As regular readers know, I am not a momentum trader, but a value investor who looks to outperform the markets in the medium to long term. I spend a lot of time researching out-of-favour companies, where there has already been ‘blood letting’, with the aim of identifying undervalued stocks. Occasionally this leads me into sectors that are considered ‘no-go’ for many investors, since there is simply too much uncertainty surrounding prospects – and the housing market is a good example:
Tip of the week: Taylor Wimpey (TW), tipped as a BUY by The Independent
Conditions are undoubtedly dire in the US property industry and deteriorating in the UK. This was reiterated at Taylor Wimpey’s first-half results last week. The group builds a range of properties, from one-bedroom apartments to detached family homes. The US unit, representing 21% of turnover, has been hit hardest due to the US housing slump, especially in Florida and California. A quarter of Taylor Wimpey’s North American staff have already been cut and land values written down by £86m. Revenues and profit margins are also significantly below those achieved last year. As for this side of the pond, chief executive Peter Redfern said “the steady rise in interest rates is expected to result in more subdued UK trading in the second half”. In response, the City has taken flight, and marked the shares down more than 30% since April – an over-reaction, I believe. Let me explain why.
Firstly, at the first-half results, Taylor Wimpey announced a £750m share buyback that shows the board’s confidence in the long-term fundamentals of the firm’s major markets. This programme will increase gearing to between 40% and 60%, but interest coverage should still be between a manageable five and seven times. Secondly, following the £5bn merger in June, integration of the two businesses seems to be going well. Targeted savings were raised from £70m to £100m per year – delivered by a combination of redundancies, better procurement and a reduction in overheads. Thirdly, the UK housing market, which accounts for about 75% of sales, may not turn out quite as bad as everyone fears – although I realise the rest of the MoneyWeek team would disagree. Despite a warning from Redfern of a “less buoyant” second half, sales levels remain solid, operating margins are rising towards 14% and 80% of targeted 2007 completions have already been booked. Meanwhile, the National Housing Federation (NHF) has been urging the government to act on its promise to build three million more homes by 2020 – potentially boosting the likes of Taylor Wimpey.
And in the US, the low unemployment rate (4.6% in July) might well stabilise the country’s property market. In fact, with such a weak dollar, America has effectively become a low-cost producer within the G8 nations – thus assisting exports and future job growth. But most important are the financial fundamentals. The shares currently trade on 2007 and 2008 p/e ratios of 8.8 and 8.2 respectively, and also pay a chunky 4.5% dividend yield, which I believe is good value, despite the higher risks.
Yes, the housing sector is notoriously cyclical. Nevertheless, in my experience economic downturns tend to occur once every decade, with roughly seven good years followed by three bad. I would value Taylor Wimpey on a ‘through-cycle’ p/e of ten. So if the group’s earnings per share figures for the past five years, plus the City’s forecasts for the next three, are averaged, then the shares would be valued at 440p – or 25% above current levels. Analysts expect sales and underlying earnings per share to hit £4.2bn and 38.3p for this year, rising to £4.4bn and 41.1p in 2008. But remember this is a risky play. Along with wobbles in the housing market, key dangers for investors are currency exposure (to the dollar) and problems integrating its acquisition.
Recommendation: high-risk BUY at 349p
• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments