The listed house building companies rose earlier this week when this news was leaked to the press, continuing their strong run of past two years. The valuation of the house building sector has risen to a level that arguably now already reflects most of the good news to come. However there is one area – and one company in particular – that also stands to benefit but has not seen the same degree of valuation re-rating.
Land more geared to housing cycle
The land market is where the house builders must go to replenish their land banks as they sell their stocks of new homes. Land prices tend to be even more geared to the housing cycle than house prices. This is because the other main component of the cost of a new home – the construction cost – tends to be much less geared to the cycle.
Labour and raw material prices moves do move up and down but not in the same big cycles as house prices. As house builders start to have more confidence in a rising house price environment they typically start to compete much more aggressively for attractive parcels of land, which can drive the price up rapidly.
What is interesting is that so far in this cycle land prices have not moved up that much. This is because, until recently, the housing market has been weak particularly outside of London. Also the house builders themselves have been focused on rebuilding their balance sheets and cash flow rather than aggressively buying land. With a recovering housing market nationwide, both of these factors could change. So how can investors look to benefit from this?
Overlooked land
Henry Boot plc is one of the few listed companies that buys and develops land. Through their Hallam Land division they are one of the main players in the UK’s land market. It is quite an unusual business model.
Typically an option is first agreed with a land owner (usually agricultural land) and Hallam Land then proceeds to bring the land through UK’s arcane planning system, sometimes taking many years. The value-add comes once planning permission is achieved and then realised on sale to a house builder.
In my view, there are a number of reasons why Henry Boot shares look interesting today:
- History has shown this to be a very lumpy business. In past periods of rising house prices, Hallam Land has generated sales and profits multiples of what it does today
- Although the planning system in the UK is notoriously difficult, the environment over the past 2-3 years has actually been more benign than before due to Government regulations that have restricted the ability of local authorities to block housing developments. As a result of this, Hallam Land currently have one of their highest ever number of sites with planning permission or minded to grant permission
- Henry Boot management have demonstrated over many years an inherent conservatism both in their accounting policies and in their forward guidance (unlike the Bank of England). The large family ownership and relatively low liquidity also mean that this company is not that well researched, a big positive if you are seeking an investment idea that may have been overlooked by the wider investment community
- Finally, much of the value within Hallam Land is arguably 'hidden' in the sense that it does not appear anywhere in the company’s financial statements. With the housing market having been so depressed for a number of years, the division has shown very little profit (since few sites have been sold) yet much progress has been made in bringing attractive greenfield sites through the planning system. Until these sites are actually sold (typically at very high margins), they are held at cost in the inventory line on the balance sheet, which understates their intrinsic value. Although Henry Boot shares have been strong over the past year, it is not difficult to see scenarios where they could be worth a lot more given the potential upside from Hallam Land.
Matthew Tillett is a portfolio manager at Allianz Global Investors. His blog is avaialble at unconstrainedthinking.com
