Since my earliest days of investing, I’ve made my biggest returns on recovery stocks. While they’re not for everyone, for investors like me who can take a long-term view and accept above-average volatility, they can prove to be highly rewarding.
I’ve found the most opportunistic recovery stocks are in sectors where the long-term outlook is upbeat. In other words, while the sector may be experiencing some uncertainty or difficulties which have prompted disappointing performance by the company in question, in the long run the industry is likely to experience a tailwind. Turning around a company in an improving sector is always easier for new management than recovering when industry demand is lacking.
For that reason, I think Bovis (LON:BVS) could be a sound recovery stock. Although the UK housing industry is experiencing challenges at the moment, I’m bullish on the sector in the long run due to the ongoing supply/demand imbalance. I also think Bovis has a large margin of safety and under a new management team could be a relatively strong performer in a buoyant sector.
Short term/long term
My view on the UK housing market is fairly straightforward. In the short run, there could be problems brought on by Brexit, but in the long run the demand/supply situation and favourable demographics mean it could be one of the best places to invest.
In the short run, demand for housing may continue its recent trend. Since the EU referendum there has been a gradual slide in house prices. While they were growing at an annualised rate of 10% or more in recent years, today they are forecast to show little if any growth in the short run. One possible reason for this is declining consumer confidence, with higher inflation now starting to bite as it gradually surpasses wage growth to leave household budgets under pressure. While mortgage rates are low and falling, this may not be enough to push prices higher in the remainder of 2017.
However, in the long run I think the UK property sector and specifically housebuilders such as Bovis have growth potential. There is already an obvious shortage of properties of all types in most areas of the UK. Due to other more pressing issues such as Brexit, housing may not be one of the big issues in the upcoming election, so I doubt whoever wins will do all that much to combat an increasing problem for first-time buyers in particular. With the UK’s population forecast to rise by 450,000 per annum over the next decade and 156,000 houses being built in 2015, it seems likely that house prices will rise.
Strategy changes
In terms of the company’s strategy, it has not yet been fully decided. Bovis has only recently appointed Greg Fitzgerald as CEO and he is sensibly taking some time to consider how best to change the business for the better. There is a chance it will be a major overhaul of the company’s operations, so there is some short-term risk to the company’s share price. However, the changes made to the business are likely to be focused on streamlining and efficiencies according to the recent trading statement.
I think the chances of Bovis producing a successful turnaround are high.
One area where I feel Bovis needs to make improvements in the short run is customer satisfaction. As someone who recently bought a house, I can say first-hand how much of a difference it makes if a developer has a positive customer satisfaction score or not. While the £7 million paid out by Bovis last year for poor workmanship may not leave vast swathes of its new developments empty over the next few years, it could lead to more discounts being required or further one-off costs to compensate customers. This could eat into profitability over a sustained period.
Opportunity
Due to its long-term growth potential, I think the chances of Bovis producing a successful turnaround are high. Even if its strategy is not particularly innovative, it may not necessarily need to be. An ability to keep costs down, improve its customer satisfaction ratings and increase completions may lead to higher profitability if house prices march higher. Therefore, I think investors searching for recovery stocks may struggle to find a better sector in which to find opportunities at the moment.
Further, Bovis has a large margin of safety which takes into account the uncertain future it faces. It has a P/E of 12.6 and is forecast to increase EPS by 13% next year. How accurate that forecast will be is questionable, but with the right strategy and favourable trading conditions, improving profitability from 2018 onwards is a realistic goal for the company.
Its dividend yield of 4.6% does not indicate an imminent dividend cut – particularly since dividends are covered 1.74x by profit. Therefore, even if management wished to retain more capital to beef up the balance sheet or reinvest for future growth, I think it is unlikely that dividends will suffer from much more than a modest reduction.
Outlook
The UK housing market may experience disappointment in 2017. As Brexit uncertainty builds, house prices may continue to trend downwards and leave housebuilders such as Bovis nursing disappointment when it comes to EPS growth.
However, in the long run the sector offers high growth potential. A lack of housing supply for a generation has left demand and supply severely imbalanced. This situation could worsen and lead to rising house prices over the long run. Therefore, I’m optimistic about the sector and feel recovery with a strong tailwind could be relatively straightforward.
While Bovis has experienced some challenges and may yet see its share price fall as its new strategy is announced, I’m optimistic about its future. A low valuation and modest payout ratio mean it offers value and income potential, while the prospects for a recovery seem bright. Although volatility and uncertainty may be in plentiful supply for Bovis in the short run, in the long run it could be a highly profitable recovery stock.