Barratt Developments warns demand slump forcing huge cut in house builds

The immediate outlook for the UK housing market is pretty grim, but is there anything in this update to encourage investors? Our head of markets runs through the numbers.

Barratt Developments (LSE:BDEV) is tweaking its model in the face of a slowdown which is currently blighting the sector.

With the trading position under some considerable strain, it is fighting the financial fires by a mixture of trying to drive revenues higher against a difficult backdrop, while taking a harsh look at its spending. Indeed, the group has become “highly selective” in land acquisition, particularly in light of prevailing prices not yet having adjusted to wider market conditions, and a spend of £820 million during the year represents a decline of 18% from the previous year.

• Learn more: SIPP Portfolio Ideas | How SIPPs Work | Transfer a SIPP

Alongside this curtailment of spending, Barratts has ramped up more innovative methods of trying to expand revenues, such as becoming increasingly involved in part exchange offerings, increasing the number of active sales outlets and testing the waters of the private rental sector market. In a trading update for the year ended 30 June 2023, it said an increase of 6.7% in house average selling prices (and 8% for the private section) has helped to mitigate some of the current challenges.

Such challenges are numerous. Build cost inflation has remained at between 9% and 10% for the year (although Barratts expects the number to halve next year), and the £180 million provision for legacy costs comes at an unwelcome time, but most of the real difficulties are beyond the group’s control.

The macro picture of an increasingly cautious consumer has weighed on sentiment generally, with mortgage availability and in particular affordability moving to centre stage. The current rate for a two-year fixed mortgage is edging towards 7% which, coupled with the end of the Help to Buy scheme, has resulted in lower demand, particularly among first-time buyers where reservations have plummeted by 49%.

More broadly, and despite an improved third quarter and slightly above average seasonal trends of late, significant demand deterioration in the second quarter has coloured the picture for the year. Some of the key metrics bear witness to the scale of the decline, with net private reservations per week having fallen by 32% and with forward sales having plunged in terms of number and value by 34% and 39% respectively. Home completions are down by 4% 17,206, and the group has suggested that a further decline up to 23% is likely in the next financial year to a range of 13,250 to 14,250.

Despite such a parlous backdrop, Barratts remains in the kind of financial health which should provide some insulation against any further downdrafts to come. The net cash position has remained solid at around £1.1 billion, with access to further funding in the unlikely event that it should become necessary. This has enabled the £200 million share buyback to be completed while also enabling the land spend. At the same time, the dividend is currently well covered, with a yield of 8.6% providing some consolation to shareholders.

• The UK's coming mortgage crunch
• Stockwatch: I’m upgrading this small-cap share to buy
• The Income Investor: dividend stocks still beat bonds and two shares I like

Perhaps unsurprisingly, the outlook from the company is cautious, although defiantly optimistic. Adjusted pre-tax profit for the year is still expected to be in line with market expectations at somewhere around £880 million, the group has reiterated its balance sheet and net cash strength, while the forward order book remains solid although reduced.

Even so, the scale of the challenges cannot be swept under the carpet, and the immediate outlook for the UK housing market, let alone the broader economy, is faltering.

The shares have taken something of a hit in early trade on the mixed messages emanating from Barratts’ statement, adding to a decline of 10% over the last year, compared to a rise of 3.6% for the wider FTSE100.

Over the last two years, the share price has dropped by over 40% which may just pique the interest of investors on a lower valuation basis. Indeed, while the market consensus of the shares has recently eased slightly, it still remains at a 'buy' which reflects some longer term optimism despite the more pressing challenges in the short run.