Shares in Telford Homes (LON:TEF) fell 15% today as there was a trilogy of notable events for investors: a trimming to full-year forecasts, a profit warning for years ahead, and a change in strategy. The share price reaction was kind, and arguably a lot of the news has already been baked in:
Despite the company name, Telford Homes operates primarily in London. The problems regarding the London market have been well documented elsewhere, but in recent times the market has been extremely buoyant, with government policies such as Help-to-Buy benefiting the housebuilders. Many companies in this sector have been reporting record profits as house price rises have far outstripped costs, and indeed, Telford itself released record results in April last year.
Since then, the housing markets have seen a downturn, with prices in London showing marked declines from their peak. And perhaps commensurately with this, Telford have given a much subdued update.
The warning comes in a ‘Strategic and Trading Update’ RNS today. First the strategy:
· The Group’s business model has been evolving in response to increasing institutional investment demand and customer rental demand
· Looking ahead, the Group intends to place even greater focus on build to rent which is now expected to exceed 50 per cent of the development pipeline before the end of 2019 and increase thereafter
· Build to rent reduces market risk with no debt and limited capital investment required in exchange for a lower margin and less overall profit on a given scheme
Build to rent represents a very small proportion of housing, so it will be interesting to see how this does evolve.
Onto more current matters:
Profit before tax for FY 2019 expected to be circa £40 million with the Group’s net asset value per share anticipated to be approximately 330 pence as at 31 March 2019
It is not mentioned, but this is a profit miss. A broker note (on Research Tree) quotes management expectations of £50m for this year. Although some of this can be put down to timings (£5m of profit has slipped into the next year), it is still a miss.
There is worse information to come for the next year:
Programme delay of six months at City North, outside of the Group’s control, expected to defer £15 million of profit between FY 2020 and FY 2021 such that profit before tax in FY 2020 is anticipated to be significantly below FY 2019
A profit warning far into the future is not a good sign, and could be even more pronounced if the housing market becomes adverse.
Telford is a much smaller developer than industry giants such as Persimmon and Barratt, and the market cap reflects that: just £220m at current prices as opposed to the billions of the others. Perhaps this difference in size reflects their different treatment on Stockopedia, as Telford has a rating of just 69, compared to the 99 and 98 of the big boys.
With their share price approaching lows not seen since the Brexit referendum, the clear worry for investors is Telfords exposure to London and the lumpy nature of their developments: as we have seen today a problem with one project can lead to a significant hit to the accounts.
That does not seem to have affected operations, as we can see from these results:
Cynics may add that anyone with no brains could have achieved profitable results selling properties in London over this period.
Unlike many others in this sector, Telford runs a significant debt balance (relative to multiples of profit). In the last year, bank borrowings have shot up to £115m, although this is part of a £210m revolving credit facility. The cash flow position has been negative in the past year, although all of this can be explained by a large swing in the working capital position.
As you can expect, there is welcome backing for liabilities. Land and buildings are great assets, as they can be shifted relatively quickly and valuations are more or less well known. Here is what Telford have:
As we also can expect from a mature business, dividends are a large part of the investment. The yield is especially high – over 5% now, and is well covered by profits. The profit warning also gives some good news in this regard:
In the future the Board anticipates enhancing the Group’s dividend policy, which is currently to pay one third of earnings, to take account of the reduced capital requirements of build to rent transactions. In the meantime there will be a period where earnings are lower than those generated for the year to March 2018 and the Board expects the annual dividend to be at least the 17 pence per share paid in that year during this time.
This sounds reassuring, but there is a ‘jam tomorrow’ element on it, as further operational problems or even a market failure would affect the profits from which these dividends are paid.
Telford’s renewed strategy to focus on rental properties is quite sensible: today we have also seen Foxtons warn that the London market is in a ‘prolonged downturn’. In this case, renting properties seems like an easier proposition and in the case of Telford there are plenty of management companies willing to manage big residential blocks.
All of that comes at a cost, of course and that is evident in the profit warning as the reduced margins bite: it seems that in the short-term the result of this strategy change will see smaller profits for the next few years and going beyond that, any increases might be down to the market.
The strategy change seems forced upon it rather than being a conscious choice: with the company having debts, having blocks of unsold new builds will be hurting. For the moment it may be right to reduce risks and avoid increasing reliance on financing.
A purchase of Telford seems like a straightforward bet on the fortunes of the London property market. The valuation is very cheap, even at the reduced level of profitability announced today and on a simple price/earnings basis it is probably the cheapest housebuilder out there (as most of the others have gained rapidly in the past month). But this reflects all the problems as seen above, which others have much less exposure to.
It may be the case that there could be further pain to come for Telford Homes. They are keen to point out that currently their net asset value per share is 330p, but it may also be the case that in the case of the housing market turning sour, there will have to be some revaluations of their assets, which would be put through as an expense.
I am slightly bearish on the property market currently but I have to accept that there are significant interests from government to protect prices, and they would much prefer a benign play-out rather than fast falls. In this case, it is hard to have much of an opinion. 3/5.