Market Commentary - Housing, Infrastructrue, Construction and Services
Bellway and Ibstock have issued statements this morning, the former an update on its progress in the year to end July and the latter its half year results to end June 2016. The evidence from both companies is that trading in July was quite strong so the triggers that caused the governor of the Bank of England and the MPC to halve the base rate yesterday must be more forward looking than we are now seeing. Serco was the leader of the pack yesterday with an 11.8% rise to 132.7p. The gyrations in sentiment on the Brexit impact and now the first substantial measure to mitigate the short-term economic effects probably triggered the lack of support yesterday for Mears which was the only loser in our 22 bellwether HICS stocks.
Bellway and Ibstock have issued statements this morning, the former an update on its progress in the year to end July and the latter its half year results to end June 2016. The evidence from both companies is that trading in July was quite strong so the triggers that caused the governor of the Bank of England and the MPC to halve the base rate yesterday must be more forward looking than we are now seeing. Bellway reports record results as it has strived in the current climate to join the big league of housebuilders; it delivered a 12.5% rise in volume to complete 8,721 units at an ASP 13% up on the prior year which combined to provide a 27% rise in revenue at 22% operating margin. Aside from a sluggishness in top-end London properties, the company saw little change in trading in July from prior periods. Ibstock floated last year but has helpfully provided comparative data which show a 3.3% rise in revenue to £210m and a 7.3% rise in EBITDA to £56m; the company saw a dip in deliveries immediately pre Referendum, but July trading was at the same levels as last year. More below.
The Base Rate reduction had a clear positive impact on the sector’s share prices, but as the decrease was expected the rise was subdued. It may also be that there is some double thinking going on insofar as investors may suspect that the forward looking indicators must be quite weak for the MPC to take this action. Our brief is to cover HICS stocks so it is wise not to delve too much into economics. But the scene is set by the BoE for fiscal stimulus to keep the post Lehman party in full swing despite Brexit. Mood swings on whether that is succeeding will have a substantial short-term impact on sector share prices.
Serco was the leader of the pack yesterday with an 11.8% rise to 132.7p. We attended the meeting which was notable for the questions being almost 100% about the credibility of future growth plans. It is a measure of the success that has been achieved as two years ago it was being shunned for consideration on certain contracts; it now has a pipeline of near £8bn and is heading for one of £10bn+ of viable contracts where it can add value and make 5-6% margins. In terms of valuation, the market might be ignoring the company’s warnings that 2017 is likely to be worse than 2016 and that dividends are some way off. On one conventional valuation, P/E, at 133p the company is trading on 25-30x prospective earnings. That said, several international services companies are trading on P/E ratios of 20x or more without the recovery potential that exists at Serco. Management has to date exceeded the guidance provided to the market and we suspect investors are now conditioned to that outcome.
The gyrations in sentiment on the Brexit impact and now the first substantial measure to mitigate the short-term economic effects probably triggered the lack of support yesterday for Mears which was the only loser in our 22 bellwether HICS stocks. It fell 1% to 408p which was no more than ebb and flow of trade on the day and does not reflect the very positive prospects the company sees ahead. There is no doubt that in any stimulus package the new government may introduce, support for social housing will feature high on the list, given statements so far about social policy.
Bellway, in common with many housebuilders has provided so much data in its update the additional data in the formal results is not that important. The key revenue and margin data are positive as shown above and the company has gone for faster growth than most rivals, especially through expansion in the South East and has succeeded. It has little activity in high end London although it does have one big tower we see every day by the railway line at Waterloo on which very little activity has taken place recently. In common with many, Bellway is on the “short-term uncertain/long-term great” tack and the numbers today offer no real credible alternative; the short-term data say what they say and cancellation rates remain very low and the order book at 4,644 units is healthy, although unchanged from last year. The company points to a good land market, for buyers and it contracted 9,555 plots last year, which is a tad more than current production levels. It ended the year with a small net cash position which given the rate of expansion of the business is a good outcome.
The easy call for the housebuilders is down from here given the level of uncertainty and the stage we are at in the cycle, but it may not be the right one. In the current climate reducing the volume of production seems unlikely, although a reduction in ASP is easily possible in some parts of the UK. Share prices may currently reflect the worst outcome for the sector and, despite the recent bounce in share prices, could still undervalue the only companies in the UK with the capacity and capability to solve the shortage of good living accommodation in the right places. And we suspect that the stimuli to the industry provided by legislation will continue for some time and may even increase.
Ibstock, in common with its peers, has seen little short-term impact from what should be a substantial change in the trading background, Brexit. It is therefore steaming ahead with its expansion programmes while preparing contingency plans in case of a recession. It is the usual argument that the short term is uncertain, but long term we should be fine because we know our business and have taken the right actions to date. The US operations which are 20-25% of revenue provide some alternative source of revenue and earnings but the substantial story is still the UK. Price increases in the UK were in low single digit percentages after several years of much higher increases but that is only in line with what might be expected after such large rises, little growth in housing volume and a slightly overstocked distribution chain. The company’s plans to improve cost efficiency, raise production levels and create new product ranges are still in place. The boost to earnings provided by lower energy and distribution costs which helped last year have diminished, but balancing that recent FX rate moves have improved the price competitiveness of UK-sourced products.
The fundamentals of house building in the UK and the actions taken by the three main UK brick makers, Ibstock, Forterra and Michelmersh, point to a positive future for the sector. However, share prices remain subdued and there is no obvious catalyst in the short term until Brexit uncertainty reduces. What is clear to us is that the scope for earnings improvement from this point is positive and today’s entry points may seem cheap on a three-year view.
Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.