Three housebuilder shares with most potential upside

The sector has been hit hard and investors are worried about the threat to massive dividend payments. But one City expert is unmoved and thinks there’s limited financial risk here.

A forecast that house prices will decline 10% has failed to derail a City firm’s support for shares in builders Barratt Developments (LSE:BDEV), Berkeley Group Holdings (The) (LSE:BKG) and Taylor Wimpey (LSE:TW.).

UBS believes the sector carries limited financial risk, given strong balance sheets and the cautious stance on land investment that’s already been adopted.

It said stress-testing exercises by the companies backed up its view that significant land impairments will not occur unless house prices decline by more than 20%.

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The bank’s analysis highlights that Taylor Wimpey has reported only 5% of its landbank has an implied gross margin of below 20%, with Barratt expecting limited land impairments of low double-digit millions if house prices were to decline in the magnitude of 10%.

UBS’s economists are predicting a material decline in house prices into next year of around 10%, but much is likely to depend on how interest rates evolve. There’s also uncertainty over how tax rises planned in this week’s autumn statement will impact demand.

Base rate expectations for next year have recovered from 6% seen during September’s mini-budget turmoil to 4.5%. This cooling of rate rise expectations has helped shares to bounce off their recent lows, although they remain down by around 40% in the year to date.

The sector now trades at about 0.9 times tangible net asset value on average. UBS said: “We don’t see that much upside on average (total shareholder returns of about 10%) but see most potential upside in Barratt, Berkeley and Taylor Wimpey.”

Its assessment follows recent trading updates in which several leading players provided a clearer picture of demand trends in the period since the UK mini-budget.

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UBS, which had a target price of 120p for Taylor Wimpey, said industry sales rates looked to have materially weakened by about 45-50% year-on-year, having reduced from a high base due to affordability concerns and negative outlook for house prices.

However, it adds that trading appears to have now stabilised at this lower level and that mortgage rates are beginning to decline from the recent peak.

The bank sees limited risk of another round of material fire safety provisions unless there is a significant change in scope, adding that it believed a recent increase by Persimmon (LSE:PSN) from £75 million to £350 million appeared company specific. The sector has now set aside around £2.6 billion, representing about 11% of tangible net asset value.

Among other City firms, Liberum said last week that it continued to have a “buy” recommendation and 113p price target on Taylor Wimpey. It is encouraged at guidance for net cash of £800 million at the end of December, better than its estimate of £600 million.

It notes that Taylor’s second half cancellation rate rose to 24% from 14% last year, but believes that bad news is pretty much now all discounted.

Liberum said: “We expect a better start to 2023 as mortgage rates settle to about 4.5% and we should see an improving market through 2023 as inflation and rate expectations calm.”