Housebuilders, particularly the bigger ones, are falling after a report from Liberum suggests that the valuations of the largest players are too optimistic to withstand the gross margin pressure expected in the coming years. Taylor Wimpey (TW.) sheds 3.3% to 191.7p, Barratt Developments (BDEV) slips 3.3% to 589.7p and Persimmon (PSN) is 2% lower at £19.29.
Charlie Campbell at Liberum maintains that 'gross margin pressure threatens to cause returns to peak in the year ahead. He goes on to remind readers that house prices are much more stretched than widely assumed because price/income multiples are now watched by a regulator with growing powers.
The sector is vulnerable to stricter controls on lending standards which is in turn likely to depress house price inflation. This could lead gross margins to fall, particularly with build costs starting to rise materially, especially labour. Falling gross margins will lower returns especially for those not growing output.
The Liberum note also spells out that while rising rates will not derail the housing market, sentiment is nevertheless vulnerable. 'We believe investors may see the first US rate rise as a signal to reset portfolios,' says Campbell. A rate rise may have a detrimental effect as returns-based models generate lower valuations as interest rates rise.
The other main risk to the sector identified by Campbell is the possibility that the Help to Buy scheme is repealed. 'The government will keep this in place while it generates job growth, but if house prices were to stall the scheme’s costs could rise materially. The broker cuts its rating on Barratt, Persimmon and Taylor Wimpey to Sell (from Hold) but maintains Buy ratings on Bellway (BWY) and MJ Gleeson (GLE).