It’s one of the highest-yielding stocks around, and it’s FTSE 100 listed. Companies analyst Edmond Jackson studies the numbers and tells us what he’d do with the shares.
When I drew attention to Northern homes’ specialist MJ Gleeson (LSE:GLE) on 10 May it was interesting partly as an early example of material director buying of a house-building stock after the sector has de-rated.
One might reasonably ask, why then have the directors at Persimmon (LSE:PSN) not bought similarly after it has fallen 35% from 3,200p a year ago? Admittedly, around 2,100p takes the stock back only to the lower end of a consolidation range that saw dips under 2,000p in 2018/19.
Critics of Help to Buy would say the stock’s rally from 900p in 2013, when the scheme was introduced, is largely explained by the government scheme.
Do low ratings already price in a significant downturn?
If guidance on consensus forecasts is fair, Persimmon currently yields 11.5% based on market expectations for a 241p dividend in 2023, slightly up on 2022.
That compares with 3.3% for Gleeson, although I pointed out how it is padded with 3.7x expected earnings cover versus just 1.0x for Persimmon.
Builders all seem confident in a scenario of house price growth simply slowing, but the stock market is pricing for a material risk of falls, and you take a view.
Persimmon is arguably already priced for a dividend cut. Meanwhile, forward price/earnings (PE) ratios on both stocks are just over 8x on current forecasts. Barratt Developments (LSE:BDEV) and Taylor Wimpey (LSE:TW.) trade on 6x.
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Enough investors are heeding an adage which says among the worst purchases to make are cyclical stocks that appear cheap in the early stages of a downturn.
Yet the UK is well behind government targets for 300,000 new homes a year, to meet demand, and the Bank of England cannot raise interest rates – which bear on mortgage rates – very much without causing recession.
The chief risk appears cost of living rises compromising the ability of homeowners to service mortgages, such that unless incomes rise then house prices must fall.
2021 income statement benefited from pent-up demand
Emerging from Covid lockdowns helped a 7% increase in new home completions and a 3% rise in the average selling price – to push Persimmon’s revenue up 8.3% to over £3.6 billion.
This year, and recalling a 27 April trading update, completions will be weighted to the second half albeit still with 4-7% volume growth expected on 2021. The average selling price in the forward order book has risen 6% from £252,000 to £266,000.
In the first four months of 2022 some 6,600 plots were acquired in 22 UK locations, such that nearly half of last year’s delivered plots were replaced in the first three months of this year.
Last year, £460 million was spent on investment, although a further £76 million was required for rectification works – mainly cladding removal and fire safety - on 33 developments.
Does Persimmon’s vertical integration sufficiently mitigate cost risk?
Most housebuilders have until 2021 sported operating margins in mid-teen percentages. However, Persimmon stands out for consistently hitting the mid-20% area. Average return on total capital has been 23% over 20 years.
The cynical view is this reflects the boost to housing demand and prices from Help to Buy which is formally due to expire next April – unless, say, the government opts to maintain it selectively versus the cost-of-living crisis, and to prove “levelling up” in the North before the next general election.
A 2017 analysis by Morgan Stanley concluded that £10 billion of taxpayers’ cash went almost entirely into the volume housebuilders which raised prices by the same amount overall. Aside from general property price inflation, from 2013 the premium for new-build homes beat second-hand by 15% from the start of Help to Buy.
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Persimmon argues its vertical integration embeds margin. For example, it owns brickworks and tile and timber frame manufacturing facilities, which have also assured materials supply during recent disruptions.
At the 3 March annual results, management said this helped mitigate build cost inflation of around 5%, hence the underlying operating margin rising from 27.6% to 28.0p. The CEO was determined even to grow this industry-leading margin.
Yet they also anticipated that continued increases in selling prices would help offset build cost inflation, which is quite an assumption.
Balance sheet strength to withstand a downturn
Intangibles barely constituted 5% of £3.6 billion, end-2021 net assets and there was no debt “just” £1.25 billion cash – hence a ratio of current assets to current liabilities of nearly 5x.
Mind how the 27 April AGM statement then cited £446 million cash as of 22 April, having returned £399 million to shareholders on 1 April and spending £314 million on land.
As part of risk assessment, severe market disruption has been modelled, for example new home sales nearly halving and average selling prices slumping 37%. Even in the event of a complete shutdown of the market i.e. no sales but fixed costs maintained, management says Persimmon would maintain substantial liquidity and a positive cash balance.
Yet the extent of future dividend payments looks pretty much at the mercy of the housing market, and Persimmon’s statements appear to carefully avoid guidance or the sense of a pay-out policy. The stock market is therefore not unreasonably pricing in a dividend cut.
Persimmon - financial summary
Year-end 31 Dec
|Turnover (£ million)||3,137||3,598||3,738||3,649||3,328||3,611|
|Operating margin (%)||24.6||26.5||29.0||28.2||23.5||26.6|
|Operating profit (£m)||771||955||1,083||1,029||784||961|
|Net profit (£m)||625||787||886||849||638||787|
|EPS - reported (p)||197||243||281||266||200||246|
|EPS - normalised (p)||198||244||283||267||220||247|
|Operating cashflow/share (p)||220||255||207||194||239||245|
|Capital expenditure/share (p)||4.6||5.6||4.9||8.6||5.9||6.5|
|Free cashflow/share (p)||215||249||202||186||233||239|
|Dividends per share (p)||135||235||235||40.0||195||235|
|Covered by earnings (x)||1.5||1.0||1.2||6.7||1.0||1.1|
|Return on total capital (%)||24.6||26.8||30.7||29.5||20.9||24.6|
|Net debt (£m)||-913||-1,303||-1,048||-844||-1,234||-1,247|
|Net assets (£m)||2,737||3,202||3,195||3,258||3,518||3,625|
|Net assets per share (p)||887||1,037||1,006||1,022||1,103||1,136|
Source: historic company REFS and company accounts. Past performance is not a guide to future performance.
A substantial land bank supports future developments
Note 7 of the annual results regarding inventories breaks down chiefly as: £1.8 billion land, barely changed on 2020, likewise £1.1 billion work in progress. A year-end land value review concluded that sales prices and costs to complete were fair.
The 2021 cash flow statement does however show only around £20 million spent on property/plant/equipment in each of the last two years.
The financing side of said statement is dominated by dividend outgoings which differ from dividends you will see quoted in respect of financial years, due to timing differences of the actual payments.
The crux is what happens to sales and house prices
I believe Persimmon’s superior margins can help it buck a downturn, yet the dividend payout – currently key to stock sentiment – can still be affected by sales rates and prices.
The outlook statement last March cited private sales up 2% in the opening weeks of 2022 and a robust forward sales position of £2.2 billion. Volume growth of 4-7% on 2021 was targeted, and margins maintained.
Yet the cost-of-living crisis has only really started to bite from April and heating bills are expected to rise again in the autumn.
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The 27 April AGM update re-iterated sales up 2%, although the forward order book had risen to £2.8 billion.
Ironically, “the growing risk of an economic impact as a result of the tragic conflict in Ukraine” was cited, albeit no mention of the key issue of affordability of new homes.
It appears to me that as things stand, housebuilders can likely continue reporting strong numbers in respect of the first-half-year. The uncertainty lies beyond.
Persimmon director remuneration is not exactly known for temperance, so it is surprising they are yet to spend money on equity at current prices – if they firmly believe what they say.
Risk/reward profile is finely balanced
My rating reflects the sense of a starter position, then to add to or ditch according to the housing market in the next two years. Buy.
Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.
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