Stockwatch: a Covid tip update and housebuilder to keep

Our analyst reports a possible Covid breakthrough and a stock to capitalise on demand for cheap homes.

The trickiest challenge for investors right now is “seeing through” more difficult months ahead, to which industries and firms can benefit as lockdown restrictions ease. It is also important to avoid paying too high a risk premium where the stock market is already anticipating some sort of recovery.

We know the US is apt to lead all; its indices have snapped back about half their falls since February’s record levels; though, on fundamentals, I’ve read at least one set of macroeconomists who reckon US stocks should anyway de-rate at least one third – both to shed froth and better reflect a slow recovery from the 2020 trough ahead.

However, I think they miss how a tsunami of Federal Reserve liquidity is liable to boost risk assets to some extent.

Potential underlined at Gilead Sciences 

I drew attention to US drugs group Gilead Sciences (NASDAQ:GILD) both on 4 February and earlier this week on 14 April, and its stock jumped 16% in after-hours dealing yesterday after details leaked of a closely-watched trial of its anti-viral drug Remdesivir.

A University of Chicago Phase III trial found most of its patients had “rapid recoveries in fever and respiratory symptoms and were discharged in less than a week.” Only two patients died out of 125 patients, 113 of whom were severely ill.

This was not spin but came from the university. Gilead declined to comment. Some health authorities in the US, China and other parts of the world have already been using Remdesivir, initially tested as a treatment for Ebola.

It looks set to raise interest in Gilead’s clinical trial results involving patients with severe cases of Covid-19, due this month, with testing of those with moderate symptoms in May.  
As with the recently soaring price of AIM-listed Covid test kit firm Novacyt (LSE:NCYT), expectations can become more powerful in the short term than eventual earnings reality, as speculators buy a momentum story.  

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I would caution that, while Gilead’s Chicago trial is encouraging, it is a quite limited timespan and doesn’t appear to involve a placebo to benchmark against, like strict trials require. However, it could herald a trend, thus profit-taking beget fresh buying too.

Duration of social distancing: the $64,000 question

Hopes for Remdesivir apply to the UK equally - as our media scrabbles at Boris Johnson’s stand-ins – as to how and when the self-imposed economic coma will be lifted. Professor Neil Ferguson, the epidemiologist who most influenced the UK government’s lockdown, said on Thursday: “a significant level of social distancing” will be required “probably indefinitely until we have a vaccine available.”

His remarks followed a junior health minister tweet, dismissing journalists’ questions about an exit strategy: “we need to find ways we can adapt society and strike a balance between the health of the nation and our economy,” they said. The practical upshot is axiomatic to businesses judging whether they can function reasonably enough.

Pressure is likely to be kept up given the key justification for lockdown was to prevent NHS intensive care capacity from being overwhelmed. This week has seen reports how the celebrated 4,000 bed Nightingale Hospital treated just 19 patients over the Easter weekend, and, apparently, we are at “peak virus”. Some epidemiologists warn, however, it’s a first peak in a mountain range to negotiate.

Help to Buy extension should support housebuilders

Meanwhile, house-building stocks are enjoying some reprieve on reports that the government is already in talks with The Home Builders Federation to extend Help to Buy beyond its current end-date of April 2021.

Savills (LSE:SVS) estate agency estimates the lockdown is setting back construction of around 200,000 new homes and government will be wincing about its electoral pledges to ensure both supply and affordability.

As yet the practicality of re-opening construction sites is dubious if strict social distancing is to be applied, although government will also be anxious to see those jobs resume – helped hopefully by more testing for Covid-19.

I therefore flag MJ Gleeson (LSE:GLE), a builder of high-quality low-cost homes mainly to first time buyers and those on lower incomes, across the Midlands and North of England where there are already acute shortages.

“The current situation is further exacerbating this position” they said when explaining an 8 April equity placing at 600p, to raise £16.4 million with 4.9% dilution. Net proceeds will position the company for an early recovery of the first-time buyer market – to include a focus on the nation’s key and critical workers – by resuming building on existing sites, accelerate opening those owned or contracted, and secure necessary supply chains.

In the March sell-off the stock fell as low as 514p, so it is encouraging that 600p was negotiated with institutions. A current price of 694p capitalises Gleeson near to £390 million, versus an all-time high of 990p last January. The 2008 down-cycle shows a fall from 400p to below 100p, then a bull run from 120p in late summer 2012.

I’ve drawn attention to the shares as a “buy” before, from 408p in May 2015, tempering my stance to “hold” last July at around 800p due more to Brexit uncertainties than company-specific issues.

Source: TradingView Past performance is not a guide to future performance

Before the Covid-19 crisis, projections were for net profit in a low-mid £30 million range for the current and 2021 years to end-June, for earnings per share (EPS) of around 56p to 62p and dividend per share of 21.6p, rising to 28.9p.

Expectations for 2020 were already down on the 2019 outcomes due to timing issues on the land investment/dealing side of the group, where revenues are prone to be lumpy.

Last February’s interim results showed no contribution from “strategic land” where like-for-like it had previously contributed £9 million operating profit on £30.3 million sales, an attractive 29.7% margin versus 15.9% for homes, when the first half of 2018/19 delivered £14 million profit on £88 million revenue.

At the interim 2020 stage, homes’ profit rose 13.6% to £15.9 million on revenue up 19.3% to £105.0 million, with a respectable margin of 15.1%.  

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In fairness, operating margins at Barratt Developments (LSE:BDEV) have trended in the high teens and Taylor Wimpey (LSE:TW.) a tad higher still. Housebuilding shares are prone to move in sync, although I would still flag Gleeson as potentially a leader say on a 12-months’ scenario – the chief risk being if the mortgage market gets difficult.

Dash to preserve cash in a recent wind-down

The story, likewise for other house-builders, turned drastic later in March, with Gleeson’s board suspending its interim dividend amid a “controlled wind down and closure of site activity”.

A Covid-19 update cited £67 million cash balances, with £60 million drawn from a bank facility additional to £10 million overdraft facility, but, like I cited a week ago regarding easyJet (LSE:EZJ), we’re not being told even an estimated rate of cash burn during lockdown.

This is frustrating, as I imagine it would be the first question off fund managers’ lips to justify supporting the placement. 

On 6 April, further Covid-19 related actions were declared: 76% of the workforce to be furloughed, according to the government job retention scheme, with the company topping up salaries by a minimum 80% and a maximum 95% of salary, while the board takes 30% cuts and senior management 5-20%.

The position will be reviewed at end-May, so maybe they will have a better sense to disclose costs then.

In recent years, the company has not had recourse to debt; instead, the end-2019 balance sheet shows £30.6 million cash. Mind, there were also £49.1 million short-term trade payables versus £19.4 million trade receivables (a ratio which improves for those longer-term: £9.2 million trade payables versus £12.4 million trade receivables.) The bulk of assets – land, homes for sale – appear held within £191.9 million inventories, the largest balance sheet entry by far.

What extent to value housebuilders on NAV?

Net asset value (NAV) computed at £202.3 million which, according to 58.1 million shares issued, equates to net assets per share of 348p and there are no goodwill/intangibles.

If they are serious about drawing on £70 million debt facilities (we cannot know without a sense for cash burn and lockdown duration), then netting off say £15 million net cash raised will take NAV down to 320p per share if circa £30 million debt was also taken out.

In which scenario the current share price is 2.2x net assets, which assumes a premium for conversion of land resources etc to profit.

Fair enough when housebuilders enter a growth phase, although benchmarking versus the big boys, Barratt actually trades at a slight discount – as implied by its stock at 0.96x NAV – while Taylor Wimpey (TW.) is on a modest 1.3x premium. Barratt’s NAV does, however, comprise 18.7% goodwill/intangibles while Taylor’s has negligible such entries.

Gleeson’s recently historic return on equity of around 13% doesn’t stand out either compared with Barratt on 16% and Taylor around 20.5%, although the timing of strategic land sales last year was cited as causing a fall.

Looking forward, however, Gleeson looks best-placed within the sector for a political meme of “helping our key workers” both for homes and jobs.

A relatively small size and attractive business split – sourcing sites for development in the South, and lower-cost building in the Midlands/North – also makes it long-term attractive for takeover.

Directors show forthright confidence in the placing

The chief executive, finance director and two non-executive directors bought a total 28,166 shares – close to £169,000 worth – while Harwood Wealth (LSE:HW.), a company closely associated with a third non-exec Christopher Mills – bought £1.8 million worth.

It is frustrating for the purposes of comment and trading, how the stock has kept rising in the last day or so, to rate “buy” once again, though I would certainly flag Gleeson’s medium to long-term potential. Hold.

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.