Interactive Investor

Stockwatch: is this the UK’s best-placed housebuilder?

20th September 2022 11:11

Edmond Jackson from interactive investor

The country’s housebuilding sector divides opinion currently, but companies analyst Edmond Jackson decides whether this small-cap builder is worth owning.

Is it time once again, to buy into MJ Gleeson (LSE:GLE), a small-cap builder of low-cost homes, now its stock trades at a seven-year low? 

Housebuilders appear to scream “buy” on a long-term view, as if already pricing in a downturn. These companies profess strong track records of earnings and dividends, seemingly quality cyclical stocks. 

Yet sceptics point out that long-term analysis shows the Help to Buy scheme – ending next month – substantially accounts for the sector’s uplift in profits. Five years ago, Morgan Stanley demonstrated how raised prices of new homes equated to money made available by government.  

If you respect Kenneth Clarke MP, chancellor from 1993 to 1997, he says the UK economy faces a tough long recession, which means the next two years will be very difficult. 

Meanwhile, desire for affordable home ownership remains keen, especially among first-time buyers, making Gleeson quite a special situation. 

“We are focused on a distinctly under-served segment of the market – young, first-time buyers on low to average incomes – where demand is expected to continue unabated,” the company said this month.

This was why I drew attention as a “buy” from 408p in May 2015, tempering my stance to “hold” from July 2019 at around 800p. As (expectations for) the economy changed radically, Gleeson slumped from 875p in May 2021 to a six-year low of 440p earlier in September. 

Latest annual results to end-June show pre-tax profit up 33% to £56 million (before £13 million exceptional costs to address cladding safety) on revenue up 29% to £373 million with normalised earnings per share (EPS) up 34% to 78p. 

This initially helped the stock rise over 6% to 490p, consolidating back to 480p which capitalises Gleeson at £280 million. 

Consensus has also edged up to anticipate EPS near 74p in the current financial year, rising to near 78p in June 2024, as if record earning power can defy Ken Clarke’s warning. 

Rating is similar to FTSE 100 housebuilders 

If true, it implies a price/earnings (PE) multiple of just over 6x, like Persimmon (LSE:PSN), while Barratt Developments (LSE:BDEV) is just shy of 6x. Greater liquidity ought to imply better ratings for big caps. On the other hand, Gleeson operates in quite a niche.  

The downside to assuming Gleeson is relatively defensive, is if those on mid- to low-income fare worse in a recession. We also have yet to see if it deepens to affect employment.  

Equity bulls say this recession will not be too bad because employment levels are high. But the UK is largely a service economy and we have yet to see if government help can prop the hospitality sector, for example, against higher energy prices. 

Supportive valuation criteria, especially net assets  

For the time being, Gleeson’s directors propose a 12p final dividend, taking the total pay-out up 20% to 18p. While this is below levels of over 30p paid out in respect of the June 2018 and 2019 years (see table), it is covered 3.3x by earnings and equates to a near 4% yield. 

MJ Gleeson - financial summary
Year-end 30 Jun

 201620172018201920202021
Turnover (£ million)142160197250147289
Operating margin (%)19.820.618.716.44.014.9
Operating profit (£m)28.233.036.941.05.943.1
Net profit (£m)23.026.230.233.34.533.9
EPS - reported (p)43.148.355.260.48.658.1
EPS - normalised (p)43.348.555.460.48.658.1
Operating cashflow/share (p)25.735.639.715.5-26.141.5
Capital expenditure/share (p)1.72.22.53.44.36.6
Free cashflow/share (p)24.033.437.212.1-30.434.9
Dividends per share (p)14.50.032.034.50.015.0
Covered by earnings (x)3.00.01.71.80.03.9
Return on total capital (%)18.419.118.719.32.617.1
Cash (£m)23.234.141.330.376.834.3
Net debt (£m)-23.2-34.1-41.3-30.3-16.8-34.3
Net assets (£m)153171188204213245
Net assets per share (p)283317345374366420

Source: historic company REFS and company accounts

EPS could therefore halve, but unless the outlook turned dire the dividend still be held with near-twice earnings cover. By comparison though, if consensus forecasts are fair, they imply a 9% yield for Barratt and near 15% for Persimmon. The market says not.   

Gleeson’s end-June net asset value (NAV) is supportive, with £272 million net assets equivalent to 467p a share with no goodwill or intangible assets.  

It is tricky to tell from the annual statement, but land values – Gleeson’s land division has 71 sites with potential for 20,241 plots – are likely in the balance sheet at cost. It would need a terrific economic slump for the stock not currently to be trading below NAV – although so does Barratt.  

As to weathering recession, there is a strong current assets position of £353 million versus £95 million total liabilities. 

Can a pincer of lower revenues and higher costs be averted? 

Gleeson says: “The board has reviewed a range of macroeconomic forecasts and, notwithstanding the current outlook for the broader economy, remains confident that the group, with its defensive qualities and within the wider house-building sector, is well-positioned to deliver further profitable growth in the current financial year.” 

I am wary it may not need much higher costs also lower revenues to hurt profits. 

The operating margin has already eased from 14.9% to 11.8% which compares with Barratt on 19.3% in its first-half-year to 31 December 2021 and 25.9% for Persimmon in their first-half-year to 30 June. 

If Gleeson can mitigate cost increases, it should have said more last week. It is clear from the news, input prices have risen - bricks and cement are energy-intensive to produce and copper for pipes and wiring has gone up – not to mention labour (shortages). 

The financial review simply cites the gross margin on homes edging up 0.5% to 29.0% as increases in selling prices more than offset cost inflation. 

On the demand side, Gleeson is relying on “an acute shortage of new homes” where the average cost of a new-build home in Gleeson’s areas of Northern England and the Midlands is said to be 59% higher than the £167,300 average cost of a Gleeson home, so it remains cheaper to buy than rent.  

The number of Help to Buy customers reduced from 69% to 53% but “the withdrawal of the scheme (this October) is not expected to impact demand”. 

Demand for quality sites with sustainable and implementable residential planning permission remains “strong” in Southern England, with the land division “well-placed to drive further sustainable growth”.  

I would be wary on that score should the housing market stall as affordability gets affected by tighter household budgets and higher mortgage costs. 

Further exceptional costs seem possible after £13 million for cladding remediation costs: “we are in the process of undertaking a programme of inspections and fire risk assessments,” says the company. 

Gleeson is also subject to an additional 4% residential property developers’ tax. 

My chief concern is whether the spike in material costs is fully reflected in the year to last June, or whether they could rise further.   

Some poor-quality Trustpilot reviews 

Half of 341 reviews are one-star versus 38% with five-stars and the remainder in between.  

This compares with 15% one-star for Barratt Homes out of 4,918 reviews, and 69% five-stars.  

Yet Persimmon Homes is also critiqued. Of 2,827 reviews, 37% are one-star versus 50% five-star. 

Despite a risk of online reviews being a magnet for complaints (hence are skewed) quality control by Gleeson and Persimmon seems a concern. Either their margins are being propped by cutting corners or site management is in question. 

It reduces to a macro question: how deep and long a recession? 

If employment is not badly affected, now may be opportune to be averaging into housebuilders. 

Mind, there are substantially more self-employed and contracted workers nowadays, so it will be easier for firms to cut back. An element of such could be candidates to buy Gleeson homes. 

My “buy” stance on Persimmon last May – for a starter position – around 2,100p was premature: its stock is down 32% as economic prospects worsen. 

As conditions become riskier, I am inclined to let housebuilders’ outlook statements better reflect this. I temper my stance on Persimmon and iterate similarly on Gleeson: Hold. 

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

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