With its shares at 185p, FTSE 100 housebuilder Taylor Wimpey (LSE: TW) is trading on just 8.9 times forecast 2019 earnings with a prospective dividend yield of 9.9%.
Ordinarily, such a low earnings rating and high yield would indicate some major underlying problem with the business, or serious risk, like a high level of debt. This was the case with FTSE 250 outsourcer and builder Kier (LSE: KIE), which required a £250m rescue rights issue late last year. And slashed its dividend in its half-year results announced today.
However, in the case of Taylor Wimpey (and fellow volume housebuilders Persimmon and Barratt), business is booming and balance sheets are awash with cash. Nevertheless, I see a number of warning lights flashing red for the builders, and Kier’s position is still precarious, despite its fundraising.
Debacle
I warned readers last November that Kier’s high level of debt could be a hindrance to it winning new contracts. Its balance-sheet-bolstering rights issue was announced 11 days later, and was poorly supported by shareholders. This debacle was followed by the departure of under-pressure chief executive Haydn Mursell, and a further fiasco in which net debt figures were significantly upped.
Work cut out
In today’s results, Kier reported a £35.5m loss before tax, and a fairly meagre £39m profit on an ‘underlying’ basis, on revenue of £2.1bn. Despite the rights issue, net debt at 31 December stood at £180.5m and average month-end net debt over the six-month period was £430m.
The company said it’s maintaining its underlying expectations for the year to 30 June, including a net cash position at the period end, with “the full-year results being weighted towards the second-half of the financial year.” This while also noting“current political and economic uncertainty” and “some volume pressures in the highways, utilities and housing maintenance markets.”
New chief executive Andrew Davies takes up his position on 15 April. I think he’ll have his work cut out, and I’m happy to avoid the stock at this stage of proceedings.
Boom and bust
Last month, Taylor Wimpey reported “another strong year,” and “a very positive start to 2019.” Currently, demand for new homes is underpinned by high employment, low interest rates, competitive mortgage deals and the Help to Buy scheme. In fact, just about everything that bears on housebuilders’ profits is favourable right now.
Taylor Wimpey posted record revenue for 2018, with profit margins and return on equity at terrific levels. The trouble is, these characteristics, together with the undemanding earnings rating and high dividend yield, are typically found at the top of the boom-and-bust housing cycle.
The boom could have further to run — particularly with the market distortion of Help to Buy — but unless “it’s different this time,” a bust will follow the boom. Taylor Wimpey’s aforementioned 9.9% dividend yield includes a good-times special. It reckons it’ll be able to maintain its ordinary dividend (current yield of 4.1%) “during a ‘normal’ downturn” of the housing cycle. But I’m not convinced it would be sufficient compensation for the likely magnitude of the fall the shares.
The current valuation is 1.9 times tangible net asset value, while housebuilders tend to go to a sub-1 multiple at the bottom of the cycle — sub-100p for Taylor Wimpey, as things stand. I don’t see the risk/reward balance as appealing at this stage of the cycle, so I’m continuing to avoid the stock.