The housebuilding sector is particularly unloved at the moment. Shares such as Persimmon (LON:PSN) and Bellway (LON:BWY) have low P/E ratios, and yet have recently reported encouraging updates which show that demand for new homes remains robust. Although economic risks may be ahead as the Brexit process draws to a conclusion, both stocks appear to have sound balance sheets and may enjoy strong operating conditions.
Fundamentals
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Bellway’s first-half trading update was a record for the business in terms of the number of completions. It was also able to reduce debt levels so that it has a modest net debt of around £26 million. Persimmon has a net cash position of over £1 billion, having significantly improved its financial standing since the financial crisis. Sound balance sheets could mean that the two companies are in relatively strong positions should the industry experience a downturn in the medium term.
Investors appear to be planning for difficulties for both stocks. Bellway has a P/E ratio of 7, while Persimmon’s rating is just 8. Given that they have both increased their earnings per share at a double-digit pace in each of the last five years, such low valuations indicate that they may be mispriced. That view is further evidenced by their positive earnings outlook for the current financial year.
Catalysts
The impact of the government’s Help to Buy scheme on the two companies, as well as the wider sector, has been significant. It forms part of a demand-side focus from the government, in terms of its housing strategy being centred on helping first-time buyers to afford homes, rather than seeking to make more homes available. By providing a loan of up to 20% of the purchase price to first-time buyers, smaller deposits are required, which is making it much easier to get onto the property ladder. With Help to Buy due to run until 2023, it could continue to support the housebuilding industry.
Other potential catalysts include the fact that there is a shortage of new homes, given rising levels of demand. The housing gap (which is the difference between the number of homes that are built and the number that are needed each year) is expected to increase over the long run. With interest rates not expected to rise to ‘normal’ levels for several years, housebuilders such as Bellway and Persimmon could continue to enjoy strong operating conditions.
Threats
With Brexit now a matter of weeks away, both shares could remain unpopular among investors. As they lack international exposure and consumers could delay their house purchases, their share prices may fail to keep up with the FTSE 100/FTSE 250 in the short run. However, given their low valuations, financial strength and the potential for long-term growth within the industry, I think they offer investment potential.
As ever, buying shares while they trade at low prices appears to be a risky move. However, the margin of safety that appears to be on offer may make the two stocks appealing from a risk/reward standpoint.