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Analysts at two City brokers believe that the recent weakness shown by shares in UK house builders presents investors with opportunities to snap up bargains in the sector.

In a research note titled ‘UK Housebuilders: Slowdown or meltdown?’, Liberum Capital said that it believed the recent selloff of house builders presents a buying opportunity since the market appears to be discounting a very poor outturn.

“We think that a reasonable slowdown scenario is baked into valuations already, which means that only a financial meltdown would put current valuations at risk, in our view,” said Liberum, which added that its top picks remain Barratt Developments (LON:BDEV), Berkeley Group Holdings (LON:BKG) and Bovis Homes Group (LON:BVS).

Liberum said that house builders’ shares had performed poorly in August as investors’ memories of 2008 are still fairly fresh. “But we think there are major differences between now and then, especially that total sector debt has fallen from £3.8 billion to £400 million,” the broker added.

Meanwhile, although Liberum estimates an economic slowdown may cause another 10 per cent hit to balance sheets, sector valuations already take this into account, it said.

In its own update on the UK house building sector, Numis Securities also noted that sector shares had been hit hard during the recent market selloff in spite of sector news flow showing a progressive improvement over the course of the year.

“This sell-down against the backdrop of falling debt has led to the house building sector’s enterprise value falling back toward the lows last seen at the height of the recession,” the broker stated in a note, also published on Friday. “In our view this fails to reflect the improving risk profile due to improvements in the macro (mortgage lending, interest rates and stable house prices) and micro backdrop (lower debt, higher margins, refinanced banking facilities and more appropriate covenants).

On this basis we feel the current weakness presents a good buying opportunity.”

Numis said that it had reviewed the sector’s enterprise value over the course of the recession and this showed that the market is now approaching the lows last seen in early 2009, when the housing market was still in freefall.

“The enterprise value of the seven pure house builders now stands at £6.687 billion, which is only 5.5 per cent above the low recorded in the nadir of the recession. This is a function of both recent share price weakness, but also reflects the significant reduction in debt from both internal pay-down and equity issuance,” said the broker, pointing out that Taylor Wimpey had debt of £1.7 billion in June 2008 but now has just £170 million.

As far as the “macro backdrop” is concerned, Numis said that although general market uncertainty “remains high”, the key variables associated with the housing sector have shown a dramatic improvement since early 2009. “Mortgage lending has improved from 27,000 approvals for house purchase in November 2008 to 48,000 in June 2011,” said Numis. “House prices have shown a flat profile over the last 18 months whereas in the 18 months leading up to the previous low EV, house prices had fallen 20 per cent and we still declining.”

Furthermore, the broker pointed out, interest rate expectations have shifted and rates are not expected to rise until well into 2012 at the earliest, which alongside the strong level of rental growth recently, “means it is cheaper to buy than rent in most UK regions”.

Numis noted that, despite the improving fortunes of the sector and current trading remaining robust, all listed house builders’ share prices currently trade below 0.7 times net tangible asset value (NTAV) per share with the exception of Berkeley Group Holdings. “This does not reconcile with the prospect of several house builders forecast to make circa 10 per cent ROCE [return on capital employed] in 2012,” it said, pointed out that such 10 per cent ROCE has historically led to a price-to-NAV rating of approximately one.

Liberum has ‘buy’ ratings for Barratt and Bovis, which it estimates are trading at discounts to NTAV of 66 per cent and 39 per cent respectively, based on 2012 forecasts. The broker also rates Berkeley as a ‘buy’ in spite of it trading at a 29 per premium to 2012 NTAV. This is mainly due to its return on equity being more than 10 per cent for both 2011 and 2012.

From: http://www.proactiveinvestors.co.uk/companies/news/32461/brokers-see-buying-opportunities-uk-house-building-sector-32461.html

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