2023-11-07 09:58:41 ET
Summary
- Persimmon has historically been a profitable housebuilder but fell out of favor due to difficult trading conditions and a cut to its dividend.
- The overall health of the UK housing market affects all housebuilders, and there are concerns of a potential downturn.
- Persimmon's performance has been poor, with declining sales volumes, margins, and earnings. The company's outlook foresees a decline in completions and struggling business.
Persimmon (PSMMY) has historically been one of the most profitable British housebuilders. It has fallen out of favour amid difficult trading conditions and a (foreseeable) cut to its formerly massive dividend last year.
I last covered Persimmon with my July 2020 "sell" note Persimmon : A Debt-Free Housebuilder To Buy On Future Weakness. Since then, the shares have fallen three fifths (and I have bought and currently hold). I now see them as a "buy".
The Bigger Context of the U.K. Housing Market
There are better and weaker housebuilders in the U.K. market but I believe that all of their fortunes are tied, to a greater or lesser extent, to the overall health of the U.K.'s housing market.
I have been expecting this to fall within 12 to 18 months. That said, I was already fairly pessimistic a year ago and much of the market has been quite resilient since then.
On one side, I think increasing interest rates, inflation squeezing household budgets and a generally pricy looking market point to the potential for a downturn. On the other side of the argument, the mismatch between limited supply and high demand means prices might not fall that much even in a tough economy. I went through the relevant arguments and evidence in my recent piece on another U.K. housebuilder in Barratt Developments : Battling A Tough And Worsening Market so will not rehash them in detail here. Suffice to say that I think there is growing evidence of a declining number of buyers being willing and able to stump up the necessary funding at today's housing market prices.
Persimmon's Performance in a Difficult Market
What does that mean for Persimmon?
A quick look at this year's interim results paints the picture fairly well.
The good news is that average selling prices moved up and the company made a profit. Aside from that, from sales volumes to margins and earnings, this was a very bleak set of results.
The company pointed to higher mortgage rates, the end of the U.K.'s socialist "help to buy" programe and "significant market uncertainty" when explaining the poor performance.
All of those factors persist. Interest rates have risen further and I would say that there is now more market uncertainty. That suggests that things could get worse from here.
The company's outlook for the full year foresaw completions expected to be at least 9,000, the top end of its previously indicated range and operating profits in line with expectations. It called out "stubborn build cost inflation". Last year saw 14,868 completions so the outlook foresees a decline of up to 40% or so. business is clearly struggling. Last month saw U.K. housebuilding contract for the eleventh month in a row.
This week the company issued a third quarter trading statement. In it, the company said that trading was in line with expectations and pricing broadly stable. Given pricing had been moving up before, I see this "broad stability" (specifically, the company's private selling price on completions was up 2% year-on-year) as poor news, signalling further slowing in market price increases that could herald a forthcoming reversal.
The company's balance sheet remains decent, and it anticipates cash balances of £300m-£500m at the end of the year. Last year's sizeable dividend cut looked prudent to me at the time and I think that events since then have proven that the board was ahead of the game. That said, the dividend remains a sizeable expense: around £191m last year, although the cut should mean this year's bill is lower. For now, I expect it to be maintained. But if business continues to get worse at anything like the current rate and the cash pile dwindles further, I do not expect the dividend to be sacrosanct.
Persimmon Valuation Looks Attractive to Me
Then again, that helps explain why the shares have plummeted so much in recent years.
Could Persimmon shares offer attractive value at their current level?
From a long-term perspective, I think they may, which is why I own them. Rather than trying to time the bottom of the housing market, I am looking to what I see what value I think the company is able to offer in future.
The reason I see Persimmon as among the better of the U.K. housebuilders is its business model, which has been historically strong. It had industry-leading profit margins for a long time. The reasons for that are its relatively high selling prices for what it builds (which aren't exceptionally high-quality houses), a well-considered assembly process including modularisation and some vertical integration of manufacturing, and an aggressive approach to banking land for future development.
Last year's profit-after tax was the lowest in five years, but still topped half a billion pounds. On that basis, the share price is trading on a P/E ratio of just 7 or so. I think earnings could fall and may even slip into the red over the next three or so years, due to the challenges in the U.K. housing market discussed above. Over time, though, I see no reason that once the market plateaus and eventually returns to clear growth mode, Persimmon should not do as well as it has in the past. After all, there remains a massive housing shortage relative to demand and the demand side could recover once the key economic levers are pulled (lower interest rates and strong wage growth, for example).
From a long-term perspective, I see the current Persimmon share price as attractive though risky. I accordingly change my rating to "buy".
For further details see:
Persimmon: Tough Market Is Now Priced In (Rating Upgrade)