Why Taylor Wimpey shares are hard to ignore

These housebuilder’s shares are trading at a huge discount to the sector, offering a great entry point for investors.

The rough ride for Taylor Wimpey (LSE:TW.) shares continued today, even as one City firm called the builder's valuation “too attractive to ignore” due to its sector-leading dividend record.

FTSE 100-listed Taylor fell another 2% to 158.6p and is one of only two housebuilders with a negative share price performance in a year when market conditions have been positive.

Fire safety costs and pace of recovery in some of its units have driven the underperformance, but analysts at Liberum think the sell-off is overdone after upping their target to 195p today.

• Invest with ii: Top UK Shares | Share Tips & Ideas | Open a Trading Account

They note that the company is now trading at a 22% discount to the wider sector, which is the biggest gap in the eight years prior to the company's £500 million equity raise in June last year.

It adds: “This provides a great entry point for a multi-year self-help story.”

• ii view: backing Berkeley Group to catch up
• Read more articles on UK shares here
• Insider: boardroom newcomers fill up on shares after big deal

Liberum points to the company's dividend record, which it expects to deliver a 24% cumulative yield over the next three years. This includes 8% in 2022 and 10% in 2023, representing the highest in the sector and significantly above the FTSE 100 average.

For 2021, the total dividend is expected to be 8.9p a share worth £324 million but with the usual July special dividend not expected to return until the following year.

Improved trading and the use of the equity raise for land buying in this year and the tail end of 2020 should reduce the need for major investment in 2022, resulting in greater surplus capital for distribution to shareholders.

The broker believes that Taylor also has the greatest scope to increase its margins out of all the large cap housebuilders, leading to a potential 39% upside for shares should the company replicate the peak operating margin seen in 2018.

Management have identified five self-help measures to improve the margin performance, including efficiency benefits from increased volumes and operational enhancements. It is aiming for 21.1% by 2024, compared with the declining figure of 19.4% in 2019.

• Check out our award-winning stocks and shares ISA
• Discover how to be a better investor
• Subscribe to the ii YouTube channel and catch all our latest interviews and video content

If house prices continue to outstrip build cost inflation, it's possible that Taylor Wimpey could achieve its margin target earlier than current market expectations. On the flip side, the recent spike in building materials inflation may impact on Taylor's ability to hit its target.

Liberum said: “Investors appear sceptical of Taylor Wimpey’s ability to return to peak margins, due to the margin slippage since 2018.

“We expect the shares to incrementally re-rate as profitability continues to improve, driven by self-help measures and strengthening trading.”

The broker points to the example of Barratt Developments (LSE:BDEV), whose shares have materially outperformed Taylor Wimpey based on its strong margin record.

Taylor's interim results are due on 4 August, having reported robust customer demand and a strong forward order book at the end of April.

Trading conditions have been robust since then, with house prices continuing to rise and other builders optimistic that the unwinding of stamp duty relief won't derail the market.