Cube Midcap Report (21 Aug 2019) – Persimmon Performs #PSN #OSB #CCFS

Cube Midcap Report (21 Aug 2019) – Persimmon Performs #PSN #OSB #CCFS

Good morning!

The midcap report is back this week. Today (Wednesday), I’m catching up on Persimmon from yesterday and then covering:


Persimmon (PSN)

  • Share price: £18.76 (+1%)
  • Market cap: £5,975 million

Half year results

This half-year report from Persimmon was received well by the market, the shares nudging up a little.

I’ve never invested much in housebuilders, due to concerns about their quality of earnings and also, more recently, their valuations.

My plan has been to leave them alone until there is a day when I can buy them at a nice price relative to book value (ideally of the tangible variety).

Persimmon, for example, has traded at the following P/TBV ratios since 2001:

Source: Sharescope, author calculations.

As you can hopefully see from the above chart, Persimmon has traded in a P/TBV range over the years of approximately 0.5x – 3.0x. It is currently around 2.2x.

Why do it this way, rather than focus on earnings? Well, for a simple Simon like me, who is not an expert in housebuilding, the tangible book value of the company is the simplest way for me to tell whether or not the shares are at a bargain level.

Besides, housebuilder earnings are volatile and can dry up in the bad years. From 2008 – 2011 (inclusive), Persimmon’s earnings were nothing to write home about.

The “Housebuilder paradox” is that their shares can look very expensive relative to earnings, when their shares are cheapest (e.g. Persimmon from 2008 to 2011). And they can look cheap relative to earnings, when their shares are expensive. Persimmon shares currently trade on a price to earnings multiple of less than 7x.

Please don’t misinterpret me. I am not suggesting that Persimmon shares are currently overpriced. I am simply giving the context for why someone like me, who is a bit wary of the sector as a whole, might not be rushing in to buy them at current levels. There is a strong possibility that I am being too cautious, and I will never get another good chance to buy them. We shall see!

Let’s look at some of the details in this report.

Financial Performance

The financial performance is fantastic, including ROCE of >40% and ROE of 31%. This is exactly what you look for, from a good housebuilder in the good years.

The number of new homes sold fell slightly, to c. 7,600. Their average selling price increased by less than 1%, to £217,000. The end result was that the company achieved lower revenues and H1 pre-tax profit of £509 million, not quite matching last year’s £516 million.

Persimmon gets more first-time buyers onto the housing ladder than any other UK housebuilder. And its average selling price is 17% lower than the national average for new homes to owner occupiers. Perhaps this model could help it to survive the next downturn?

Pipeline – a very important number, the number of plots owned stayed almost constant at 75,400.

Forward sales  – down slightly to £2.05 billion (versus £2.12 billion last year).

Outlook

There are a few snippets in the commentary worth mentioning. With respect to higher-priced homes, the company says:

“We have seen a continuation of a little less urgency from customers acquiring new homes at higher price points”.

Is this the beginning of a major trend lower, or just a little turbulence? That’s the tricky bit! At least the housing gross margin stayed strong at 33.8% (versus 32.4% last year). But customer service spending, to support these margins, increased significantly.

Getting away from customer demand and looking at the supply chain, there are also one or two dark clouds:

We have continued to experience some pressure with respect to the cost and availability of certain materials in the supply chain as the output from the industry continues to expand.We currently anticipate that cost inflation for the Group will be around 4% for the current year.

But the main points in the outlook statement are positive: macroeconomic conditions remain favourable for now (high employment rates, low interest rates, mortgage availability).

Customer service improvements and development spending will continue to increase, reducing returns somewhat:

Whilst this substantial commitment will reduce the returns we generate from the capital employed in the business, we believe this is the correct approach to support our customers and provide greater quality and choice moving forwards. However, we expect the Group’s cash generation will remain strong, reflecting the continued disciplined approach to land replacement.

My view

While I’ve already outlined the core elements of my view at the top of this article, the interim report from Persimmon has certainly helped to give me extra insights into where we might be in the cycle.

For now, the company has strong economic tailwinds and I expect that it will sail through Brexit without any major difficulty (assuming that we don’t have major negative changes in employment, interest rates or mortgage availability).

A few small negatives:

  • a little softness in demand at certain price points
  • 4% cost inflation
  • increased customer service expenses, reducing prospective returns

For the long-term shareholder in Persimmon, I personally don’t see any reason why this report would make them want to exit.

For someone like me who is a potential shareholder but only at bargain basement prices, I similarly don’t see any reason why this report would make we want to get involved at current levels.

So ultimately, I don’t think this H1 report will have changed anyone’s mind on Persimmon.

 


One Savings Bank (OSB)

  • Share price: 339p (-4.6%)
  • Market cap: £832 million

Half year results

This is slightly larger than the usual financial stocks I study. You can see its range of (mostly property-focused) lending activities here. Buy-to-let accounts for 72% of the loan book.

OSB has been described as one of the “smaller challengers”, alongside AIB (UK Division) (AIBG), Aldermore, Close Brothers (CBG), Metro Bank (MTRO), Shawbrook and Secure Trust Bank (STB)*.

These results aren’t too exciting, if I’m honest. The share price seems to agree with me.

The company remains profitable and with a high ROE but as with Persimmon, there are perhaps one or two reasons for concern.

Net interest margin has softened, “primarily due to the changing mix of the loan book, despite broadly stable asset pricing. The mix of the loan book continued to change as the higher yielding back book refinanced onto front book pricing.”

Reported profits haven’t made any progress, due to some exceptional transaction costs as the company prepares to combine with Charter Court (to be discussed next). On an underlying basis, PBT did improve by 5.5%.

The outlook is measured:

It is clear that the overall housing market is subdued with Brexit and geopolitical concerns weighing on pricing and activity. However, we are still achieving growth in our core market segments and are encouraged by our strong pipeline and application levels. Given this and considering the growth already achieved this year, we now expect to deliver net loan book growth in the high-teens in 2019, driven by organic lending and strong retention. The impact on NIM of the changing mix of the loan book, as the higher yielding back book refinanced onto front book pricing, has largely run its course, assuming current mortgage pricing, cost of funds and swap spreads continue.

My view

At a P/BV ratio of 1.5x, I am a little wary of this. It is very heavily exposed to the risky B2L segment and so I’m not sure if this market valuation can be justified, despite some strong returns metrics. Worth looking into in more detail.

Now let’s look at Charter Court, which is set to merge with OSB.

 

(Aldermore and Shawbrook were listed prior to their respective acquisitions. List source: KPMG)

 


Charter Court Financial (CCFS)

  • Share price: 277p (-5%)
  • Market cap: £663 million

Half year results

These results are also rather dispiriting. We see a declining pre-tax profit,  a flat net interest margin and sharply rising “cost of risk”, “reflecting the deteriorating and uncertain economic outlook as well as the observed increase in arrears.

The profit figure was affected by “lower gains on structured asset sales, net fair value movements on derivatives and increased administrative expenses”.

As was the case with OSB, CCFS reports very high ROE (26.5%) but lower compared to H1 last year (38.4%).

Despite these challenges, the overall size of the business continues to grow strongly, with a 24% increase in the loan book (albeit reduced from a 29% growth rate last year).

More progress on the all-share merger with OSB is expected in Q3.

Outlook

Despite the heightened uncertainty in the wider economy, we continue to see robust demand for our specialist lending propositions. We believe in the resilience of our business model, which was purpose built to capitalise on structural drivers in markets where we have significant experience and expertise.

My view

There is a clear pattern in today’s report. The economy is still treating the housebuilder well, but the bankers are under some pressure. Could that be a leading indicator, perhaps, for further bank weakness which could feed through to mortgage weakness and house price pressures?

CCFS shows tangible net assets as of June 2019 of £488 million, giving rise to a tangible P/BV of 1.36x. This is getting towards the sort of valuation for a small bank which I could get interested in, if I was satisfied that it would weather an economic storm.

I’ll reserve judgement for now, in advance of the planned merger, and come back to look at OSB/CCFS when they report again.


 

Thanks for dropping by! I’ll be back with more midcap news tomorrow.

Cheers

Graham

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