Bellway: a cheap stock with long-term growth potential

7 mins. to read
Bellway: a cheap stock with long-term growth potential

Robert Stephens discusses why the FTSE 250 housebuilder could offer a more robust financial outlook than its current valuation suggests.

First seen in Master Investor Magazine

Master Investor Magazine Issue 54

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The unpopularity of UK housebuilders such as Bellway could present a buying opportunity for long-term investors. Although house prices have fallen in the last two months according to the Halifax House Price Index, they are 4.1% up over the last year. This suggests that while further falls may be unsurprising as the Brexit process approaches its conclusion, a lack of supply and robust demand may act as catalysts on the wider industry over the long run.

Indeed, the imbalance between supply and demand within the housing market is expected to increase. This could provide Bellway with robust operating conditions – even as government policies such as Help to Buy and stamp duty land tax (SDLT) relief evolve over the medium term.

With the company having a net cash balance, it is in a strong position to increase the size of its land bank and invest in new sales outlets. Its solid customer-satisfaction rating reduces the risk of customer redress, while a diverse geographical exposure across the UK means that it could capitalise on house price growth outside London and the South East, where prices are at historic highs when compared to average incomes.

Since the stock trades on a low rating, it appears to offer a margin of safety. Although it may not be a favourite of many investors at the moment, the company could deliver a potent mix of income and capital growth over the long run.

Favourable position

While a number of Bellway’s sector peers have experienced significant criticism for the quality of their homes, the company was recognised as a five-star housebuilder by the Home Builders Federation in 2019. This means that over 90% of its customers would recommend the company to a friend, and it is the third year in succession that it has been awarded five stars. It should mean that the prospect of major customer redress or a slowdown in completions in order to address quality issues, which have affected peers such as Bovis and Persimmon in recent years, are minimised.

In fact, Bellway has increased the number of annual completions in each of the last 10 years. It now builds over 10,000 homes per year and has the potential to maintain robust growth over the long run. Its forward order book comprises of 4,878 homes, while demand among consumers has remained robust according to its recent updates.

Its net cash position of £201 million means that it is in a strong position to purchase additional land in what remains an attractive wider market according to the business. Should the property market experience a prolonged downturn, it may be able to significantly increase the size of its land bank. Since the property market has historically been cyclical, doing so could put the company in a stronger position to generate a relatively high return on capital over the long run.

The company’s diverse geographical exposure may be a major ally in what is proving to be a two-tier UK housing market. While London and the South East has experienced a marked slowdown in the rate of house-price growth in recent months, other UK regions are enjoying more robust levels of performance. As a result, the business may be able to better overcome what could prove to be a rather mixed housing market, in the short term at least, compared to many of its sector peers.

Market prospects

Given the high employment levels in the UK and the competitive mortgage market, demand for new homes could remain robust over the medium term. Clearly, affordability is seen as a risk by many investors at a time when house prices are close to their highest-ever level when compared to average annual incomes. In fact, in 2019, the average house in the UK costs almost six times the average annual salary. The last time it was at a similar level was shortly before the financial crisis, after which house prices experienced a period of decline.

First seen in Master Investor Magazine

Master Investor Magazine Issue 54

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Despite a high price-to-earnings multiple, house prices remain affordable for a wide range of consumers across the UK. Evidence of this can be seen in the proportion of average incomes that are spent on mortgage repayments. Currently, this figure stands at under 30%. Prior to the financial crisis it stood at almost 50%, with its current level being the same as it was in the year 2000 following a ‘lost decade’ for house prices.

Clearly, low interest rates have been a key factor in improving the affordability of homes across the UK. Interest-rate rises could reduce affordability, although a loose monetary policy is expected to remain in place over the medium term. Interest rates, for example, are forecast to reach around 1.25% in 2022. This suggests that new homes could remain highly affordable for a prolonged period, which may equate to stronger operating conditions for Bellway than the stock market is currently pricing in.

The main catalyst for house prices over the long term is likely to be a continued imbalance between demand and supply. The projected household formation rate in England is currently running at 233,000. The supply of new-build completions is around 184,000. Even when conversions of existing buildings into residential dwellings are included in the figures, the annual supply of new homes stands at 217,000. As a result, demand is higher than supply. This could provide support to house prices, and allow housebuilders to enjoy rising profitability over the long run.

Possible threats

With Brexit now a matter of weeks away, Bellway’s UK focus could mean that it faces a period of uncertainty. Moreover, a fluid political situation means that changes to government policies such as Help to Buy and SDLT relief may be ahead. Since they have had a positive impact on the wider sector, and have helped to further increase the affordability of houses during a period of low interest rates, there is the potential for a slowdown in growth across the sector.

The political consensus, though, is likely to remain supportive towards aiming to increase the number of new homes being built each year. This may mean that while policy changes are somewhat inevitable, they are unlikely to inhibit the industry over the long run.

Therefore, while the housebuilding industry is likely to experience change over the next few years as the Help to Buy scheme is forecast to wind down, the fundamentals of the market in terms of supply and demand could lead to growth opportunities in future years.

Investment potential

The risks to the wider UK economy from Brexit-related disruption appear to be priced in to Bellway’s valuation. It has a P/E ratio of around 6.6, while it trades on a price-to-book ratio of 1.3. These figures suggest that investors are anticipating a slowdown in demand for new homes that leads to a decline in the company’s growth rate. While this is a possibility, the fundamentals of the housing market suggest that operating conditions for Bellway and its peers may be more positive than the stock market is expecting.

First seen in Master Investor Magazine

Master Investor Magazine Issue 54

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As well as a low valuation, the stock also has an impressive income-investing outlook. It currently yields around 5% from a dividend payment which was covered three times by earnings in the 2018 financial year. Since it plans to maintain dividend cover at the current level, its dividend growth rate could prove to be similar to its increase in profitability over the long run. And, due to it having a strong net cash position, its capacity to pay a rising dividend may not be impacted by opportunities to invest in future growth opportunities.

Future outlook

The uncertain outlook for the UK economy and housebuilding sector in the second half of 2019 means that other FTSE 350 shares may offer more robust investment prospects – particularly in the short run. Factors such as Brexit and the political uncertainty it may produce could mean that investors demand a wider margin of safety for companies that are highly dependent upon the UK economy for their sales and profitability.

However, Bellway appears to be in a strong position to generate improving financial performance over the long term. It has a net cash position, a strong order book and its operating conditions may prove to be more robust than many investors are currently anticipating. Factors such as a continued low interest rate, an increasing imbalance between the demand and supply of new homes and the affordability of homes relative to historic levels suggest that the housebuilding industry may experience favourable trading conditions.

With Bellway having a low valuation, as well as the potential to offer a high and growing income return, its investment prospects appear to be bright. It may continue to be an unpopular share over the coming months, with many investors likely to remain cautious regarding its future financial prospects. But, with an encouraging long-term outlook for the wider housebuilding industry and a solid position relative to its peers, it could deliver high returns.

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