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Taylor Wimpey (TW.) perhaps needs limited introduction, it is one of the larger players in the housing development sector. TW’s focus is almost entirely on the UK market, of which 25% of its revenues come from London and the South East. It was no surprise then that following the BREXIT vote that the shares were marked down almost 40% in the immediate aftermath. The shares have recovered 27% since trading around 170p, but after this week’s trading results can we expect a further recovery?
The Trading Statement Unpicked
The full RNS is here, i’ll go through the highlights below but for those who want to skip the detail I have translated the release into hard numbers in Figure 1.
In 2016 total home completions increased by 4% to 13,881, including our share of joint venture completions (2015:13,341).
Our net private reservation rate for 2016 was 0.72 homes per outlet per week (2015: 0.73). Cancellation rates remained low at 13% (2015: 12%).
Taylor Wimpey informs us that demand continues to look strong. Cancellation rates have increased slightly by 1%, although some of that may be attributed to the immediate uncertainty post the BREXIT vote. The management team confirmed this hypothesis in the analyst call.
The mix impact of better quality locations continued to have a positive impact with average selling prices on private completions increasing by 13% to £286k (2015: £254k). Our overall average selling price increased by 11% to £255k (2015: £230k).
The average prices of the sales continue to increase, this is good news for TW clearly. However, whilst the locations may be of higher quality much of this increase will also be around the general increase in house prices. This growth in house prices continue to be far outpacing the real earnings growth, which is around 1.5% according to the Labour Costs Index. Many market commentators question whether this is sustainable and it doesn’t take a genius to understand why. So is it feasible for TW to post further increases in selling prices for 2017? I would suggest not, I’ll discuss the outlook later in the article.
We ended 2016 with a year end order book valued at £1,682 million as at 31 December 2016 (31 December 2015:£1,779 million), excluding joint ventures, with a small fall in the average selling price largely due to a number of high value Central London completions in December 2016. This order book represents 7,567 homes (31 December 2015:7,484 homes). We enter 2017 with 285 outlets (31 December 2015: 297)
This gives an indicator of the prospects going into 2017, the value of the book has fallen by 5% from £1,779m to £1,682m year on year. The total number of orders though has increased by 83 homes, i.e. 1% year on year. This starts to give a picture at the slow down in the London market, which Taylor Wimpey attributes this to. This again reinforces the point that the selling price is likely to be static at best for 2017.
As at the end of December 2016, our short term landbank stood at c.76k plots (2015: c.76k plots), having successfully converted over 9k plots from the strategic pipeline into the short term landbank (2015: c.9k). Looking ahead, we remain mindful of the wider macroeconomic uncertainty created by the outcome of the EU Referendum. In line with our disciplined strategy and with the benefit of a long landbank and underpin of strategic pipeline, we will continue to be selective in further land investment.
The landbank provides the inventory for future developments, at the interim results in June this land bank was recorded at £2.8bn, stated at the lower of cost and Net Realisable Value. It is by far the biggest balance sheet item and thus sensitive to impairment in downturns. The company quite rightly sounds caution over future investments in land, which is sensible given a potential overheat in land prices. The company thought as plenty of inventory here assuming the demand continues, with 76,000 plots at current average selling price of £0.255m the landbank provides for around £19.38bn of potential future revenue. I think it is fair to comment we should not be worried about the pipeline, management can afford to be overly prudent on replenishment for a while it seems. Next…
The Spanish market continued to be positive. We completed 304 homes in 2016 (2015: 251) at an average selling price of €358k (2015: €315k)
Encouraging, but the Spanish market represented just 2% of the total revenue in 2015, so I won’t spend any time on. Marching on further…
In 2016, the first year of operating towards our enhanced medium term targets, the Group expects to report an improved operating profit margin of c.20.8% (2015: 20.3%) and a return on net operating assets of over 30% (2015:27.1%).
Operating margins have improved slightly by 0.5%, this is positive and with prices increasing quicker than costs in the UK market this results in an increase in the profitability per completion of 14%. It is encouraging that Taylor Wimpey have retained some of the additional revenue and this hasn’t been lost in the supply chain.
We ended the year in a strong position with net cash of c.£365 million (31 December 2015: £223.3 million net cash), due to the strength in underlying trading and after the payment of £355.9 million of dividends to shareholders in 2016 (2015: £308.4 million).
There is no denying that Taylor Wimpey has thrown off the cash this year, when you add back the dividend it seems the company has generated around £0.5bn of free cashflow (FCF). With a market capitalisation of £5.6bn, this looks very favorable indeed and places my favorite metric of FCF/Earnings ratio of just over 10 – well in the value range…
We remain confident in our ability to pay significant dividends through the cycle, and are focused on our medium term target for dividends which is to pay a total of £1.3 billion of dividends in cash to shareholders over the period 2016-2018.
The company retains it’s dividend guidance of dishing out on average £400m per year over the next three years, which puts the company on an estimated dividend yield of 7.9% at the current share price. This dividend was covered by 1.4 times by free cashflow so fairly safe for at least the next two years (2016 and 2017 payments).
We expect to deliver full year profitability at the upper end of market consensus [EBITDA £706m-£755m]. Looking ahead, we remain confident that our disciplined strategy will enable us to continue to deliver value over the long term.”
The company finally states it is likely to come in at the upper end of market expectations. I calculate it will hit £755m bang on, perhaps even a little higher. The company even helps us mere mortal shareholders out by stating what that guidance was in the footnote. Bonus Point to the management.
So in summary 2016 was an exceptional year but what about the future?
Can Taylor Wimpey keep this performance up going into an uncertain environment?
I am far from an expert on the sector, but here are my views for what they are worth. I am a long term investor and my long term view is that we are still short of housing in the UK, which is backed up by the ONS, the long term fundamentals are therefore positive.
The house price has though increased on average by 7% year on year since 1980, I don’t deny this is making it very difficult for the younger generations to get on the housing ladder which means we are seeing some of the lowest first time buying rates in a very long time. I also don’t deny that house price increases by 7% each year against real wage growth of 1-2% is also not sustainable. We may well be due a large correction in prices and we start to see this in London now as evidenced by the trading statement. Let’s for a moment though take a fairly bearish scenario, reducing Operating Margin, completions and the average selling price by 20% (see figure 1). I calculate that this would still give a PE ratio of 20, not exactly great value but far from a disaster. Taylor Wimpey also has a strong balance sheet, unlike the last time the housing market suffered a correction in 2008/2009. The company at present is carrying just £100m of debt and even in the bear case it would still likely to be able to throw off around £300m of cash each year, not enough to sustain an 8% dividend yield but perhaps still 3% or so.
It is true we don’t know the effects of BREXIT, but in my view it would take a long and deep recession rather than just a correction in the housing cycle for Taylor Wimpey to be a long term sell.
Author Recommendation – Buy, Target 230 / 35% upside
A price of 230p would still give a dividend yield of around 6% and a PE ratio of 13 on 2016 numbers. This even at that level would give an appealing dividend yield, but discounts in some risk for a downturn in the housing cycle.