PSMMF - Persimmon: Possible Risk Of Earnings Downgrade

2023-03-07 09:26:29 ET

Summary

• Persimmon Plc sales rates have been improving sequentially in the last two weeks, with year-over-year trends improving from -70% in Q4 to -20% in the last two weeks.
• Construction price inflation is estimated to be at 7-8% per year, but it is expected to moderate through 2023.
• The performance of home prices is the key to Persimmon Plc outperforming expectations.

Thesis

Persimmon Plc ([[PSMMF]], [[PSMMY]]), established in 1972, is a major player in the UK housing market. Persimmon Homes, Charles Church, and Westbury Partnerships are the brand names under PSMMF. The group's primary brand, Persimmon Homes, constructs and sells traditional family homes for families in the UK. Charles Church stands apart as the group's premium brand, producing larger, higher-spec houses in the most desirable areas of the UK. Westbury Partnerships sells homes to housing associations all over the UK, with a focus on providing low-income families with a stable place to live.

With the stock collapsing from mid-3000p to the current 1283p, PSMMF has turned into a stock that investors don't dare to touch. In my opinion, investors' doubts in management's ability to produce stable results persist, and the extra cladding provision made at the 3Q22 trading update hasn't helped. Given the more benign macroeconomic environment, the new dividend policy is a prudent one, allowing for the discretionary use of surplus capital as conditions warrant. Investors' expectations for FY23 performance should have been reset, in my opinion, thanks to mini hints provided by management (and no formal guidance).

Until the story improves (which will depend on management's ability to deliver), I think it's prudent to hold off on buying Persimmon Plc stock. I continue to believe that the group will be able to weather the uncertain macro backdrop and reclaim its valuation premium if it can maintain its track record of consistent delivery supported by high-quality assets.

Selling rates and pricing

Persimmon Plc management has observed that sales rates have been sequentially improving over the past two weeks as the number of website visitors continues to remain strong. Year-over-year trends have also shown an improvement, from -70% in Q4 to -20% in the last two weeks. Additionally, it is encouraging that management has emphasized the need to maintain a disciplined approach to incentives. I believe there's probably room to raise prices as well. Over the next few months, ASP should be supported by the private order book of 2,812 homes, which accounts for nearly half of the 6,000-7,000 private completions.

Inflation

While Persimmon Plc management estimates that build cost inflation of 8% ( FY22 earnings call ), it is expected to moderate through 2023. How much it will moderate by is unclear. While we have no say in the matter, I think it's important to consider a range of possibilities because they could significantly affect PSMMF's bottom line right now. Consistently poor performance could further unnerve investors, even if the root cause isn't permanent (cost price, in this case).

Capital allocation

I note that management has put greater assurance that work-in-progress [WIP] will receives more attention (which I believe management meant capital and labor investment) in match build programs to local demand, with the dividend policy set at 60p (FY22 earnings call) and anticipated to increase over time. While the company says it plans to return excess capital through buybacks and specials, the CFO stresses that this is not something they expect to do for several years. Given that the best returns for shareholders come from investing back into the business, this does not surprise me in the least. I expect the stock price to be more volatile in the near future as a result of dividend investors selling their shares after hearing this news.

Regulation

Management's optimism that politicians are paying attention to the planning issues is one factor that could spark PSMMF stock. I think it's great that the CMA is conducting a review, because it will bring to light the significant planning and regulatory hurdles that both small and large homebuilders face. While I don't anticipate Help to Buy 's return, I do think there's room for growth in PSMMF's First Homes program.

No guidance

PSMMF has provided some parameters , but no concrete guidance due to the current uncertain environment. That said, what we know is that sales rates has improved to 0.52 from 0.3 in Q4 2022, and that management expects completing 8,000-9,000 homes if current sales trends continue. However, margins will be affected by slower sales rates. The lower sales rate could push margin to much lower levels in FY23, which worries me for PSMMF as they might not meet consensus guidance. A significant decline in operating profit would not be surprising if falling margins exceeded the projected increase in home prices (which I assumed a mid-single digit growth in the base case in the current environment). Comparing this to consensus estimates, they are only expecting a slight drop in EBIT margin. I believe there is a significant possibility of a downgrade because of this. Therefore, I think the performance of home prices is the key to outperforming expectations. From here, you can go one of two ways:

1. If house prices were to continue falling, it would be really bad for PSMMF, but would also set a stage for strong rebound as the trough is near. This would also mean the stock price will get impacted greatly in the short-term.
2. If house prices were to improve from here, PSMMF would surely benefit, and the stock would perform.

Conclusion

Current uncertain environment presents challenges for Persimmon Plc, which leads to investors having doubts in management's ability to produce stable results persist. The collapse in stock price has always put investors on the sidelines until the narrative turns better. That said, with continued strength in website visitor levels, improving sales rates, possibility for increase in ASP supported by the private order book, things could start to turn better. However, the performance of home prices is the key to outperforming expectations (on profits).

Over the long term, the Persimmon Plc group's track record of consistent delivery supported by high-quality assets could help it weather the uncertain macro backdrop and reclaim its valuation premium. However, I believe now is not the time to put capital into Persimmon Plc stock, as the risk of earnings revision (downwards) is on the table.

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