Interactive Investor

Stockwatch: should investors follow an entrepreneur into this small-cap?

31st May 2022 11:40

Edmond Jackson from interactive investor

Our companies analyst Edmond Jackson considers a construction-related stock and whether he’d buy, sell or hold.

Construction-related stocks are a conundrum: potentially late-cycle after Help to Buy boosted house-builders from 2013 yet this scheme is ending; likewise, ultra-low interest rates since 2008 benefiting construction more generally.

Do you engage “cheap” stocks the market is pricing for a downturn; or small-caps focused on niches – successfully to date – such as MJ Gleeson (LSE:GLE) that I discussed recently or Henry Boot (LSE:BOOT) where a latest update intones how “strong” all aspects of the group are performing? No one has a crystal ball on the wider economy.

Well placed to continue benefiting from levelling up

I drew attention to Sheffield-based Boot in March 2021, as a “buy” at 275p given that it was well placed to capitalise on the government’s levelling up agenda for northern Britain. In November 2020, the CEO had also bought £100,000 worth of shares at 243.5p for his family.

Currently 330p after a 340p all-time high last April, this £440 million developer is similar to Gleeson in the sense of being an active land dealer – acquiring and sometimes selling on land to other house-builders – which can bolster construction-related profits, if making for lumpy cash flows according to the timing of sales.

Similarly as I like Gleeson for its bias towards low-cost housing in the North, Boot remains well-positioned for the Tories to hasten delivery on promises from the 2019 general election before the next major poll. Boot is also involved in urban regeneration and industrial/logistics property.

This may explain why its stock appears fairly priced than offering stark value like the volume house-builders – assuming you trust profit forecasts for the latter.

At 330p, Boot’s prospective price/earnings (PE) is 11.8x based on consensus for £39.5 million net profit this year, easing to 11.3x if £41.7 million profit is achieved in 2023. A prospective yield barely over 2% is nothing like what is offered by the major house-builders, and technical analysis qualifies Boot as a momentum stock – versus house-builders in a recent bear trend. Moreover, it trades on a 26% premium to end-2021 net asset value of £349 million or 262p a share.

Perhaps this relative success in valuation terms reflects both the urban regeneration theme also selective small caps enjoying more committed investors – where underlying credentials are firm – than active traders of more liquid stocks.

AGM update ideally needed the progress quantifying

But if construction is now late in its cycle, you still want reassurance on valuation, lest economic change lies ahead.

This is why Boot's latest statement can read frustratingly: it declares how “strong” trading is across the three markets of industrial & logistics, residential, and urban development, likewise progress towards medium-term strategic targets. Yet the dynamics were not clarified.

Despite supply constraints, cost inflation and rising economic uncertainty, management says it is well placed for the rest of 2022 and has a pipeline of longer-term opportunities.

My late-cycle concern is whether high land prices might potentially compromise margins for land dealing and development. Boot’s recent performance has been supported by land disposals alongside property development; yet land values have expanded along with property, amid exceptional monetary stimulus since Covid.

Is there a current risk of overpaying for land now that stimulus measures are withdrawn and interest rates are on the rise? Builders say not since Britain still fails to meet demand for homes.

David Gladman has few doubts about investment value

Interestingly, this Cheshire-based property developer passed the 3% disclosure threshold for his personal stake on 16 May, and on 24 May lifted this over 5.3% - implying £23.5 million worth of Boot equity.

That is some commitment to one company, especially a less-liquid small cap. Gladman clearly does not fear the short to medium term, and/or is willing to look beyond current risks. It is a firm endorsement of Boot’s activities from one of Britain’s canniest property operators.

He founded his eponymous development company in 1987 and became the UK’s largest speculative developer of offices and warehouses. The “speculative” tag implies ability to judge the market and take a risk than requiring space to be pre-sold before building commences.

Last January, it was acquired by Barratt Developments (LSE:BDEV) for £250 million partly due to its “excellent land sourcing and promotion capabilities” – having achieved £6.9 million pre-tax profit in its year to 31 March 2021. The operation continues as a stand-alone business within the Barratt group with David Gladman remaining chairman.

While it is always possible that operators in one industry lack objectivity on the wider economy, I incline to respect Gladman’s positive view of Boot – despite its stock around an all-time high.

Obviously, he has needed to start finding a home for his net cash proceeds, or watch them rot at bank, but £23.5 million allocated to one company says a lot.

This entrepreneur is decades-experienced in judging property exposure with his own money on the line plus bank debt to service.     

It implies that Boot equity rates at least a “hold” and possibly to stay on a “buy” list – with timing according to one’s choice.

Henry Boot - financial summary
Year end 31 Dec

  2014 2015 2016 2017 2018 2019 2020 2021
Turnover (£ million) 147 176 307 408 397 380 222 231
Operating margin (%) 19.0 18.0 12.9 13.8 12.4 12.9 3.7 15.4
Operating profit (£m) 28.0 31.7 39.5 56.2 49.2 48.9 8.3 35.6
Net profit (£m) 21.2 23.0 28.3 42.4 37.5 37.6 11.9 28.2
Reported EPS (p) 15.9 17.3 21.3 31.8 28.0 28.1 8.9 20.8
Normalised EPS (p) 15.7 17.0 21.1 32.0 28.2 27.6 9.8 20.5
Earnings per share growth (%) 87.0 8.0 25.0 51.0 -12.0 -2.0 -62.8 110
Price/earnings multiple (x)               16.1
Return on capital (%)   12.2 14.4 18.6 14.9 13.9 2.3 9.5
Operating cashflow/share (p) 6.6 0.2 15.1 27.2 8.1 8.8 10.4 -32.3
Capex/share (p) 1.4 1.6 1.8 3.4 1.4 1.5 0.9 0.8
Free cashflow/share (p) 5.2 -1.4 13.3 23.8 6.7 7.3 9.5 -33.1
Dividend per share (p) 5.6 6.1 7.0 8.0 9.0 5.0 5.5 6.1
Yield (%)               1.8
Covered by earnings (x) 2.9 2.8 3.0 4.0 3.1 5.6 1.6 3.4
Cash (£m) 4.4 12.0 7.4 10.3 10.9 42.3 42.1 11.1
Net debt (£m) 36.4 38.9 32.9 29.0 18.4 -27.0 -27.0 43.5
Net assets/share (p) 150 166 175 201 224 237 232 262

Source: historic company REFS and company accounts. Past performance is no 

Cash flow was the only niggle in the 2021 annual results

Understandably, with £60 million said invested in new opportunities across the group – a good sign – it was unsurprising how the end-December balance sheet went from a £27 million net cash position to £43.5 million net debt, for gearing of 12%.

But despite pre-tax profit more than doubling over £35 million, the cash flow statement showed after-tax cash from operations turning down from £13.8 million generated to a £43.8 million outflow. Possibly, the timing of land sales was a factor, if still a bit odd considering a 20% underlying return cited from the investment portfolio.

Return on capital doubled near 10% amid £15 million debt re-paid but also £55 million proceeds from new debt.

AGM update reflects a strong market currently

The land management side has sold 3,477 plots amid buoyant and competitive demand from house-builders; but after a major disposal at Didcot the land bank was replenished to keep its plots stable at 92,569.

Assets being developed are 73% pre-let or pre-sold amid high demand also from industrial occupiers. Wakefield Hub, a development of industrial/warehouse units, has received planning consent, and a regeneration scheme for Cheltenham council is close to signing.

The Stonebridge Homes subsidiary has secured 93% of its 2022 delivery target of 200 units. It says that UK housing continues to experience high demand and sales values have offset cost inflation. Planning consents have been achieved at Barnard Castle and Masham, a town in the Yorkshire Dales rated among the best UK places to live, with building due to start this summer.

Construction trades in line with expectations, for example, residential developments in Sheffield and York. Both the plant hire business and A69 road link are ahead of budget.

Mind how plant hire can be notoriously cyclical, hence a risk of peak trading currently if the UK economy weakens.

Citing a first-half-year weighting to performance can appear a portent of change, although management says this is due to a significant number of transactions’ timing.

Activity levels are expected to be high in the second half, albeit contributing financially to 2023 and beyond.

A “hold” stance can be justified overall but I respect David Gladman's judgement hence maintain: Buy.

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.

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