Housebuilding is one of those cyclical sectors I find extra attractive when investing sentiment is glum. Right now I’d buy any of our blue-chip builders. But today, I want to look specifically at Taylor Wimpey (LSE: TW) shares. Here’s what’s happening.
When we go through a strong period of housing demand, purchase prices continue to rise. So shares in Taylor Wimpey and the rest climb strongly. Then interest rates rise, for example, and investors are hit by fear of house price weakness.
So they sell out to wait for better times, and share prices tumble. But I reckon these investors are making one fundamental mistake.
They seem to think that housebuilders need rising house prices to make their profits. They don’t.
Builders’ profits
Builders’ profits depend on the difference between construction costs and selling prices. And those construction costs depends heavily on the cost of land. And when house prices fall, land prices fall too.
The last time the housing sector went through a weak patch, I watched the big builders snapping up as much cheap land as they could. I noted Persimmon, in particularly, ramping up its land bank. And the others weren’t far behind.
We’ve since seen soaring profits and huge dividends from the sector. And those long-term returns were boosted by that short-term land buying spree.
It’s true that this time round the builders are facing rising materials costs as inflation and supply-chain problems bite. And yes, I do think that could squeeze profit margins. But that’s surely only going to be a short-term effect.
Rising profits
And in its first half, Taylor Wimpey actually reported a rise in its operating margin, from 19.3% to 20.4%.
So far, CEO Jennie Daly tells us that “housing market fundamentals remain positive, supported by an enduring supply and demand imbalance and good availability of attractively priced mortgages.”
That “enduring supply and demand imbalance” is the key. The UK has been suffering a housing shortage for decades, and it shows no sign of changing. That, surely, makes this a great business to get into for the long term, doesn’t it?
Yes, the second half of the year is likely to be tougher economically. But Taylor Wimpey expects its full-year operating profit “to be around the top end of the current market consensus range“.
Dividend cash
Meanwhile, Taylor Wimpey shares are forecast to generate a dividend yield in excess of 8% this year, partly thanks to the depressed share price. It would be close to three times covered by forecast earnings. The company has just completed a £150m share buyback too, so there’s no shortage of cash.
What’s the downside? It’s all about market sentiment. When investors turn away from a sector, it can remain in the dumps for ages. There’s also a chance the dividend could drop in the next year or two — it does happen with cyclical sectors.
That, in turn, could damage sentiment further. But I reckon the best time to buy cyclical dividend shares is when everyone is running scared.