July 18, 2024
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Why housebuilders open their doors to consolidation

Why housebuilders open their doors to consolidation

Two things happen when the housebuilding sector enters a challenging period, writes Rosie Carr.

First, investors flee, and second, bosses’ thoughts turn to consolidation, and, more covetously, to rivals’ land banks.

Housebuilding is notoriously cyclical and in recent years it’s been buoyed along by the Help to Buy scheme. That support has gone and higher materials and wage costs and the bitter monetary medicine being dished out by the Bank of England have hurt the sector.

Cooling demand as mortgages have become unaffordable has been a particular problem for Crest Nicholson. But it’s got a rather nice assortment of plots, lined up for the next boom. That is likely to be the chief motivation behind rival Bellway’s £650mn offer to take it over. Whether it — or another bidder succeeds — may depend on the CMA. The number of listed housebuilders has fallen by about two-thirds to fewer than 10, and the competition authority is taking a keen interest in Bellway-peer Barratt’s attempt to buy Redrow.

As for investors wondering when they should jump back in, better times beckon. Interest rates are set to fall, and if Labour wins the election, major planning reforms are on their way.

The Home Builders Federation blames the cumbersome planning system for plummeting supply. Labour plans to permit building on greenbelt land, to set mandatory housing targets and to build more new towns — all of which will get the JCBs fired up. But housing is not an issue that can be solved overnight so investors should expect to encounter snagging along the way.

BUY: Young & Co’s Brewery (YNGA)

Net debt has soared but a rapid deleveraging is anticipated, writes Christopher Akers.

Young & Co’s Brewery’s biggest acquisition to date has been greeted with scepticism by the market, with the shares down by 12 per cent since the purchase of Aim rival City Pub Group was announced in November. The £158mn deal completed in March and was at the heart of the annual results, delivering more than a third of total revenue growth and contributing to the slide in statutory pre-tax profits due to transaction costs.

Integration is on track, with the deal adding 55 pubs and 240 bedrooms to Young’s estate in high-end locations. The acquisition contributed £7.2mn of revenue and £1.7mn of cash profits in its four weeks in action during the financial year, and the material nature of the deal was highlighted in post-period trading as it drove managed house revenue up by a quarter over the past nine weeks compared to like-for-like growth of 2.4 per cent.

Funding the acquisition meant that net debt shot up by around £194mn, to £360mn, with the net debt to adjusted cash profits ratio moving from 1.9 times to 3.9 times year on year. But as profits from the deal start flowing through, the leverage ratio should quickly come down again. This opens up the possibility of further acquisitions in the coming years.

As well as purchase costs of £6.2mn for the City Pub Group acquisition, a negative property revaluation of £12.8mn and a £5.5mn impairment charge over goodwill and right-of-use assets pushed statutory profits lower. Adjusted operating profit climbed 9.4 per cent to £57.3mn, with the related margin up 50 basis points to 14.7 per cent despite cost inflation pressures. Adjusted pre-tax profit of £49.4mn, meanwhile, was a record for the business.

Elsewhere on the investment front, the company spent £48mn in the year on improving the existing estate. It picked up eight other pubs, including four from Marston’s.

Like-for-like sales rose 3.4 per cent in the year, with food and drink sales up 1.5 per cent and 3.9 per cent respectively on a 52-week basis. As Investec analyst Roberta Ciaccia points out, like-for-like growth rates “show that management keeps pricing discipline”. Organic sales are now more than 15 per cent ahead of pre-pandemic levels, and the combination of the pricing approach and a likely improved volume picture from what the company calls “a feast of summer sporting events” should aid trading in the near term.

The shares are valued at seven times enterprise value/Ebitda, a lowly rating among the freehold pub operators. We think long-term prospects remain strong and that the City Pub deal makes strategic sense.

HOLD: Crest Nicholson (CRST)

Home completions are expected to fall from earlier estimates, writes Mark Robinson.

Crest Nicholson has warned on profits and slashed its half-year pay rate as demand within the housebuilding sector remains subdued, while more build problems across legacy sites continue to weigh on its financial performance. A review of completed site costs resulted in a one-off “remediation or maintenance” charge of £31.4mn, more than double the previous estimate. There was also increased set-aside linked to historic building fire safety costs — an ongoing issue.

The announcement brought an end to a mini-rally in the share price, which seemed curious in itself given lingering uncertainties over the base rate. The prospect of political change in the UK may also be having a cooling effect on industry volumes, at least temporarily.

The interim numbers reflect the industry challenges. Revenues were in line with the low level of reservations, with completions falling by 12 per cent year on year. Weekly sales per outlet contracted, although average selling prices were stable. And profitability was constrained because the group derived a higher proportion of revenue from low-margin sites. Matters were not helped by a £5.9mn pre-exceptional charge relating to remaining cost obligations on completed sites, but even if this one-off charge is discounted, the adjusted operating profit came in at £6.2mn against the £21.1mn recorded at the 2023 half-year mark.

Home completions are expected to fall between 1,800-1,900 units, a decline from original guidance. Including the one-off pre-exceptional charge for completed sites, management expects adjusted pre-tax profit in the range of £22mn-£29mn. Investors might realistically expect further unhelpful developments given the broad spread, not least because an incoming Labour administration might take a harder line on remedial issues, although we think the existing 29 per cent discount to net assets adequately reflects the balance of risks.

SELL: Victoria (VCP)

Flooring demand has yet to recover to pre-pandemic levels, writes Mark Robinson.

Victoria, the flooring manufacturer, managed to reduce its net cash outflow for full-year 2024 and delivered numbers in line with those provided in the March year-end trading update. The fall in revenue was explicable in terms of the unfavourable trading backdrop as inflation and increased credit costs weighed on consumer sentiment. And shareholders can take heart from the 70 basis point increase in the gross margin to 33.2 per cent.

The designer, manufacturer and distributor of floorcoverings certainly kept a lid on costs, and prices for raw materials and energy have moderated to a certain extent. Yet underlying cash profits (Ebitda) declined by 18 per cent to £161mn as operational leverage effects were more prominent due to faltering sales volumes, particularly in relation to UK and Europe ceramics.

Management said that in view of the overall revenue decline, the fall in the underlying margin of “less than 100 basis points” highlights the productivity gains and cost savings through successful integration projects, although that seems like cold comfort, as the transition through to the bottom line wasn’t helped by £93.6mn in exceptional costs.

Executive chair Geoffrey Wilding posits that because flooring demand remains well below pre-pandemic levels, reversion to the mean suggests that we could witness a volume uplift of more than 25 per cent.

Whether that conjecture was made rather more in hope than expectation is difficult to gauge. But even if it came to pass, the group would still need to pursue further self-help measures to restore the net margin, not least of which is the imperative to reduce the leverage ratio ahead of the refinancing of the existing bond issuances.

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