Market Commentary - Housing, Infrastructure, Construction and Services 6th February 2017
Housing will be the issue this week and not just with Redrow reporting its half year on Wednesday. Firstly, the long awaited Housing White paper may be due also this week but some of what it is expected to say, especially about increased availability of affordable housing is happening already
This morning Interserve has announced it has won a £65m/five year FM contract from Network Rail. Homeserve has announced the appointment of a new permanent FD, David Bower who has been acting as Interim since June 2016 and joined the company 12 years ago. Renew Holdings has announced that John Samuel, its FD, will leave within the next 12 months or earlier depending on the timing of the appointment of a successor. Sigma Capital has announced that it has spent £27m on three new sites on which it will build 200 new rental homes for its PRS portfolio. More below on Renew.
Housing will be the issue this week and not just with Redrow reporting its half year on Wednesday. Firstly, the long awaited Housing White paper may be due also this week but some of what it is expected to say, especially about increased availability of affordable housing is happening already. Secondly, L&Q, one of the largest UK Housing Associations, has just paid £505m to buy the strategic land holdings of privately owned Gallagher Estates. This provides L&Q with control of 42,500 potential plots in the Midlands and South East and will help fulfill its ambition of building 100,000 homes; that will roughly double the size of its current stock. Thirdly, UK Housing Associations bought 4x more building land in 2016 than they did in 2015. Our reading of the most recent Annual Reports of the top 20 Housing Associations in the UK showed all expecting to double annual production by 2021. We thought at first that the stated intentions were just about tickling the tummy of the HCA but it’s more real than that. Fourthly, there have been considerable government measures to improve infrastructure and land availability. Consultation meetings are being held throughout the country at present regarding intentions to convert vast tracts of greenbelt land, permanently, into house-building land.
Our point is that while the White Paper may outline the full scale of the Government’s intentions many of the expected changes are already happening. In that sense it’s hardly a White Paper but an summary of many changes already happening and some kite flying on others.
The greybeards will say it will never happen, been there before and other things of the like; most post 2WW UK governments want more houses and most fail to deliver. Notwithstanding the sceptics we have to believe that the policies being introduced will have some effect.
From the perspective of the stocks that will benefit clearly there are few exceptions among the materials producers so Forterra, Ibstock and Polypipe are at the head of any buying list, especially the former which trades on a p/e of 9x.
The companies that are committed to building new units for Partnership and PRS should get more attention and Morgan Sindall, Galliford Try and Kier are at the forefront of that but also note that Carillion has taken an active interest in large scale residential projects and has projects in that space. Clearly the housebuilders should also benefit though in many cases they have maxed out on the volumes they are willing to build save for the smaller ones such as Redrow, Gleeson and Crest. The logical consequence of greater housing supply is that price increases may be subdued but we are talking quite long term in that regard, we believe.
The Merchants, (SIG, Travis Perkins, Grafton and Woseley) who should benefit from greater volumes but on new build the amount of direct to site volumes is increasing. Modern technology can reduce the role of the Merchant and sites with plenty of storage around them (such as greenbelt) mean the Merchants role in breaking bulk delivery is not as crucial as it is on small sites.
Companies that provide services to the Housing Associations and other large scale dwelling owners will gain in the new world of rented housing. Given the expansion is still at early stages it’s probably too early to get “excited” but Mears, Lakehouse and Mitie are at the forefront in that area among the quoted stocks, especially Mears.
Finally, expansion of housebuilding on the scale suggested will cause numerous ripples in the supply chain. The main obvious one is of course in labour markets where skills are already scarce and getting scarcer with Brexit. The inflationary impact will be felt across the construction industry so in the forthcoming results round that issue will be a key one in questions. The government’s part answer to that issue will be increased use of Modern Methods of Construction (MMC) which is very likely in any event but it does not completely deskill construction processes and arguably just changes the location of some of the work. Recent questions about build and finish quality in new build will not be eased by the increase in housing volumes or for that matter MMC on its own.
News later this week will come from Bellway tomorrow with an update and St Modwen with its Finals; Redrow on Wednesday, as indicated and Atkins will update us on that day as well. It’s all quiet on Thursday and on Friday Electrocomponents and Shaftesbury provide updates which will be useful for read across.
The winners on Friday last were Galliford Try up 1.9% and Kier up 1.2%. While both have a mixed bag of work within their portfolios the house builders in general have had a good year so far (up 5% YTD) and these two have benefitted a little, GFRD is up 8.7% YTD and Kier 2.9%. These two, along with Morgan Sindall should get a boost from the latest approach to raising new build. The Housing Associations may have the land but they do know how to build new dwellings save in one or two cases. The back markers on Friday were Mears down 1.8% on little volume and Polypipe down 1.7%. Both stocks have had strong runs recently and are at high ‘ish valuations on a one year view. The structural changes suggested in new housebuiding in the UK will favourably impact both stocks but we are still at an early stage.
Regular readers will know that Renew has been a favourite for many years. It is therefore a disappointment to hear that the steady hand of John Samuel will no longer be at the hand of the financial tiller at the company by this time next year. The company remains very well placed in its markets and the man who has guided the business from the almost bankrupt Montpellier some 15 years ago, Roy Harrison, the Chairman, remains in post so there is every reason to believe that the company can continue to grow as it has in recent years.
Moves last week
The market and the sector saw limited movement last week so we shall not dwell too much on it. The sector is performing a little better than the market so far with the housebuilders in particular doing well, up 5.3%. But the first quarter is traditionally good for the sector relative to the rest of the UK market. Our sense is that he sector will perform in line with the market this year, after underperforming last year and outperformance in 2015 remains unchanged.
The largest gainer last week was Galliford Try ahead of its half year results and the strategy update due later this month. Aside from some contractual glitches in Construction which will hold back margin, we suspect, GFRD should be performing well as its main sources of profit are in good shape and are growing. It remains undervalued in our view on a prospective p/e of 9.4x , yielding 6.2%.
The main loser was Capita, down 4.7% last week and 7.7% YTD. Bad news on two contracts, in terms of Capita’s performance well covered in the main stream press does not help. Our intelligence from the front line informs us that Capita has disappointed in terms of delivery on many contracts over a long timescale. A process of renewal is probably needed along with a reassessment of its role as a small ‘ish company in a field where substantial investment in systems and innovation is needed. The price of course in part reflects the possible equity fund raising which seems increasingly inevitable and if that is needed so too is a new strategy.
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.