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Even a dead cat can bounce, so will Taylor Wimpey and Barratt Developments prove they have more life in them than that?
by Carlo Svaluto
There’s little hope that the UK mortgage market will suddenly perk up and halt what seems to be a continuing fall in house prices. Yet to some in the City the valuation of some is so poor that they have become worth a punt on the basis that the fall won’t be as rough as the pessimists predict.
Two interesting recommendation upgrades on UK house builders Taylor Wimpey and Barratt Developments stand out, as most analysts have been trimming their earnings estimates and target prices right across this troubled sector. The Bank of England’s decision to cut base rates by 25 basis points to 5% appeared unsurprisingly cautious, unlikely to change the City’s assumption that mortgage lending, and therefore house prices, are in the doldrums.
However, the team of construction stocks analysts at Goldman Sachs, led by Eshan Toorabally, upgraded Taylor Wimpey from sell to neutral, and increased its six-month target price by 25% to 163p, little above the 162p the shares were trading at on Monday. The move, says a Goldman Sachs research note, comes as the shares fell considerably after the US investment bank added Taylor Wimpey to its sell list, and the fall in the share price means the company is now fairly valued.
Taylor Wimpey was formed last year with a £5.5 billion merger between Taylor Woodrow and George Wimpey, in a move that a year on clearly looks pro-active rather then reactive. The issue was protecting weak margins through synergies and while this has been achieved to an extent, the merger came perhaps a little late. As the companies snuggled up, the US housing sector had already contracted and the merged firm, which has large US operations, soon started feeling the blow of a slowing UK housing sector too, which in some way anticipated the credit crunch storm later in the year.
Finding its spirit levels
Goldman Sachs says that after it added the company to its sell list last November the shares are down 10.6% against a 3.5% fall for the FTSE World Europe. Later in February the company was added to Goldman Sachs’s conviction sell list but the shares have gained 1.5% versus an 8.3% jump of the FTSE World Europe. Over the past12 months, the shares are down 65.7%, and now the valuation has become more compelling according to the investment bank. The new target price is derived through a SOTP (sum of the parts) methodology, which implies that the estimated 2008 price-to-book ratio is 0.5, lower than the UK house builders’ sub-sector’s 0.9.
Goldman Sachs analysts admit there are risks that more write-downs of US assets could come, albeit the company had already done some hefty ones a year ago. Another risk is that Taylor Wimpey will have to write down some UK assets as the value of land holdings and housing stock in the pipeline drops. This pessimistic outlook is becoming more popular, and pressure on house prices, volumes and margins for Taylor Wimpey are on the cards. M&A activity and stronger-than-expected house price growth, volumes and margins are key upside risks according to the bank.
Barratt Developments is another company that has also become attractive after a poor share price performance over the past few months, according to Rachael Waring of Panmure Gordon. Barratt was upgraded from sell to hold as its share price moved back below Panmure’s 400p target price.
Waring says the ongoing risks are factored into the share price, with a 2008 PE of 4.3 and 11% yield, according to her analysis. She adds, however, that Barratt is not one of Panmure’s preferred house builders at this stage in the cycle, due to its high level of gearing, its acquisition of Wilson Bowden at the top of the cycle at two-times the company’s assets and possible write-downs as house prices continue falling.
At the interim results at the end of February Barratt was upbeat, saying the order book was strong and showing completions were up. However, like-for-like margins were down. News on the state of the country’s mortgage market came after the company’s results, and with deals falling through at the last minute as lenders don’t release the money, Barratt will surely feel the pressure at the finals later this year.