The numbers are all rosy at homebuilder Persimmon (LSE: PSN) after the latest trading update, with revenue up 13% year-on-year, average home prices up 4.5% and £1.1bn worth of orders booked. However, does this good news portend the peak in share prices? Share charts of famously cyclical homebuilders look like roller-coaster rides when viewed over the long term, and many analysts are calling this the end of the ascent for Persimmon shares after rising nearly seven-fold from their floor during the financial crisis.
While I would certainly be taking seriously this opportunity to book profits if I had bought in at the bottom, there is reason to be optimistic over the medium term for Persimmon. The Conservative government’s emphasis on home ownership has seen the Help to Buy and Starter Homes schemes do their part to keep demand for new homes high. This demand has been largely unsatisfied as the smallest homebuilders haven’t recovered from the financial crisis and large homebuilders have expanded more slowly, leaving annual houses completed below pre-crisis levels.
Persimmon has leveraged this supply-demand imbalance to increase operating margins to 20.5% despite rising inputs costs. Impressive cash flow has allowed the company to return cash to shareholders through a dividend yielding 5.4% at current prices. Despite these strong financials, the risk of investing in a highly cyclical industry at current valuations won’t disappear, and long-term investors should only consider Persimmon if they believe the housing market will continue to hum along for years.
Much as Persimmon is a bet on continued growth in the domestic economy, Intercontinental Hotels Group (LSE: IHG) is a play on the health of the global economy, and the United States in particular. While IHG is globally diversified, the Americas provided more than 65% of operating profits in 2014.
Revenue per available room (RevPAR), a key industry metric, has grown in line with the positive growth in the US as business and leisure travellers alike have sent occupancy rates to record levels across the industry. IHG has taken advantage of ruddy health across the industry to divest most of its owned hotels at high valuations, leaving the company with over 85% of its hotels franchised. This model protects IHG from short-term market fluctuations, lowers capital requirements and has helped boost operating margins to just shy of 45%.
IHG was one of the first international brands to enter the Chinese market, which now provides 11% of operating profits, and remains the leader by room volume in so-called Tier 1 cities such as Shanghai and Beijing. The company has also moved aggressively into Tier 2 and 3 cities through mid-level brands, which has negatively affected the share price in the short term, but I believe remains a very good long-term play on the continued rise of the Chinese middle class.
The shares have dipped 16% since the start of the year, hit by overall market sentiment and exposure to China, and now trade at a reasonable 15 times earnings. After a 10% increase in dividends over the latest financial year, the shares now yield a modest 2.3% but are projected to increase by a further 10% this year. With economic growth in the US picking up and an attractive franchise model, I believe IHG shares should be on many investors’ watch list if they continue to be hit by the broader market sell-off.
