Robert Stephens, CFA, discusses why Taylor Wimpey, Berkeley and Bellway have sound long-term prospects.
Investing in housebuilders such as Bellway (LON:BWY), Taylor Wimpey (LON:TW) and Berkeley (LON:BKG) while UK house prices are at record highs may seem counterintuitive. Higher house prices generally mean they are less affordable to buyers, which could reduce demand for new homes and lead to less optimal trading conditions for housebuilders.
However, low interest rates and a lack of supply mean that FTSE 350 housebuilders could enjoy sound performances over the long run. In my view, their current valuations are attractive given the long-term prospects for the UK housing market.
Opportunities for growth within the housebuilding industry
Despite repeated government attempts over the past 30-40 years, demand for new homes has generally exceeded their supply. For instance, housing starts in 2019 were around 151,000. Compared against a projected rise in household numbers of 160,000 per year in England over the next eight years, competition among buyers for new homes is likely to increase. This could help to sustain demand for new homes built by the likes of Taylor Wimpey, Bellway and Berkeley.
Today’s record house prices do not necessarily mean that the sector will experience reduced demand based on affordability issues. The key reason for this is that the recent decline in interest rates has kept mortgage repayments as a proportion of average earnings below 30%. To put that figure into context, it stood at 45% prior to the financial crisis. It has not been below its current level for almost 20 years, which means that new homes are likely to be affordable despite being at record highs. This may mean that housebuilders experience positive trading conditions over the long run, since affordability is not being negatively impacted by record house price growth.
Overcoming potential threats
Undoubtedly, there are risks to sector incumbents. Rising unemployment may limit demand in 2021. It now stands at its highest level for three years. Sadly, many more people are likely to lose their jobs before the pandemic is finally over. Meanwhile, changes to government policy regarding Help to Buy and SDLT relief could mean that there are fluctuations in demand for new homes in the short run.
However, housebuilders generally have solid balance sheets through which to overcome near-term threats to their financial performances. Berkeley has over £1.1 billion in net cash, while Taylor Wimpey and Bellway have net cash positions of £61 million and £550 million respectively. They have vast land banks that widen their economic moats, while strong customer service scores mean that they are likely to remain dominant players for many years.
Investment prospects after share price declines
In my view, valuations within the housebuilding market are attractive at the moment. The sector has failed to fully recover from its decline earlier this year. This has resulted in Berkeley having a price-earnings ratio of 15, while Taylor Wimpey and Bellway’s prospective price-earnings ratios are 11 and 12 respectively.
All three stocks have made gains of late due to improving market sentiment. But, on a long-term view, their fundamentals and likely trading conditions in an undersupplied market where affordability is high suggests there is more upside on offer.