Sector Screener: why prospects for housebuilders will improve
It’s not been a great period for the housebuilding sector, but investors are still interested in its recovery potential. Analyst Robert Stephens investigates how a turnaround might come about.
22nd January 2025 11:23
by Robert Stephens from interactive investor
The performance of the FTSE 350 Household Goods and Home Construction sector has been highly disappointing since it was first discussed in this column during September 2023. It has declined by around 3%, lagging the FTSE 350 index by around 15 percentage points.
- Invest with ii: Top UK Shares | Share Tips & Ideas | Open a Trading Account
Its underperformance is largely due to a tough operating environment over the past 16 months. Indeed, inflation has been at or above the Bank of England’s 2% target in all but one month during the period. This has caused a fast-paced increase in costs for housebuilders and contributed to a squeeze in their profitability.
Above-target inflation has also sustained a restrictive monetary policy, with the bank rate having been cut only twice and still standing at a relatively high 4.75%. Higher borrowing costs have contributed to reduced demand for new homes that has prompted a slump in completions across the sector over recent months. And while the UK economy was in the midst of a recession during September 2023, its declining growth rate and 0% expansion in the third quarter of last year have continued to act as a drag on investor sentiment towards cyclical companies such as housebuilders.
Demand growth
However, the outlook for the sector is set to significantly improve. Inflation may still be 50 basis points above the Bank of England’s target, but it is expected to gradually fall over the medium term according to the central bank’s forecasts. This should support profit margins among housebuilders, thereby providing scope for improved share price performance.
- Stockwatch: have housebuilding shares put in a low?
- 19 UK stocks on list of conviction ‘buy’ ideas for 2025
A modest rate of inflation also means there is scope for additional interest rate cuts that have a positive impact on the economy, as well as on demand for new homes. Indeed, the UK economy is forecast to expand by 1.6% this year and by a further 1.5% next year, according to the International Monetary Fund (IMF), which is up on its 0.9% growth rate of last year and ahead of several other developed economies such as the eurozone over the same period.
With a more buoyant economy likely to prompt a faster pace of wage growth, which has already been ahead of inflation since April 2023, and ease the recent rise in unemployment, demand for new homes could rise substantially over the coming years. This may have a positive impact on profitability across the Household Goods and Home Construction sector, thereby bolstering its performance.
Performance (%) | ||||||
Rank | Top five FTSE 350 sectors over one year | Price | One-month | Year-to-date | One-year | 2024 |
1 | Banks | 5,285 | 9.8 | 7.1 | 53.8 | 34.0 |
2 | Leisure Goods | 34,835 | 7.4 | 5.4 | 45.4 | 37.4 |
3 | Telecommunications Equipment | 572 | 1.2 | 0.9 | 44.3 | 43.6 |
4 | Precious Metals & Mining | 10,961 | 6.3 | 7.9 | 37.5 | 2.6 |
5 | Aerospace & Defence | 12,284 | 5.9 | 6.6 | 36.9 | 34.2 |
Source SharePad. Data as at 22 January 2025. Past performance is not a guide to future performance.
Performance (%) | ||||||
Rank | Bottom five FTSE 350 sectors over one year | Price | One-month | Year-to-date | One-year | 2024 |
39 | Household Goods & Home Construction | 10,795 | -1.6 | -1.2 | -18.7 | -16.6 |
38 | Chemicals | 7,224 | 2.7 | 1.4 | -16.7 | -25.7 |
37 | Automobiles & Parts | 1,184 | 4.2 | 2.1 | -13.2 | -26.9 |
36 | Real Estate Investment Trusts | 1,995 | 0.4 | -0.5 | -11.6 | -16.5 |
35 | Personal Goods | 16,070 | 3.5 | 2.4 | -7.6 | -27.7 |
Source SharePad. Data as at 22 January 2025. Past performance is not a guide to future performance.
Limited supply
Alongside the prospect of rising demand for new homes, supply continues to be limited. Although figures on housing starts in the UK are only available until mid-2024, they show that 114,000 new dwellings were started in the previous year. This compares with 220,000 over the prior 12-month period.
Clearly, the government is aiming to dramatically increase the supply of new homes through making changes to the planning process. However, the longstanding scale of imbalance between demand and supply could mean that the average sale price of new homes remains robust. This may provide greater scope for higher profits among housebuilders should completions recover from their current low ebb in future.
Solid fundamentals
Of course, inflation is proving to be stickier than many investors previously anticipated. This could prompt a continued brisk pace of increase in costs for housebuilders, while also delaying the pace at which interest rates are cut. Meanwhile, the existence of time lags means that it is likely to take many months for the full impact of monetary policy easing on the economy’s growth rate to be felt. This could mean that the Household Goods and Home Construction sector continues to deliver lacklustre returns relative to the wider FTSE 350 index over the short run.
However, with many of the sector’s incumbents having solid financial positions, they appear to be well placed to overcome further economic-related challenges. And with an upbeat long-term outlook, the sector is positioned to generate a much-improved absolute and relative performance over the coming years.
Company | Price | Market cap (m) | One month | Year-to-date | One year | Forward dividend yield (%) | Forward PE |
2,456p | £2,914 | 2.4 | -1.4 | -9.0 | 2.7 | 15.1 | |
434.95p | £6,276 | 0.5 | -1.2 | -19.4 | 3.7 | 15.7 |
Source SharePad. Data as at 22 January 2025. Past performance is not a guide to future performance.
Bellway
Shares in FTSE 250-listed housebuilder Bellway have risen by 5% since they were first discussed in this column during September 2023. This equates to an eight percentage point outperformance of the Household Goods and Home Construction sector.
The company’s recent financial performance, though, has been downbeat. In its latest financial year to July 2024, for example, it posted a 30% decline in revenue and a 58% slump in pre-tax profits. This was largely due to a 30% drop in completions, as well as a 600 basis point decline in its operating profit margin, as constrained demand and a fast pace of build cost inflation weighed on the firm’s performance.
- Shares for the future: a top 5 stock that’s ‘absurdly cheap’
- Sign up to our free newsletter for investment ideas, latest news and award-winning analysis
Still, its strong financial and market positions mean it is well placed to capitalise on an improving outlook for the wider sector. For example, its net gearing ratio is currently less than 1%. This suggests it can overcome further industry-related difficulties as the process of monetary policy easing takes time to complete. And with a land bank in excess of 95,000 plots, it has a solid competitive position through which to deliver rising profits in a more buoyant operating environment.
Bellway’s shares currently trade at a 17% discount to net asset value. This suggests that investors have factored in further challenges facing the firm in the short run, while providing scope for capital growth over the long run.
The company’s shares could experience elevated volatility over the coming weeks due to a trading update scheduled for release next month. But with a solid financial position, the prospect of stronger trading conditions amid interest rate cuts and a wide margin of safety included in its market valuation, the stock is well placed to further outperform its sector over the coming years.
Barratt Redrow
Following its recent merger with Barratt, investors in Redrow received 1.44 shares in the new entity for every share they previously held. Based on the combined entity’s current stock price, this equates to a capital gain of 23% on Redrow’s shares since they first featured in this column during September 2023. This is 26 percentage points ahead of the sector’s performance over the same period.
The combined firm’s first trading update stated that integration is under way, with it expecting to achieve at least £90 million of cost synergies through a mix of procurement and structural changes. Although its shares currently trade on a rather rich forward price/earnings ratio of 15.7, the company is forecast to post a rise in earnings per share of around 31% next year. This suggests that it offers a wide margin of safety which provides scope for capital gains.
Clearly, a merger almost inevitably brings a period of uncertainty for the new entity as it seeks to deliver on its rationale for the combination. This is likely to be exacerbated by tough operating conditions that could persist over the near term. Furthermore, the firm’s share price could be affected in the short run by the release of its half-year results next month.
However, with the prospect of significant economies of scale resulting from the merger and an increasingly upbeat outlook for the wider housebuilding industry, Barratt Redrow appears to be well placed to generate share price growth over the long run.
Robert Stephens is a freelance contributor and not a direct employee of interactive investor.
These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.
Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.
Disclosure
We use a combination of fundamental and technical analysis in forming our view as to the valuation and prospects of an investment. Where relevant we have set out those particular matters we think are important in the above article, but further detail can be found here.
Please note that our article on this investment should not be considered to be a regular publication.
Details of all recommendations issued by ii during the previous 12-month period can be found here.
ii adheres to a strict code of conduct. Contributors may hold shares or have other interests in companies included in these portfolios, which could create a conflict of interests. Contributors intending to write about any financial instruments in which they have an interest are required to disclose such interest to ii and in the article itself. ii will at all times consider whether such interest impairs the objectivity of the recommendation.
In addition, individuals involved in the production of investment articles are subject to a personal account dealing restriction, which prevents them from placing a transaction in the specified instrument(s) for a period before and for five working days after such publication. This is to avoid personal interests conflicting with the interests of the recipients of those investment articles.