BTDPY - How To Invest In Property Stocks As Bank of England Holds Rates

2023-09-22 13:13:23 ET

Summary

• In line with the U.S. Fed earlier this week, the Bank of England kept interest rates unchanged yesterday as inflation fell faster than expected recently.
• FTSE 100 property stocks saw an uptick, as they see weaker demand due to rising mortgage rates and a generally unfavorable economy.
• Of these, Taylor Wimpey still has some upside left despite its dismal recent results, though I'd wait for Barratt Developments' upcoming update before making a decision.

The Bank of England [BoE] mirrored the Fed’s decisions to hold interest rates unchanged yesterday, but only just. The Monetary Policy Committee [MPC] voted 5-4 to maintain rates, with 4 members voting for a 0.25 percentage point increase from the current bank rate of 5.25%.

Faster inflation decline than expected

The decision follows an unexpected decline in headline inflation to 6.7% year-on-year (YoY), compared to the bank’s expectations of 7.1%. Similarly, core inflation fell to 5.2% too, from 6.9% in July. Inflation is still higher than the BoE’s target rate of 2%, to be sure, but it says:

CPI inflation is expected to fall significantly further in the near term, reflecting lower annual energy inflation, despite the renewed upward pressure from oil prices, and further declines in food and core goods price inflation.

Subdued growth prospects

It has come at a price, though. GDP is expected to have declined by 0.5% in July and the BoE expects:

“Underlying growth in the second half of 2023 is also likely to be weaker than expected.” While the labor market is still strong, the bank further says that “Indicators of employment have generally softened against the backdrop of subdued activity.”

The housing market, in particular, has been impacted by rising interest rates, higher cost of living and a weaker economy. For the 12 months to July, they essentially remained flat and are expected to decline between 8-10% in 2024.

Property stocks respond positively

With the latest inflation print coming in softer and the pause in interest rates though, UK house builders breathed a sigh of relief yesterday. All three big real estate stocks in the FTSE 100 ( UKX ), Taylor Wimpey ( TWODF ), Barratt Developments ( BTDPF ) and Berkeley Group Holdings ( BKGFF ), were up yesterday.

Among these, the performance of Taylor Wimpey and Barratt Developments has been positive year-to-date [YTD], even as their trailing twelve months [TTM] GAAP price-to-earnings (P/E) ratios at 7.4x and 8.6x remain lower than that for Berkeley Group Holdings at 9.8x. Here, I look at both of them in greater detail.

Taylor Wimpey

When I last wrote about TWODF in June, it was expecting a softening in sales and that has indeed happened. The company’s revenues declined by 21% year-on-year (YoY) in the first half of its financial year (H1 FY23, ending July 2) and reported EPS dropped by 30.6%. Its outlook is weak too, with expectations of operating profit to range between GBP 440-470 million, halving from last year.

So why the bullishness on it? It has entirely to do with how low the stock is still trading. While its TTM GAAP P/E is now higher than the 6x it was when I last checked, it’s still competitive compared to peers like BKGFF and BTDPF, implying that there could still be a fair bit of upside ahead.

Second, it’s dividend paying, with a TTM yield of a notable 7.7% and is expected to continue being profitable. It has an even higher forward yield of 8.2%. This enhances its total returns, compared to price returns (see chart below). Like the rest of the property set, it’s not without the risk of a much sharper slowdown in the housing market next year, but for now, there are still gains to be made, if not from its price then through dividends.

Barratt Developments

Barratt Developments, on the other hand, is performing relatively better. It saw a 1% revenue rise and a 5.1% EPS increase during its financial year ending June 30, 2023. However, it also acknowledges that “in the UK, short-term demand has been impacted by mortgage affordability challenges.” In line with this, its forward order book was 49% sold at the end of the financial year, compared to the 60% figure for last year. It expects to see continued softening in-house sales over this financial year.

It’s also worth pointing out that the share price is still trading rather low compared to the previous five years (see chart below). Also, its forward dividend yield looks even better than Taylor Wimpey, at 10.1%, though its TTM yield is lower at 7.1%. Of course, this can change fast enough considering its outlook.

However, going by its weak outlook and the fact that that its P/E is still in line with the peers’ average, I’d much rather hold until its trading update due to be released in October to assess how much it has weakened this financial year.

What next?

Ultimately, how the house builders perform depends critically on the housing market conditions. So far the UK economy has avoided a recession, which was widely forecast earlier in the year. Even the housing market itself is not declining just yet, though it has flattened recently. But with the pause on interest rates and an expected continued decline in inflation rates, it remains to be seen whether the dire predictions for the housing market actually materialize.

In the meantime, though, FTSE 100 property stocks like Taylor Wimpey and Barratt Developments have actually managed to see price rises YTD. Interestingly, this is despite signs of actual or expected weakness in their financial performance in the recent past.

There are really two reasons for this. One, their prices overcorrected in early 2022 and they are far from going back up to those levels. And two, their dividend yields look rather attractive right now, supported by the fact that they are in fact still clocking profits.

Of the two, I believe there’s some further upside possible to Taylor Wimpey even in the short term, especially from dividends. For Barratt Developments, however, it would be better to hold at least until its trading update in early October going by its current fair valuation. In the medium term, as the economy picks up, inflation normalizes further and interest rates start coming off, I’d expect both stocks to return to better health both in terms of their financial and stock market performance.

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