Taylor Wimpey - Building for the Future

http://plc.taylorwimpey.co.uk/
Taylor Wimpey Logo
Since the housing bubble burst during 2008, housebuilders have been operating in a challenging, but slowly improving market. The result has been that housebuilders are way off their share price lows across the board, and Taylor Wimpey (LSE:TW.) is no exception. The modest recovery in the housing market has been backed by government stimulus schemes such as the recently announced 'Help to Buy' project that helps buyers enter the housing market through having to stump up less of the initial cost required. The housing market improvement has also seen UK housebuilder Persimmon re-enter the FTSE 100 whilst Wimpey has remained within the FTSE 250 (currently the 5th largest constituent). Wimpey has a market capitalisation of £3.5bn and has a current share price of 108.3p. The shares have performed very strongly on a 3 year basis, but is there further upside for the housebuilding major?



The recent price movement for Wimpey has been clearly bullish. Having failed to sustain the psychologically important 100p level earlier in the year, the shares recovered and re-tested 100p. On this occasion the price was broken through and a clear breakout has been noted. Backed by strong buying and bullish momentum, the steep price drop of last week was heavily bought in to today with the share price up 6%. By no means should this be considered a dead-cat bounce. Furthermore, this drop was among all housebuilders following fears over a rise in interest rates capping the appetite in the housing market.

The fear has arisen because people with mortgages have to pay interest that is linked to the Bank of England's base rate, which is currently at 0.5%. A rise in the base rate would mean homeowners have higher repayments that could deter further growth in the housing market (I'll discuss this later). The drop was bought into across all house builders today which suggests institutional interest, on a day which the FTSE 100 remained relatively flat. Such interest bodes well for the future share price. As you would expect with FTSE 250 companies, institutional backing is strong and directors hold a fair percentage of Wimpey shares. Based on the continuing share price strength, re-adjustment of technical indicators and a decent sector outlook (in at least the medium term), I would not be surprised if Wimpey continues to move upwards. A sensible first target on technicals alone is 125p with 135p being the target after this. Should these levels be hit, the gains would amount to 15.4% and 24.7% respectively - not a bad potential return on an investment in a relatively secure company.
 
Taylor Wimpey is the result of a large merger (worth £5bn at the time) between construction companies George Wimpey and Taylor Woodrow. The companies merged at the height of the housing boom during 2007 - clearly not great timing, but the end product is a leading housebuilder in the UK market. To a far smaller extent Wimpey operates in Spain and Gibraltar, but for this article I will focus on the more important UK part of the business. Therefore the most important factor for analysing the long-term future of Wimpey is to see what the drivers for the UK housing market could be.

courtesy of lydia_shiningbrightly on flickr
Currently, the housing market is buoyant, but this strength is located mostly within cities and populous areas such as London. Year-on-year, house prices are up 3.1%. To emphasise that point, a survey for July by the Royal Institution of Chartered Surveyors noted that house prices for the month had increased at the fastest rate since 2006. In London alone, the year-on-year house price increase was 8.1% - a substantial increase. Housebuilders such as Wimpey are already seeing the benefits of these rises to their results, but if you actually look at the UK as a whole, house prices are only up 1% compared to the same period in 2012, which suggests that there is plenty of room for upside outside of London. Indeed, their order books indicate an expected pick-up in Scottish house sales during the remainder of 2013.

In Wimpey's Half-Year report, CEO Pete Redfern commented: "During the first half of 2013, there has been meaningful improvement in the housing market, with more positive consumer sentiment, a more available and affordable mortgage market, and the presence of Government mortgage schemes, all adding to a favourable outlook. Our business is ideally positioned to perform well in this environment with a strong land position and a very effective housebuilding operation. We continue to open all new outlets with implementable planning permission."

There are a couple of government controlled catalysts though. The first of these is the 'Help to Buy' scheme I alluded to earlier. Under the scheme, new homebuyers who have a 5% deposit, are lent 20% of the value of new-builds up to a cap of £600,000. This, coupled with the 'Funding for Lending' scheme (which sees banks able to borrow money cheaply providing it's passed on to businesses or individuals) has led to strength within the housing market and consequently, housebuilders. However, there are concerns that this will do little to alleviate the problem, because fundamentally there is a shortage of supply compared to demand.

In the short-term the rises in house-prices are encouraged by the government. Construction is a major driver of the economy and in addition, the economy tends to benefit from the 'wealth effect', where the increasing value of assets, acts as psychological encouragement for increased consumer spending. The whole point is the scheme does seem counter-intuitive though. So far it has helped a minority, but has helped boost house prices for the majority. And that makes it more expensive for potential buyers to get on the housing ladder, which is not the intended objective.

However, there is a clear risk, and that is of a housing bubble. Some analysts are saying that, with supply currently outstripping demand, even without the full effects of the government scheme being felt, house prices will continue to rise to unsustainable levels. The housing market is not improving across the EU either. The Netherlands is suffering from another downturn in it's housing market. The problem could be worse because the taxpayer is involved, and any bubble will directly impact upon the government's finances. Former Bank of England governor Mervyn King has also cast doubts stating that the Help to Buy scheme is 'too close to comfort' when compared to the US mortgage guarantee scheme that helped energise the US housing crisis. Another point to be made that counters this though is that inflation has been steady at a few percent for the last few years and during this period, house prices have been relatively stagnant.

The all important question is then whether supply can meet demand. Naturally, if house prices continue to rise, housebuilders will exhaust their land banks in order to capitalise upon the profit, even if this means at the expense of some margin. The result is that the demand could be met with supply. Nonetheless, there is a credible threat - as investors though, this should not be an issue, a simply stop loss and decisiveness can limit any quick downsides. Any bubble certainly shouldn't be expected for a few years though and that is ample time for housebuilders to benefit financially.

The second point is to do with the UK base rate as noted earlier. Any rise in this (although likely) has the potential to ease a sustained rise in the housing market. Of course, in the long-run this is preferable because a boom is not good for the government, housebuilders or the public. However, Bank of England governor Mark Carney publicly announced that the base rate will be dependent upon the UK unemployment rate. He stated that the base rate will not rise from its multi-year lows until UK unemployment hits 7% (currently 7.8%). Carney noted that this level could take up to 3 years to achieve. A shorter-term potential obstacle for house prices could be the easing off of both the US and UK QE, but once again the effects of this will likely not be seen until 2014.

For at least the short-term, it is difficult to see the housing market ease off materially. Whilst such a house price relief could come further down the road, that is unlikely not be of concern to short/medium-term investors. Housebuilders have been accumulating stocks of land so I would expect an uplift in supply once this land becomes increasingly used to build on, rather than being stockpiled. CEO Redfern commented in Wimpey's last report: "We do not forget, however, that the macro uncertainty which has characterised the last few years still remains and as such we retain a cautious approach."

Turning to Taylor Wimpey directly, there is a lot of positivity that can be gleaned from the 2013 H1 results:
- Operating margin increased from 11% to 13.1%
- Revenue up 11.1% to £1007m
- Net asset value increased by 9p to 67.2p/share
- 34% increase in Group operating profit
- 80% increase in adjusted Earnings Per Share to 2.7p
- Improved balance sheet with a reduction in gearing to 18%. Interim dividend increased to 0.22p
Looking past the headline figures, there was a 7% increase in the average sale price and importantly 102,000 strategic land plots than can be used. The results are certainly encouraging and should be followed through H2 2013. The next financial report will be the Interim Management Statement that is due for release on November 14th.

Looking at the PE Ratios for housebuilders, Wimpey is modestly priced in comparison. Bovis Homes, Barratt Developments, Bellway and Persimmon are all currently on PE Ratios of over 20. Whilst each of these has their relative merits, there is a second pack of housebuilders including Taylor Wimpey, Berkeley Group and Galliford Try that are currently on PE Ratios around 15.  This disparity should narrow, and looking back at the technicals, it is no surprise to see the second pack looking stronger on the whole.

Another point of encouragement was released post results. The company announced the completion of the refinancing with a new £550m revolving credit facility that lasts up until August 2018. Group Finance Director Ryan Mangold said: "We are very pleased to have completed this refinancing well ahead of schedule. The new debt facility will provide ample headroom to deliver our strategic objectives whilst reducing our finance costs. This provides us with a solid base to further optimise our capital structure later this year with the repayment of the Senior Notes, creating a more efficient debt structure by the end of the year and positioning the Group well for the future."

Looking briefly at the various broker views, there is a general sense of optimism. Whilst target prices are not massively higher than the current price, there has been a steady stream of target price upgrades in tandem with the rising share price. The most recent broker to adjust their stance was JP Morgan who adopted a bullish Overweight stance and reiterated their target of 120p. Bank of America and DeutscheBank both have buy recommendations whilst Citigroup and Davy Research have neutral recommendations.

Assessing Taylor Wimpey on a long-term perspective, like other housebuilders, is not easy. The housing market remains volatile and despite there having been a pickup in general, issues remain in the long-term. A number of (at least partial) solutions are available although they are not easy to implement. One key idea is to either relax planning regulations or speed up the planning process - the planning process has been one of the main points that housebuilders have highlighted as being disruptive. This barrier of slow process has been present in the housebuilding sector for decades and this has restricted supply. In the short-term I would expect Taylor Wimpey's strong share price and financial performances to continue to maintain their strength and thus an initial target of 125p should be attainable unless the FTSE deteriorates. Revenues continue to grow, margins are improving and debt is decreasing. At this point, the shares could be evaluated and a decision could be made whether to continue to hold for the 135p price target. A sensible way to play Taylor Wimpey at the moment would be to set an end of day stop loss at 102p which amounts to 6.3p worth of downside or 5.8%. This can be adjusted in necessary. The stop is quite tight, but the technical outlook would look less bullish should that level be reached. The stop would also allow for a decent risk/reward ratio - 6% of downside vs. 15-25% of upside. Therefore a Buy tag makes sense at the current point in time.

UPDATE 28/08/13 - In light of recent market weakness, I have moved Taylor Wimpey's end of day stop loss to 96p

UPDATE 27/09/13 - I have removed Taylor Wimpey's stop loss. I firmly believe the potential for 125p and higher remains and thus any short-term decline should be ignored

UPDATE (09/10/14) - I have moved Taylor Wimpey from Buy to No Rating for a share price of 113.37p inclusive of dividends. Although the financials are still very attractive, wider markets will dictate share price movement in the interim and as noted in the Q3 portfolio review, it is best to remain flexible

UPDATE (20/10/14) - The recent market correction appears to be subsiding. It therefore makes sense to re-open a position in Taylor Wimpey at 112.70p today given the attractive fundamentals and resilience despite the market decline. That suggests that housebuilders could perform well in any market recovery

UPDATE (24/02/15) - I have moved Taylor Wimpey from Buy to No Rating at 142.70p for a 26.62% profit, in line with the cessation of company reviews

7 comments:

  1. Very nice to hear about macro themes

    Thanks! CraigJ

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  2. I am not a politician but these decisions they are making will only create a boom in house prices in places where its already expensive to live. There needs to be more help out of towns and cities. From experience, it's difficult to enter the housing market due to the sheet costs but this is because of a shortage of housing supply. The government are missing the point here

    Meanwhile housebuilders like Taylor Wimpey, Galliford Try and Barratt Developments will march on. question js for how long.

    Thanks for a good write up
    Eric

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  3. Quality analysis well done

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  4. As always, it's very interesting to read your views.

    mcturra2000

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  5. What is the approx. estimate time period to reach the initial target price of 125p?

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    Replies
    1. Barring a breach to the downside, before year-end should be achievable although a bit conservative (i.e. longer than probable).

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