Can Persimmon Build on This Recovery?

I last wrote on Persimmon (PSN) shares last month when they were languishing at 1,239p and it struck me that they were looking remarkably good value on the fundamentals.

It is always a bit risky calling shares before the actual results but where there is risk there is the potential for reward as well. I hasten to add that my assessment of the shares then was not based on any prophetic vision of the future – which is always unknown including the long-term impact of the UK leaving the European Union. Rather it was based upon what are commonly referred to as the ‘fundamentals’ – that is to say, what you do or do not get for your money in light of recent company financial trends. It is not a science – nothing ever is in stock markets – having more in common with a backwoodsman’s tracking methods. It requires doing some financial analysis which not everyone finds an engaging pastime.

The ‘Brexit’ macro background

Persimmon’s half year results came on the back of the Brexit vote. So far as the potential and possible consequences of the referendum vote itself are concerned, they were greeted thumbs down by the smart money of the foreign exchange markets.

Notably, the economically more sophisticated international currency markets and the institutional and commercial UK property markets reacted more bearishly. Financial institutions holding currencies as a store of value and property companies holding property for capital growth both tend to respond with longer term prospects in mind, as they then perceive them.

Current post-referendum vote talk of the Leave vote confounding the expectations of the so-called “campaign of fear” is premature. It also leaves out of the equation the immediate effects of the Bank of England’s fearful counter response, by halving the lending rates to a novel, head scratching 0.25 per cent, and the government’s stated intention to put demand into the UK economy through deficit financing to prevent it sliding down the slipway into the deep waters of recession.

What Persimmon had to say post Brexit

“While the result of the EU Referendum has created increased economic uncertainty, customer interest since then has been robust with visitor numbers to our sites around 20% ahead year on year. Our private sale reservation rate since 1 July is currently 17% ahead of the same period last year. The Group is now trading through the traditionally slower summer weeks but customer demand remains encouraging and we anticipate a good autumn sales season.”

An economy in which there is significant imbalance between the latent social demand for housing and its supply is bound to witness a strong demand for houses at higher prices providing those prices are affordable and supply does not seriously increase in the short to near term. The Bank of England has delivered another round of the former in the form of even lower borrowing costs, and the inefficiency of the economy (shortages of skill labour and planning arrangements etc.) has added to the latter. In the short to near terms there seems little likelihood of demand and supply moving against cash generative builders like Persimmon.

What you need to know about the interim results  

Sales revenue increased a reverberating 12 per cent and profit before tax a thumping 29 per cent on the back of operating margins of a more than palpable 23.8 per cent – up from 20.5 per cent in the same period the year before. Return on capital climbed a whole one hundred and fifty basis points to 29 per cent. These are the sorts of returns you see from companies with scarce intellectual property assets – not builders of houses, which should be a near commodity within a free and efficient market.

Builders are not riding a normal short-term financial and supply and demand cycle but a long-term imbalance between the supply of houses and the demand for them. The Brexit vote has put off, for reasons of political and economic necessity, the previously expected slow return to higher interest rates. It is an alchemist’s formula for builders’ continuing prosperity for the near future. In a year by year comparison, Persimmon saw cash rise by two thirds from £278 million last time to £462 million this time.

The future  

Reverting to the fact that the future is always an unknown fact, one can only add that the arrival of Brexit makes it even more unknowable; this is new terrain of which we have no past experience to guide us. My own view is that interest rates will remain historically low for some time and that should keep demand for houses strong even if the average price is wholly detached from the economic lives and incomes of most of the UK population. What the ‘buy-to-let’ mob lost on the swings with a partial loss of interest tax allowance, they seem to have clawed back on the roundabouts with even lower borrowing costs.

The market consensus of estimates for this year includes a 6 per cent jump in earnings per share to a forecast 184p, which implies a price to earnings ratio of 10.2 times and an estimated dividend yield of 5.9 per cent at the current price of 1,874p.

The market consensus of estimates for Persimmon indicates an expectation that the rip-roaring days of massive earnings growth are over: from plus 39 per cent last year to an estimated 6 per cent this year and minus 9 per cent next year.

Personally, I think those forecasts look too conservative. It is easy to take a profit after a 54 per cent capital gain, but on a prospective estimated PER of 10 times and a dividend yield of near 6 per cent when cash is flowing strongly, I reckon the shares are worth holding even now.