Interactive Investor

Stockwatch: An off-the-radar bet on Help to Buy

3rd October 2017 13:42

Edmond Jackson from interactive investor


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Is this "affordable" housebuilder and land trader MJ Gleeson set for continued growth despite interest rate poised to rise?

Following latest prelims to end-June the FTSE Small-cap stock is up 8% to 670p, still below its 2017 high of 705p, representing a 12-month forward price/earnings (PE) ratio of about 12.5 times and yielding 4.1%, twice covered by projected earnings.

Cash flow lags earnings (see trend in table), although this last year it's mainly due to a £22.3 million increase in inventories, which is fair enough in a busy schedule. Yet the board has opted to hike the dividend 66% to 24p, a firm vote of confidence in medium term prospects.

It comes after pre-tax profit rose 17% to £33 million on revenue up 13% to £160 million, with earnings per share (EPS) similarly up 14% to 48.5p. Return on capital employed is also very respectable, up from 23.2% to 25.4%.

Management intends to double the size of its house-building operation (65.4% of operating profit) within five years, taking the view "affordable homes" are a growth business irrespective of economic and political change. With a milestone target of 1,000 home sales a year now achieved, 2,000 has been set for within five years.

"Affordability remains very attractive and demand exceeds supply with buyers queuing on site opening days," the company says. Gleeson Homes' land pipeline is up from 9,284 to 11,588 plots, equivalent to more than 11 years of sales at current build rates.

The strategic land trading business also continues to do well amid "extremely strong" demand for prime quality sites in southern England. For the current year it is cited obtaining planning consent on six sites and entering agreements on six new sites potentially adding another 1,846 plots for development.

How significant is cheap finance for home-buyers?

When I first drew attention to the stock at 408p in May 2015, I wrestled with the longevity of Help to Buy, although it was Gleeson's prioritising affordable homes in the North of England that attracted me.

Addressing a critical gap in the market, this strategy seemed capable of riding out volatility in "subsidised finance" – be it exceptionally low interest rates or taxpayers' money used to help buyers for homes under £600,000. This is the listed house-builder most oriented towards relatively low-priced homes.

Gleenson's land trading profits appear more cyclical according to what extent of land is bought at attractive prices relative to subsequent housing demand, although negotiating planning permission generally adds value also.

Two years or so ago, the stock also traded at a 70% premium to its last declared, net asset value, indicating that Help to Buy is boosting earnings/dividends such that PE and yield look attractive despite the premium to NAV.

Analysis of listed housebuilders shows their regaining pre-2008 operating margins of 20%-plus (see the table for Gleeson), sceptics argue as a result of new-build pricing adjusted higher to compensate for the subsidy.

Gleeson concedes it is enjoying keen demand while mortgages remain highly affordable and two-thirds of its customers are using Help to Buy; yet its average home price this last financial year was £122,210 and the highest £183,445, well below the current subsidy limit.

The typical buyer is said to be young blue collar: "Our chosen segment of the market is large, mostly untapped and not really affected by politics or the economy, because their outgoings relating to buying a Gleeson home are significantly less than renting a council or housing association house."

Doubling the homes' business within five years will be achieved, they say, by growing the pipeline of sites, investing in new office locations (two new offices in Cumbria and East Yorkshire besides seven in the North and North Midlands), developing staff (up from 333 to 405 over last year), mitigating costs and listening to customer needs.

So, although the stock may continue affected by sentiment towards house-builders, Gleeson is in a sound niche operationally.

MJ Gleeson - financial summary           Consensus estimates
year ended 30 Jun 2013 2014 2015 2016 2017 2018 2019
Turnover (£ million) 60.7 81.4 118 142 160    
IFRS3 pre-tax profit (£m) 5.8 12.2 17.3 28.2 33.0    
Normalised pre-tax profit (£m) 5.8 12.2 18.6 28.4   36.0 39.3
Operating margin (%) 9.4 15.1 16.1 20.3      
Return on capital employed (%) 5.2 9.5 13.9 18.8      
IFRS3 earnings/share (p) 18.9 32.8 23.0 43.2 48.3    
Normalised earnings/share (p) 19.0 33.5 25.4 43.9 48.7 52.7 57.2
Earnings per share growth (%) 192 76.2 -24.3 73.0 10.9 8.2 8.5
Price/earnings multiple (x)         13.8 12.7 11.7
Historic annual average P/E (x) 16.3 15.5 14.7 17.3 13.5    
Cash flow/share (p) -15.9 10.3 14.9 25.7      
Capex/share (p) 2.2 1.2 1.6 1.7      
Dividend per share (p) 0.5 3.1 7.6 11.8 16.5 26.8 29.0
Dividend yield (%)         2.5 4 4.3
Covered by earnings (x) 38.4 11.0 3.4 3.7 3.0 2.0 2.0
Net tangible assets per share (p) 212 241 254 283      
Source: Company REFS              

Help to Buy to run to 2027 under a Labour government?

Housebuilding shares were hit early last August after the London School of Economics was tasked by the government to evaluate Help to Buy, its scrapping or tapering seen as possible.

While the Conservative government seeks to contain public expenditure, its very survival is at stake with a poll suggesting more than twice as many voters under the age of 45 think Jeremy Corbyn's Labour party is now "on their side".

A sense is growing that Help to Buy will extend much further than 2021, potentially closer to Labour's last election manifesto of 2027. Thus the Conservatives' response, pledging another £10 billion with the government lending up to 20% of a home purchase price (40% in London).

The stockmarket is aware how significant it is for housebuilders' profits, with 40% of completions using the scheme; hence the likes of Persimmon rising rapidly at the start of this week.

Off-the-radar as a small-cap, Gleeson offers more attractive risk/reward given its focus on affordable homes also the North of England where prices are now rising fastest in the UK amid keen demand.

Major shareholders only slightly trimming exposure

After the stock's strong run (from about 170p in 2013) there has been some selling, but it looks like prudent risk management for long-term holders than a "sell" verdict.

Figures vary: according to Company REFS, North Atlantic Value LLP holds 14.8%, although REFS also cites Christopher Mills who's both a non-executive director of Gleeson and the founder of Harwood Capital which runs the North Atlantic fund, holding 18.6%.

Page 40 of Gleeson's 2016 report cites Harwood owning 20.4% and a holdings' RNS exactly a year ago showed it reducing below 19%.

The REFS figures are also a bit odd where Schroder Investment Management is cited owning 11% but a holdings' RNS from last April shows this fund manager reducing its stake from 11% to 10%.

According to another RNS last March, Mrs J C Cooper also reduced her stake, from 5% to 4%, though is cited by REFS as owning 4.7%. All these investors are implicitly medium to longer-term confident otherwise they would not retain sizeable stakes in a £360 million housebuilder.

With recent uncertainty over Help to Buy removed by the Conservatives and the Bank of England likely only to raise interest rates very modestly, the house-building cycle looks set to extend plenty further as political parties jockey to claim they help the young.

MJ Gleeson looks about the best-risked company in the sector to capitalise on this while limiting downside as an "affordable" home specialist. Its high rates of return should therefore persist, hence a "buy" rating.

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