2023-08-22 11:42:53 ET
Summary
- Persimmon's share prices have declined by over a third as a result of a meltdown in the housing market amidst record-high mortgage rates.
- Housing sector continues to be challenged as average selling ask prices decline coupled with declining buyer inquiries, lower mortgage approvals, and the end of government's Help to Buy program.
- It reported underwhelming results for H1 2023, however, upping its guidance on volumes higher.
- We initiate at Neutral as a result of an increasingly uncertain macro environment and limited upside at current levels (8x EV/Fwd EBITDA).
Investment Thesis
Persimmon ( PSMMY ) has been facing challenging times amidst a turbulent housing market as it stares at significantly higher mortgage rates, affordability challenges, credit tightening with banks demanding higher LTV along with the end of government's Help to Buy program. It reported an underwhelming results, as was expected, however upping its guidance to have at least 9,000 homes delivered (up from 8,000 - 9,000 previously) while reaffirming its EBIT outlook as cost inflation is likely to offset the increase in volumes. PSMMY's financial strength remains robust with a net cash position and marginal debt, however, given the uncertain macro environment, we remain neutral on the stock.
Company Background
Persimmon is one of the largest homebuilders in the UK, operating through Persimmon Homes, Charles Church, and Westbury brands. It primarily focuses on affordable segment and first-time home buyers with a blended average selling price of ~£260,000 (as of 2022). It also has subsidiaries through the value chain focused on manufacturing timber frames, wall panels, roof cassettes, tiles, concretes, and bricks.
Challenges Continue in UK Housing Market
According to a report from Rightmove (RTMVF), average seller asking price in August dropped 1.9% sequentially to £364,895 but still was up 19% compared to pre-pandemic levels in August 2019. The decline is exacerbated as a result of sellers trying to compete aggressively as a result of affordability challenges amidst the highest BOE base rates in over a decade.
In addition, home sales have been declining which is down 15% compared to pre-pandemic levels in 2019, however, first-time buyers are relatively faring better (home sales for first-time buyers are down 10%) amidst a hot rental market. According to RICS Residential Market Survey report , new buyer inquiries have declined substantially down 45% in July YoY similar to last month's figure of being down by 46% signaling a sharp downturn in the demand environment while it expects the downturn to continue going forward.
Royal Institution of Chartered Surveyors
Monthly mortgage approvals remain lower amidst tightening credit and demand meltdown.
In line with the decreasing demand, housing starts declined 6% YoY for the year ending March 2023 while affordable homes now form 78% of total home starts, up from ~72% a year earlier, demonstrating the increasing focus on affordable home segments amidst burgeoning mortgage rates.
The Royal Institution of Chartered Surveyors
The end of Help to Buy government program in March this year has also led to increasing challenges for the housing market already burdened with record mortgage rates and tepid demand.
Earnings Corner
PSMMY reported softer trading for H1 2023, underwhelming consensus estimates, with sales decreasing by 27% YoY driven by volumes declining by 36% YoY while average sales price improving by 4%. Sales per site remained relatively resilient during Q2 at 0.58 vs 0.62 in Q1, with H1 2023 sales staying at 0.59, down 35% YoY. The proportion of first home buyers has dropped from 42% last year to 34% currently as a result of tightening credit demanding higher LTV ratios along with the end of Help to Buy government scheme. Retailer gross margin declined 950 bps as a result of a rise in construction costs along with lower volumes, partially offset by an improvement in average sale prices. Operating margins declined over 10 percentage points as a result of lower gross margin along with sticky SG&A expenses and other fixed costs.
It ended with a cash balance of £357 mn (down from £862 mn in December 2022) as a result of £240 mn spent on land, including £182 mn of settlement with land creditors as well as £192 mn of dividend payments. Net cash remained at £1 mn less land creditors. It has also signed a sustainability-linked RCF facility of £700 mn for a 5-year term till July 2028 providing them adequate flexibility to navigate challenges.
PSMMY expects to deliver at least 9,000 homes for the year (up from 8,000 - 9,000 homes guided previously) as a result of improvement in cycle times while EBIT guidance remains unchanged reflecting an improvement in delivery volumes is likely to be offset by elevated cost inflation.
Valuation
Persimmon trades at EV/ FWD EBITDA of 7.9x and Price to Book of 1.0x, in line with its peers Taylor Wimpey ( TWODY ) and Berkeley Group ( BKGFY ). We believe there is limited catalyst and no significant moat as the housing segment continues to remain challenged amidst expectations of further rate hikes with demand for affordable homes can be further pressured with the end of the government's Help to Buy scheme while supply crunch of resale inventory and record rentals can spur demand within the segment. Given the multiple sectoral headwinds and limited catalyst for upside at current levels, we initiate at Neutral.
Risks to Rating
1) Any change in the overall macro backdrop can have a significant impact on the housing market as it is significantly linked with the economy correlated by the mortgage rates and consumer spends.
2) Higher than anticipated cost savings from the new initiatives it launched this year including £25m overhead savings from hiring freeze resulting in employee count reduction by ~300, specification savings of £1,800 per plot, and sub-contractor pricing can improve the operating margin profile.
3) Any favorable/adverse in input costs including labor, building material, and other related input costs can significantly impact the gross margins.
Conclusion
Persimmon's shares have dropped by over a third in the past year as a result of a troubled housing market in the UK. The challenges continue to mount as it faces a tepid demand environment as a result of tightening credit, record mortgage rates, and declining sales prices. At 8x EV/Forward EBITDA, PSMMY is trading in line with its peers, while at a discount to its long-term average, reflecting the pessimistic outlook for the company and the sector at large. Initiate at Neutral.
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Persimmon: Challenges Galore, Initiate At Neutral