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Bumper yields and UK bets draw fund managers to house builders

With yields in double figures for some house builders, fund managers are drawn to their sector as the 'cleanest' contrarian bet on the UK economy.

Bumper yields and UK bets draw fund managers to house builders

As Brexit fears continue to weigh on UK domestic stocks, fund managers are being drawn to the area of the stock market offering both the purest bet on the UK economy and the cheapest prices: house builders.

Barring Bovis (BVS), which trades on a price earnings (PE) ratio of 11.4 times, all the other major listed UK house builders are trading on PE ratios in single figures. Yields are meanwhile in double figures, or approaching that mark, in some cases: including special payouts, Persimmon (PSN) offers 10.2%, Taylor Wimpey (TW) 9.2% and Bovis (BVS) 8.8%.

Mark Boucher (pictured), who manages the £126 million Smith & Williamson Enterprise fund with Mark Swain and Rupert Fleming, said house builders offered standout valuation opportunities versus other areas of the UK domestic market.

‘Its relative valuation is the lowest out of all the domestically focused areas of the UK, and since it is also the most geared to UK consumers, it is the cleanest way to play UK domestic growth,’ he said.

The managers recently added a 1.5% position in Persimmon, to sit alongside an existing top 10 holding of 2.3% in Barratt Developments (BDEV) in the absolute return fund. 

Recent annual results saw Persimmon become the first UK housebuilder to make more than £1 billion of annual pre-tax profit, up 13% from £966 million in 2017. Yet the shares have continued to languish, with reports last month that housing secretary James Brokenshire was reviewing the builder’s participation in the Help to Buy scheme the latest drag.

‘Persimmon’s shares had become oversold, and recent updates from the business confirmed what we suspected about the housebuilding sector in general; earnings have continued to rise despite investors selling out,’ said Swain.

Despite the sector being clouded by Brexit uncertainty, Swain argued it was poised to benefit from a fall in building costs amid resilient demand for housing.

Boucher added his team was optimistic the government would avoid a ‘no-deal’ scenario and any deal should see ‘UK-focused equities rally hard’, although he stressed they were not adopting a ‘gung-ho’ approach.

‘Once there is some clarity, we can increase gross exposure, but in the interim keeping exposure to factor risks relatively low is a prudent way to invest.’ 

Neil Woodford, the high-profile fund manager hit by performance difficulties, is among those to have bet big on the house building sector. Barratt Developments overtook Imperial Brands to become the largest position in his £4.7 billion Woodford Equity Income fund last month, while Taylor Wimpey is a top 10 position.

Both housebuilders reported strong results last month, with Barratt's revenue increasing 7.2% over the six months. Earnings per share grew by 20.7% and gross margins increased to 22.6%.

Barratt said it would hand shareholders £175 million in special dividends in November this year and deliver another extraordinary £175 million payout in 2020.

‘Including these special returns, the company is set to return more than 22% of its market cap in less than two years,’ said Woodford Investment Management manager Stephen Lamacraft in an update to investors.

‘This is a unique housebuilder, providing decent top line growth, augmented by margin progression through self-help,’ he added.

Taylor Wimpey last month reported a 5.5% rise in full-year profits to £856 million and reassured on demand, which it said was ‘robust, underpinned by low interest rates, a wide choice of mortgage deals and the government's Help to Buy scheme’.

‘The financial strength of this business and its confidence in the future, is most evident, however, in its dividend commitments,’ said Lamacraft.

Taylor Wimpey will pay a 10.7p special dividend in July, on top of May's 3.8p final payout and last November's 2.44p interim.

While the huge sums house builders are delivering back to investors in dividends are producing their high yields, these are also a function of investors' scepticism over the sector, which has weighed on their shares.

But Colin Morton (pictured), fund manager at Franklin Templeton, believes these fears are overdone.

‘Housebuilding is one sector that has been generating solid dividends recently. But it is seen as potentially exposed to political uncertainties, including a possible no-deal Brexit or a change in the UK government,’ he said.

‘We have a more stoical view of housebuilding in the UK: No one has yet worked out a way of building houses online so we’re pretty confident that there’s a need for house builders,’ he added.

‘There is undoubtedly a shortage of appropriate housing in the UK. And any post-Brexit UK government will still need to address that shortage.’

Morton holds Taylor Wimpey, Bovis and Bellway in the £579 million Franklin UK Equity Income fund he runs with Mark Hall and Ben Russon. The manager also holds Bovis in his Franklin UK Opportunities fund.

House builders are also a popular pick for Morton's colleagues at Franklin Templeton.

Taylor Wimpey accounts for 2.9% of the Franklin UK Mid Cap fund, run by Hall with Richard Bullas and Paul Spencer. Retirement housebuilder McCarthy and Stone (MCS) makes up 2.6% of the portfolio.

The trio's Franklin UK Smaller Companies fund, which Daniel Green also runs, has a 1% holding in Alternative Investment Market-listed builder Telford Homes (TELF).

 

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Ben Russon
Ben Russon Average Total Return:
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Mark Swain
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