Another week, and another raft of grim data and media commentary on the state of the UK housing market.
Rising mortgage rates, lower demand, falling property prices. It seems the storm clouds continue to gather.
The week also brought a trading statement from FTSE 100 housebuilder Barratt Developments (LSE:BDEV). The first update from one of the big volume builders since April.
The shares fell as much as 5.4% in morning trading. Persimmon and Taylor Wimpey also headed south on a read-across from the update.
What does the latest news mean for Barratt’s shareholders, or anyone thinking of investing in the stock?
A year of two halves
Barratt’s update was for its financial year ended 30 June. Management said: “During a year of economic and political uncertainty, we have delivered a strong operational and financial performance.”
Total home completions were down by 3.9% to 17,206 from 17,908 in the prior year. On the face of it, that doesn’t seem too bad.
However, completions actually grew 6.9% in the first half (the six months to 30 December). The damage was done in the second half. Reservations fell away, and completions declined 12.8% in the six months ended 30 June.
Falling profits
The pattern for completions was repeated in Barratt’s profits. But to a more extreme extent.
Management said it expects to report a pre-tax profit for the year in line with a market consensus of £881m. This would be a drop of 17% from £1,055m in the prior year.
Going through the accounts, my sums tell me profit actually increased 16% in the six months to 30 December. But collapsed by a whopping 41% in the first six months of the current calendar year.
It seems Barratt’s performance is faithfully reflecting the general deterioration in the UK housing market.
Headwinds
The outlook isn’t great.
Management said: “We recognise that there are significant macro-economic headwinds, most notably persistent inflation and a higher interest rate environment, which will impact UK economic growth, employment, consumer confidence and spending.”
The company expects to build in the region of 20% fewer homes in its financial year just started than in the year just ended. Namely, between 13,250 and 14,250 homes compared with 17,206.
This means another hefty profit fall is in the offing.
We’ve been here before
Barratt found itself in pretty deep trouble in the last market crash. That was when house prices fell 19% between autumn 2007 and spring 2009.
It had completed a substantial acquisition (of rival Wilson Bowden) in the first half of 2007. As a result, it went into the crash with net debt of £1,301m.
Ultimately, it needed the support of investors – via a £720m fundraising – to reduce its indebtedness and keep its lenders onside.
That was then, this is now
Barratt’s in a much stronger position today should the housing market suffer a full-blown crash. Last week’s trading update told us that, as of 30 June, it held net cash of £1,070m. In addition, it has an undrawn revolving credit facility of £700m.
In its last annual report, the company stress tested what level of fall in house prices it would take before it breached its financial covenants or headroom policy. The result came out at 22.4%.
Dividends on the line
Barratt didn’t model mitigating actions available to it that would enable it to handle a more severe fall than 22.4%. But it did list a number of such actions it could take, including a “reduction or suspension of dividend payments“.
In fact, lower dividends for the foreseeable future are now very much on the cards anyway. This is because the board’s dividend policy is to pay shareholders 50% of profits. And profits have fallen in the year since the stress test.
The equation is simple: if profit falls by X%, the dividend falls by the same percentage.
Risks
The principal risks for investors are lower dividends. Or the suspension of payouts altogether in the event of a severe 20%+ housing crash.
Given Barratt’s strong balance sheet, it would probably take the remote risk of the mother of all crashes for shareholders to be asked to stump up funds to see the business through.
Rewards
On the other hand, there are high potential rewards for buyers at today’s depressed share price.
Investors with a tolerance for volatility and the patience to wait for the next upleg of the housing cycle could see substantial capital gains from a recovery in the share price. As well as a high yield on their investment from future fat dividends in the rising cycle.
