Net debt (£m) -38.6 -145 -127 -339 4.3 -201
Net assets (£m)        1,016        1,057 1,061 1,272 2,195 2,391
Net assets per share (p) 727 756 760 828 988 1,075
Source: historic Company REFS and company accounts

Housebuilder with a community-based, projects side 

After Vistry was formed from the 2019 merger of Bovis Homes and Galliford Try, it faced a challenging two years due to Covid, although a 2020 drop in profit was swiftly overcome for record 2021 performance.  

Such factors blur chart analysis as there is no long-term track record for a relatively new entity.  

Around 80% of operating profit derives from housebuilding and 20% from “partnerships” – still housebuilding, but community-based projects in conjunction with government bodies, housing associations and local authorities.  

Operating margins have to date been better on the main housebuilding side.   

Housebuilding saw 2021 annual adjusted revenue up 39% to £1,829 million, with adjusted operating margin up 6.1 points to 16.7% - achieving operating profit of £305 million. 

Partnerships revenue rose 19% to £864 million with its margin up 2.5 points to 9.2% and operating profit near £80 million. 

Build cost inflation for 2022 was envisaged at 6%, hence the overall equation for value currently looks positive – the 8 July update citing a 16% increase in the forward sales position to £2,144 million, for the housebuilding and partnerships operations combined. 

Vistry CEO says: “With leading capability across all housing tenures and being one of the largest private sector providers of affordable housing, the group is uniquely positioned within the house-building sector, and we continue to drive the benefits from our house-building and partnerships combination.” 

The land bank has been more than replenished, securing 3,360 housebuilding plots in the first half-year at an average gross margin plus return on capital employed above 25%. On the partnerships side, 2,166 sites have been acquired with an operating margin target of at least 12% and ROCE over 40%.  

First half completions rose 3% to 3,219, with the gross margin ahead of a 23% target. 

It is possible the partnerships side offers a modest buffer for “affordability risk” if councils etc have guaranteed buying partnership housing. Quite for how long that might last if a recession ensues is unclear. 

Planning, however, remains the most significant constraint on the business, hence longer lead times are being factored into site forecasting. “Our strong balance sheet and breadth of operations provide resilience to cope with any specific issues,” the firm says.

Vistry’s CEO buys nearly £125k worth of shares 

On 4 March, Vistry’s boss acquired nearly £25,000 worth of share sin the company at 944p, then a further two tranches on 27 May - nearly £15,000 worth at 909p, and £84,500 at 899p. 

Also, on 8 April, a non-executive director since last June bought £10,700 worth at 919p. 

At least it shows the board believes sufficient commercial momentum can persist. 

Yet a latest PMI report cites housebuilding slowing 

After these big company updates came a purchasing managers’ index (PMI) report for June – measuring monthly changes in industry activity, citing “a considerable loss of momentum” for construction as a whole.

So, who to believe? Ultimately, it boils down to matters of philosophy: to what extent the future is predictable and your appetite for risk.

Quite likely, worse news lies ahead for the sector, so be steeled for continued stock weakness. Yet prices could form a base, even rally, if updates prove not as bad as valuations imply. There may be an even better case to consider averaging into Vistry than Persimmon. Buy. 

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