Yahoo Finance We’re not building enough homes – and that’s great for this developer
Buying shares today may seem like a high-risk pursuit. After all, the economic outlook is extremely uncertain.
Rampant inflation, rapidly rising interest rates, political instability and extremely weak consumer confidence are just some of the threats that could cause stock prices to decline further over the short run.
At the same time, though, avoiding the purchase of grossly undervalued shares today is also a high-risk strategy. After all, holding cash guarantees a vast negative real return.
More importantly, the stock market’s stunning track record of recovery from every one of its previous downturns means investors who continually wait in anticipation of better buying opportunities will ultimately miss out on a rebound.
In Questor’s view, the most sensible action in the current climate is to buy high-quality companies when they offer good value for money.
Investors must also accept the potential for paper losses in the short run in return for the prospect of long-term capital gains.
Clearly, it is difficult to see positive catalysts for companies such as housebuilder Bellway at the moment. Its near-term prospects are highly challenging, with fast-paced interest rate rises likely to reduce demand for new homes as larger mortgage repayments mean many buyers are simply unable to afford them.
This uncertainty appears to be priced into the firm’s shares. They currently trade on a bargain-basement price-to-earnings ratio of 4.2.
Their price-to-book ratio of 0.7 – its market value compared with its net assets – further highlights the mammoth margin of safety that is currently on offer.
Investors, it seems, are preparing for an Armageddon scenario that may not arrive. Indeed, the UK has a fundamental undersupply of new homes. In the 10 years to 2020, population growth amounted to around 450,000 people a year, while just 165,000 new homes were built each year.
Although population growth is expected to moderate in future, it nevertheless is expected to grow by 265,000 a year between 2020 and 2030 and exceed the rate at which new homes are being built.
This ongoing supply/demand imbalance, which has been present for decades, could support house prices and prompt less downbeat trading conditions for housebuilders than the stock market is currently anticipating.
And since the industry is an oligopoly controlled by a limited number of large operators with giant land banks, the supply of new homes is unlikely ever to materially exceed demand.
Even if Bellway’s trading environment deteriorates, it has the financial means to survive. Unlike during the last major decline in house prices, which took place during the global financial crisis, housebuilders’ balance sheets are generally healthy heading into the imminent economic downturn.
The firm’s net cash of £245m means it could even capitalise on lower land prices over the coming months, which would provide the opportunity to earn greater margins in the long run.
Equally, its recent full-year results highlighted that its owned and controlled land bank of roughly 61,000 plots, which equates to 5.5 years of supply at its current rate of completions, means it is under no pressure to divert cash resources to land investment should it decide to prioritise having a large net cash position.
Since first being tipped as a buy in this column in July 2020, Bellway’s share price has declined by 33pc. All of its decline, and more, has taken place in the current calendar year: the shares are down by 48pc so far this year.
While dividends received since our initial tip amount to 8pc, the stock’s total return thus far is nevertheless extremely disappointing.
In Questor’s view, Bellway has the financial means to ride out the current economic downturn. Although its shares could fall further in the short run, their cut-price valuation suggests investors have accounted for industry-related challenges as rising interest rates threaten to hit demand for new homes over the coming months.
Over the long run, a seemingly innate imbalance between the demand and supply of new homes means the industry offers attractive growth prospects. Investors who buy now, or hold on to their existing position in Bellway, are likely to be well rewarded in the long run.
Those who gamble on waiting for even lower prices may be able to make even greater returns. But they risk missing out on a long-term recovery that will equate to a vast opportunity cost.
Questor says: buy
Ticker: BWY
Share price at close: £17.61
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