Bellway Plc BWY
October 07, 2011 - 9:33am EST by
rosco37
2011 2012
Price: 667.00 EPS $0.39 $0.52
Shares Out. (in M): 120 P/E 0.0x 0.0x
Market Cap (in $M): 800 P/FCF 0.0x 0.0x
Net Debt (in $M): 33 EBIT 74 90
TEV ($): 832 TEV/EBIT 11.2x 9.2x

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Description

 

The markets being what they are these days have made the entry point on this investment about 12% worse off than when we started writing (i.e. four days ago!).  Given the volatility I'm sure anyone watching BWY will get another crack at a decent price point.  Having said that, we believe Bellway represents a compelling investment opportunity with a good margin of safety and solid upside. 

 

Description:

Bellway is the 4th largest homebuilder in the UK, headquartered in Newcastle Upon Tyne, employing close to 1,400 people, with activities in:  land acquisition, finance, planning, architecture, design, build management, marketing and customer service.  They have been in business for over 50 years and have operations that span across England, Scotland and Wales.  Bellway's operations focus on the mid to lower end of the housing market.  This year Bellway's average selling prices was around £175k versus the national average price of £161k. 

 

Management:

The main executives are:

John Watson, CEO - joined Bellway in 1978, CEO since 1999 (compensation 2010:  £1,091,148, 2009: £799,646, 228,674 shares owned)

Alistair Leitch, CFO - joined Bellway in 1981, CFO since 2002, due to retire at the end of 2011 (compensation 2010 £717,397, 2009: 527,725, 148,638 shared owned)

 

Total employee options outstanding:  1,682,152 w/a weighted average strike of £6.81 and 3.5yr duration.

 

Background:

The UK housing market, outside of London, has suffered similar price and activity declines as other western markets; not from overbuilding (excluding Ireland) but from accessibility to mortgages and interest rates.

 

Historically the largest impact on housing activity in the UK has come from (in order of importance):

  • Interest rates
  • Government policy
  • Overall debt levels
  • Access to funding
  • Income growth
  • Demographic trends

 

Currently access to funding is the greatest impediment to housing activity and we would expect this to continue despite government efforts to re-start the mortgage market.

 

As mentioned, overbuilding outside of Ireland has not been a factor in this housing crisis. In fact there is an on- going debate in the UK about the shortage of housing required to meet the current and forecasted number of households.  The table below shows housing production peaked in 1968 and has been on a steady decline since.  Leaving aside the current shortage of housing stock for a moment, private and public studies indicate that at current trend the UK is expected to create over 6m households in the next 20 years.  Should this number be accurate that translates into a need of approximately 3.6 million dwellings (houses and flats) or a build rate of close to 200,000 new dwellings a year.  Trend projection has never been reliable so we discounted the current studies by 20% for conservatism which puts the need at about 160,000 dwellings a year.   If we use the historical stock numbers, 82% of these dwellings (130,000) should translate into private homes each year going forward.  The current situation exacerbates the supply/demand problem as estimates suggest the UK (mainly England) has been undersupplied by 35,000-85,000 suitable dwellings a year since 1996. 

 

There is always going to be some debate over forecasts and numbers. What we are trying to illustrate is that the current run rate of around 130,000 dwellings is close to a trough level (and is the lowest level since 1954 for private enterprise) and there is a sustainable model of house building in the UK for the foreseeable future.

 

Completions per year

 

 

 

 

 

Number of dwellings

 

 

 

 

 

Private
Enterprise

Housing Associations

Local
Authorities

All
Dwellings

Population (000,000's)

Households (000's)

1946

 

 

..

..

..

..

 

 

1947

 

 

..

..

..

..

 

 

1948

 

 

..

..

..

..

 

 

1949

 

 

28,460

8,020

168,780

205,260

 

 

1950

 

 

30,240

7,290

167,900

205,430

 

 

1951

 

 

25,490

7,350

169,020

201,860

 

 

1952

 

 

36,670

10,130

201,520

248,320

 

 

1953

 

 

64,870

16,800

245,160

326,820

 

 

1954

 

 

92,420

22,120

239,580

354,130

 

 

1955

 

 

116,090

12,850

195,480

324,420

 

 

1956

 

 

126,430

9,850

171,390

307,670

 

 

1957

 

 

128,780

8,520

170,290

307,590

 

 

1958

 

 

130,220

8,220

140,200

278,630

 

 

1959

 

 

153,170

6,520

121,880

281,570

 

 

1960

 

 

171,410

7,240

125,620

304,260

 

 

1961

 

 

180,730

6,320

116,140

303,190

 

16,662

1962

 

 

178,210

6,030

129,410

313,640

 

..

1963

 

 

177,790

7,550

122,380

307,710

 

..

1964

 

 

221,260

9,790

152,140

383,190

 

..

1965

 

 

217,160

12,360

161,710

391,230

 

..

1966

 

 

208,650

14,890

172,470

396,010

 

..

1967

 

 

204,210

15,070

196,180

415,460

 

..

1968

 

 

226,070

15,320

184,450

425,830

 

..

1969

 

 

185,920

16,660

175,750

378,330

 

..

1970

 

 

174,340

15,210

172,670

362,230

 

..

1971

 

 

196,310

16,490

151,670

364,480

 

19,027

1972

 

 

200,760

11,220

118,960

330,940

 

..

1973

 

 

191,080

12,130

101,430

304,640

 

..

1974

 

 

145,230

13,870

120,540

279,630

 

..

1975

 

 

154,600

22,050

145,360

322,000

 

..

1976

 

 

155,300

23,100

146,440

324,840

 

..

1977

 

 

143,970

30,650

139,540

314,160

 

..

1978

 

 

152,230

26,290

110,170

288,690

 

..

1979

 

 

144,120

21,390

86,320

251,820

 

..

1980

 

 

131,990

21,480

88,530

242,000

 

..

1981

 

 

118,590

19,700

68,330

206,630

 

20,727

1982

 

 

129,020

13,740

40,090

182,850

 

..

1983

 

 

153,040

16,820

39,170

209,030

 

..

1984

 

 

165,560

17,290

37,570

220,410

 

..

1985

 

 

163,400

13,650

30,420

207,470

 

..

1986

 

 

178,010

13,160

25,380

216,540

 

..

1987

 

 

191,250

13,150

21,830

226,230

 

..

1988

 

 

207,420

13,490

21,450

242,360

 

..

1989

 

 

187,540

14,600

19,320

221,460

 

..

1990

 

 

167,470

18,050

17,710

203,230

 

..

1991

 

 

159,510

20,870

11,060

191,450

 

22,863

1992

 

 

147,350

26,670

5,670

179,690

 

..

1993

 

 

146,700

36,000

3,370

186,070

 

..

1994

 

 

153,920

37,170

2,880

193,970

 

..

1995

 

 

157,440

39,040

3,440

199,930

 

..

1996

 

 

154,410

33,100

1,760

189,270

 

..

1997

 

 

161,230

28,340

1,540

191,110

 

..

1998

 

 

155,830

24,100

1,100

181,020

 

..

1999

 

 

157,930

23,730

330

181,990

 

..

2000

 

 

154,580

21,990

280

176,850

 

..

2001

 

 

152,650

21,080

360

174,080

 

24,557

2002

 

 

162,770

18,940

250

181,960

 

..

2003

 

 

172,620

17,620

250

190,490

 

..

2004

 

 

182,700

20,660

130

203,490

 

..

2005

 

 

185,850

23,490

240

209,580

 

..

2006

 

 

186,510

26,000

290

212,800

 

25,579

2007

 

 

197,460

27,590

280

225,330

 

..

2008

 

 

150,870

31,470

630

182,960

61.4

26,048

2009

 

 

118,190

33,630

810

152,630

 

 

2010

 

 

103,960

28,790

1,320

134,080

 

 

2013

 

 

 

 

 

 

63.5

27,407

2018

 

 

 

 

 

 

65.6

28,870

2023

 

 

 

 

 

 

67.8

30,284

2028

 

 

 

 

 

 

69.8

31,621

2033

 

 

 

 

 

 

71.6

32,849

 

One of the main reasons why housing development has slowed, besides mortgage accessibility, is due to the complex planning laws across the UK.  Until about 5 weeks ago it could take up to 4 years (if ever) to get permission for a site; now the new draft national planning policy framework  (published in July) will streamline more than 1,000 pages of policy to just 52.  Among its "core principles" it says that those making decisions about planning applications "should assume that the default answer to development proposals is 'yes' except where this would compromise the key sustainable development principles set out".  This is important legislation as its turns around the guilty until proven innocent bias.

 

Competition:

 

There are about 5,500 home builders in the UK; The top 10 national homebuilders account for about 45% of all new dwellings, with the top 25 building 65% of the new dwelling each year.  Bellway is currently ranked the 4th largest with about 5% market share; this has gradually increased from their first appearance in the top ten back in 1995.  Bellway seems to pick up market share during periods of distress due to their unlevered balance sheet.

 

 

 

Top ten UK homebuilders:

 

1.       Taylor Wimpey

2.       Persimmon

3.       Barratt

4.       Bellway

5.       Berkeley Group

6.       Redrow

7.       Miller

8.       Crest Nicholson

9.       Gadedale

10.   Bovis

 

Barriers to entry:

 

Along with the normal barriers associated with product differentiation, scale and branding the following are the biggest hurdles in the market:

 

Entry and Expansion - it's relatively easy to enter the homebuilding market but difficult to reach critical mass and stay among the top ten, where scale provides benefits.  Over the past 25 years only two builders have remained in the top ten - excessive leverage has had the greatest effect on the survival rate of homebuilders during booms and busts.

 

Land - acquisition of land and a quality land bank is crucial in the UK market; both take time and capital. 

 

Financing - access to capital is a main barrier to a firm's entry and survival.  Many of the UK firms operate on a highly levered basis making them vulnerable in downturns.

 

Knowledge - local knowledge and relationships take time to establish; even with a large amount of capital this barrier makes it difficult for foreign entry and expansion.

 

Regulatory - federal and regional regulatory requirements take time and on average add up to about 10% of the development costs.

 

Business Model:

 

The standard model for most UK homebuilders, including Bellway, is to start with the required profit margin and reverse out the costs to determine affordability of land and project development.

 

For example; from the per unit sales price most homebuilders target a profit margin of 20-25%;

Less:  10% cost of regulation

Less:  35% build costs, infrastructure etc (including funding)

Less:  30% land value

 

Bellway uses a capital allocation model where projects are presented by the various regional directors to head office, with the best prospects for return (after clearing the 20% hurdle) being funded.  Management ability to assure conservative unit pricing and costs is essential in maintaining margins.  Except for '09 and '10, where margins were compressed due to the crisis, we found CEO Watson and CFO Leitch to both be very disciplined operators.

 

Balance Sheet:

 

Bellway has a clean balance sheet with minimal use of debt.  Management is generally averse to borrowing but will use it when outstanding opportunities arise.  Under normal conditions they have the ability to replenish the land bank with cash generated.  They did raise equity in '09, when debt wasn't available, to take advantage of cheap land prices.

 

Inventory (land bank) is the main asset and provides the margin of safety to the investment.  It's made up of five parts:  Land with planning, pending planning, work in progress, show homes and part exchange.  Land with planning and work in progress represent 90% of the inventory value.  In order to establish its credibility we spoke with industry competitors and independent evaluators and from what we have been told it is fairly marked to market.  To be conservative we still apply a 20% discount for liquidity.  In 2008 they wrote down the inventory by £131mm (about 8%) and another £66.3mm in 2009 (approx. 5%).  The other important component is the site mix (age of stock) and this is where BWY has an advantage over competitors.  According to the company most of the '05-'07 lower margin stock will be sold off by 2012-13 and the site mix will have over 50% of plots generating in excess of 20% margins.

 

 

H1 2011

FY 2010

FY 2009

FY 2008

FY 2007

FY 2006

FY 2005

 

 

 

 

 

 

 

 

Assets

 

 

 

 

 

 

 

Cash & Near Cash Items

93.30

145.69

43.21

109.31

25.38

2.33

66.44

Accounts & Notes Receivable

50.60

13.00

11.03

13.64

15.95

12.08

16.96

Inventories

1190.50

1148.71

1211.35

1503.94

1537.87

1434.00

1246.43

Other Current Assets

 

32.80

40.56

40.85

29.30

14.42

20.12

Total Current Assets

1334.40

1340.20

1306.16

1667.75

1608.51

1462.83

1349.95

 LT Investments & LT Receivables

7.80

7.72

0.00

0.00

0.00

0.00

0.00

 Gross Fixed Assets

 

20.87

28.72

29.11

27.53

27.12

29.22

 Accumulated Depreciation

 

12.66

13.09

13.46

12.45

11.65

11.59

Net Fixed Assets

8.70

8.22

15.63

15.65

15.09

15.46

17.63

 Other Long-Term Assets

39.90

36.36

28.15

13.60

13.03

15.91

13.48

Total Long-Term Assets

56.40

52.29

43.78

29.26

28.12

31.37

31.11

Total Assets

1390.80

1392.49

1349.94

1697.00

1636.62

1494.20

1381.06

 

 

 

 

 

 

 

 

Liabilities & Shareholders' Equity

 

 

 

 

 

 

 

Accounts Payable

188.90

116.71

95.68

112.27

165.00

180.77

88.82

Short-Term Borrowings

20.00

0.00

0.00

52.00

60.55

17.02

2.00

 Other Short-Term Liabilities

9.60

111.79

150.47

172.63

248.39

198.23

236.66

Total Current Liabilities

218.50

228.49

246.15

336.90

473.95

396.03

327.47

Long-Term Borrowings

100.00

100.00

100.00

295.00

77.00

159.00

236.00

 Other Long-Term Liabilities

25.50

29.20

38.78

64.02

49.86

35.67

21.47

Total Long-Term Liabilities

125.50

129.20

138.78

359.02

126.86

194.67

257.47

Total Liabilities

344.00

357.70

384.93

695.92

600.81

590.70

584.94

 Total Preferred Equity

0.00

0.00

0.00

0.00

0.00

0.00

20.00

Minority Interest

-0.07

-0.07

-0.07

-0.07

-0.07

-0.07

-0.07

Share Capital & APIC

177.27

175.67

131.57

131.30

129.82

126.16

123.04

Retained Earnings & Other Equity

869.60

859.20

833.51

869.85

906.06

777.41

653.14

Total Equity

1046.80

1034.80

965.01

1001.08

1035.81

903.50

796.12

Total Liabilities & Equity

1390.80

1392.49

1349.94

1697.00

1636.62

1494.20

1381.06

 

 

 

 

 

 

 

 

Net Debt

26.70

-45.69

56.79

237.69

112.17

173.70

171.56

Inventory - Land with planning

 

724.99

774.68

920.78

1041.79

919.93

0.00

Inventory - Work in Progress

 

370.91

386.57

497.71

429.32

452.03

1234.37

Inventory - other

 

37.82

42.11

44.79

36.84

35.41

58.75

 

 

 

 

 

 

 

 

Net Capital

 

989.11

1021.80

1238.77

1147.99

1077.20

967.68

ROIC

 

5%

4%

15%

22%

22%

24%

 

Earnings:

 

Earnings are driven by number of houses sold and average selling price.  The main cost affecting margins is the price of land.  Working off the expensive inventory has put pressure on margins along with a decline in volume.  Construction costs have been steady to down over the past few years and the company does not see labour costs being a factor for the next few years.  Although materials prices have been volatile this is only a small portion of overall costs.

 

The targeted gross margin is 20-25% and should be achievable by 2012-2013.  Operating margins should also start climbing back to their longer term average of about 15%. 

 

Important to note in the cost of goods sold is a 20% non-cash charge for land repurchases.  Think of this more as maintenance cap-ex.  According to the company, 20% of the sales number is allocated to keeping the land bank topped up.  Spending/investing anything less than this amount generates after tax cash.

 

 

2011E

H1 2011

FY 2010

FY 2009

FY 2008

FY 2007

FY 2006

 

 

 

 

 

 

 

 

Units Sold

4922

2332

4595

4380

6556

7638

7117

Avg Price

175000

168428

163175

154005

169729

173300

169000

 

 

 

 

 

 

 

 

Turnover

865.00

407.90

768.34

683.81

1149.54

1354.02

1240.19

 Cost of sales

 

357.50

678.55

596.68

774.84

1042.10

947.92

Gross Profit

 

50.40

89.79

87.13

374.70

311.92

292.27

Gross Margin

 

12%

12%

13%

33%

23%

24%

Operating Expenses

 

22.30

38.72

41.55

189.53

59.18

54.08

Operating profit (loss)

73.53

28.10

51.07

45.58

185.18

252.74

238.19

Operating Margin

9%

7%

7%

7%

16%

19%

19%

 Interest Expense

-7.00

-4.10

9.10

20.71

22.68

22.96

21.34

 Net Non-Op Losses (Gains)

0.00

0.00

-2.47

61.42

127.73

-5.07

-3.86

Pretax Income

66.53

24.00

44.43

-36.55

34.76

234.85

220.71

Income Tax Expense

15.30

-5.50

8.62

-9.11

7.76

68.14

64.97

Income Before XO Items

51.22

18.50

35.81

-27.44

27.00

166.71

155.74

Net profit (loss)

 

 

35.81

-27.44

27.00

166.71

155.74

 

Valuation:

As we mentioned at the start the numbers look better about 12% lower when we starting writing.

 

Enterprise value:  £832mm

Expected 2011 EBIT:  £74mm

 

Current Earnings:  suggests an EV/EBIT of about 11.25x

Assuming a modest 3% growth in sales (mortgage market improvements, gain market share) and slow return in margins could see 2011-12 EBIT around £90mm (9.24x) and 2012-13 close to £110mm (7.56x)

 

Valuing BWY from its balance sheet:

TBV:  £1040mm or about 25% from current market value.

If we discount the inventory 20% for liquidity then TBV= £840mm or at market value.

 

Looking at the business in run-off:

If we assume things don't get much better for the company and sales and margins stay flat, given their current land bank they would have about 7 years of operations.  Since there is no investment in land, all cash is returned to the owners. 

 

Using the expected final numbers for this year, after tax profits should be around £50mm; add back the 20% of sales for land purchases, £173mm, and total after tax cash for this year is about £223mm.  Discounting that number for the next seven years (starting with 3% ending with 9%) and the present value of running off the business (and paying down debt) is conservatively about £1.1bln or 32% above current market value.

 

Conclusion:

 

Obviously getting Bellway 12% cheaper makes the investment more compelling but even from current levels it's a good story.  There is a strong argument that housing completions are at the low end of the cycle and government assistance and recent changes to the planning are going to improve home builder's circumstances.  Bellway is considered in the better part of the market, building more affordable homes, especially when incomes are stagnant.  Under normal conditions, margins are likely to improve as old stock is sold off and better margined plots are developed.  Bellway has been better than the rest managing their inventory and should see margin improvement ahead of the competition.  Their management has done a good job through the crisis and this has translated into market share.

 

Outside of the crisis the company has been able to produce a solid ROIC averaging 25% for 10yrs  pre-2008 and 20% for 10yrs including 2008-2010.

 

The company's balance sheet is clean, with minimal use of debt.  The assets are verifiable but even discounting the current stock by 20% still produces value.  In the extreme scenario where someone buys the company to run it down a 32% after tax return could be achieved.

Catalyst

- earnings October 18, 2011
- general economic improvement
    sort by   Expand   New

    Description

     

    The markets being what they are these days have made the entry point on this investment about 12% worse off than when we started writing (i.e. four days ago!).  Given the volatility I'm sure anyone watching BWY will get another crack at a decent price point.  Having said that, we believe Bellway represents a compelling investment opportunity with a good margin of safety and solid upside. 

     

    Description:

    Bellway is the 4th largest homebuilder in the UK, headquartered in Newcastle Upon Tyne, employing close to 1,400 people, with activities in:  land acquisition, finance, planning, architecture, design, build management, marketing and customer service.  They have been in business for over 50 years and have operations that span across England, Scotland and Wales.  Bellway's operations focus on the mid to lower end of the housing market.  This year Bellway's average selling prices was around £175k versus the national average price of £161k. 

     

    Management:

    The main executives are:

    John Watson, CEO - joined Bellway in 1978, CEO since 1999 (compensation 2010:  £1,091,148, 2009: £799,646, 228,674 shares owned)

    Alistair Leitch, CFO - joined Bellway in 1981, CFO since 2002, due to retire at the end of 2011 (compensation 2010 £717,397, 2009: 527,725, 148,638 shared owned)

     

    Total employee options outstanding:  1,682,152 w/a weighted average strike of £6.81 and 3.5yr duration.

     

    Background:

    The UK housing market, outside of London, has suffered similar price and activity declines as other western markets; not from overbuilding (excluding Ireland) but from accessibility to mortgages and interest rates.

     

    Historically the largest impact on housing activity in the UK has come from (in order of importance):

    • Interest rates
    • Government policy
    • Overall debt levels
    • Access to funding
    • Income growth
    • Demographic trends

     

    Currently access to funding is the greatest impediment to housing activity and we would expect this to continue despite government efforts to re-start the mortgage market.

     

    As mentioned, overbuilding outside of Ireland has not been a factor in this housing crisis. In fact there is an on- going debate in the UK about the shortage of housing required to meet the current and forecasted number of households.  The table below shows housing production peaked in 1968 and has been on a steady decline since.  Leaving aside the current shortage of housing stock for a moment, private and public studies indicate that at current trend the UK is expected to create over 6m households in the next 20 years.  Should this number be accurate that translates into a need of approximately 3.6 million dwellings (houses and flats) or a build rate of close to 200,000 new dwellings a year.  Trend projection has never been reliable so we discounted the current studies by 20% for conservatism which puts the need at about 160,000 dwellings a year.   If we use the historical stock numbers, 82% of these dwellings (130,000) should translate into private homes each year going forward.  The current situation exacerbates the supply/demand problem as estimates suggest the UK (mainly England) has been undersupplied by 35,000-85,000 suitable dwellings a year since 1996. 

     

    There is always going to be some debate over forecasts and numbers. What we are trying to illustrate is that the current run rate of around 130,000 dwellings is close to a trough level (and is the lowest level since 1954 for private enterprise) and there is a sustainable model of house building in the UK for the foreseeable future.

     

    Completions per year

     

     

     

     

     

    Number of dwellings

     

     

     

     

     

    Private
    Enterprise

    Housing Associations

    Local
    Authorities

    All
    Dwellings

    Population (000,000's)

    Households (000's)

    1946

     

     

    ..

    ..

    ..

    ..

     

     

    1947

     

     

    ..

    ..

    ..

    ..

     

     

    1948

     

     

    ..

    ..

    ..

    ..

     

     

    1949

     

     

    28,460

    8,020

    168,780

    205,260

     

     

    1950

     

     

    30,240

    7,290

    167,900

    205,430

     

     

    1951

     

     

    25,490

    7,350

    169,020

    201,860

     

     

    1952

     

     

    36,670

    10,130

    201,520

    248,320

     

     

    1953

     

     

    64,870

    16,800

    245,160

    326,820

     

     

    1954

     

     

    92,420

    22,120

    239,580

    354,130

     

     

    1955

     

     

    116,090

    12,850

    195,480

    324,420

     

     

    1956

     

     

    126,430

    9,850

    171,390

    307,670

     

     

    1957

     

     

    128,780

    8,520

    170,290

    307,590

     

     

    1958

     

     

    130,220

    8,220

    140,200

    278,630

     

     

    1959

     

     

    153,170

    6,520

    121,880

    281,570

     

     

    1960

     

     

    171,410

    7,240

    125,620

    304,260

     

     

    1961

     

     

    180,730

    6,320

    116,140

    303,190

     

    16,662

    1962

     

     

    178,210

    6,030

    129,410

    313,640

     

    ..

    1963

     

     

    177,790

    7,550

    122,380

    307,710

     

    ..

    1964

     

     

    221,260

    9,790

    152,140

    383,190

     

    ..

    1965

     

     

    217,160

    12,360

    161,710

    391,230

     

    ..

    1966

     

     

    208,650

    14,890

    172,470

    396,010

     

    ..

    1967

     

     

    204,210

    15,070

    196,180

    415,460

     

    ..

    1968

     

     

    226,070

    15,320

    184,450

    425,830

     

    ..

    1969

     

     

    185,920

    16,660

    175,750

    378,330

     

    ..

    1970

     

     

    174,340

    15,210

    172,670

    362,230

     

    ..

    1971

     

     

    196,310

    16,490

    151,670

    364,480

     

    19,027

    1972

     

     

    200,760

    11,220

    118,960

    330,940

     

    ..

    1973

     

     

    191,080

    12,130

    101,430

    304,640

     

    ..

    1974

     

     

    145,230

    13,870

    120,540

    279,630

     

    ..

    1975

     

     

    154,600

    22,050

    145,360

    322,000

     

    ..

    1976

     

     

    155,300

    23,100

    146,440

    324,840

     

    ..

    1977

     

     

    143,970

    30,650

    139,540

    314,160

     

    ..

    1978

     

     

    152,230

    26,290

    110,170

    288,690

     

    ..

    1979

     

     

    144,120

    21,390

    86,320

    251,820

     

    ..

    1980

     

     

    131,990

    21,480

    88,530

    242,000

     

    ..

    1981

     

     

    118,590

    19,700

    68,330

    206,630

     

    20,727

    1982

     

     

    129,020

    13,740

    40,090

    182,850

     

    ..

    1983

     

     

    153,040

    16,820

    39,170

    209,030

     

    ..

    1984

     

     

    165,560

    17,290

    37,570

    220,410

     

    ..

    1985

     

     

    163,400

    13,650

    30,420

    207,470

     

    ..

    1986

     

     

    178,010

    13,160

    25,380

    216,540

     

    ..

    1987

     

     

    191,250

    13,150

    21,830

    226,230

     

    ..

    1988

     

     

    207,420

    13,490

    21,450

    242,360

     

    ..

    1989

     

     

    187,540

    14,600

    19,320

    221,460

     

    ..

    1990

     

     

    167,470

    18,050

    17,710

    203,230

     

    ..

    1991

     

     

    159,510

    20,870

    11,060

    191,450

     

    22,863

    1992

     

     

    147,350

    26,670

    5,670

    179,690

     

    ..

    1993

     

     

    146,700

    36,000

    3,370

    186,070

     

    ..

    1994

     

     

    153,920

    37,170

    2,880

    193,970

     

    ..

    1995

     

     

    157,440

    39,040

    3,440

    199,930

     

    ..

    1996

     

     

    154,410

    33,100

    1,760

    189,270

     

    ..

    1997

     

     

    161,230

    28,340

    1,540

    191,110

     

    ..

    1998

     

     

    155,830

    24,100

    1,100

    181,020

     

    ..

    1999

     

     

    157,930

    23,730

    330

    181,990

     

    ..

    2000

     

     

    154,580

    21,990

    280

    176,850

     

    ..

    2001

     

     

    152,650

    21,080

    360

    174,080

     

    24,557

    2002

     

     

    162,770

    18,940

    250

    181,960

     

    ..

    2003

     

     

    172,620

    17,620

    250

    190,490

     

    ..

    2004

     

     

    182,700

    20,660

    130

    203,490

     

    ..

    2005

     

     

    185,850

    23,490

    240

    209,580

     

    ..

    2006

     

     

    186,510

    26,000

    290

    212,800

     

    25,579

    2007

     

     

    197,460

    27,590

    280

    225,330

     

    ..

    2008

     

     

    150,870

    31,470

    630

    182,960

    61.4

    26,048

    2009

     

     

    118,190

    33,630

    810

    152,630

     

     

    2010

     

     

    103,960

    28,790

    1,320

    134,080

     

     

    2013

     

     

     

     

     

     

    63.5

    27,407

    2018

     

     

     

     

     

     

    65.6

    28,870

    2023

     

     

     

     

     

     

    67.8

    30,284

    2028

     

     

     

     

     

     

    69.8

    31,621

    2033

     

     

     

     

     

     

    71.6

    32,849

     

    One of the main reasons why housing development has slowed, besides mortgage accessibility, is due to the complex planning laws across the UK.  Until about 5 weeks ago it could take up to 4 years (if ever) to get permission for a site; now the new draft national planning policy framework  (published in July) will streamline more than 1,000 pages of policy to just 52.  Among its "core principles" it says that those making decisions about planning applications "should assume that the default answer to development proposals is 'yes' except where this would compromise the key sustainable development principles set out".  This is important legislation as its turns around the guilty until proven innocent bias.

     

    Competition:

     

    There are about 5,500 home builders in the UK; The top 10 national homebuilders account for about 45% of all new dwellings, with the top 25 building 65% of the new dwelling each year.  Bellway is currently ranked the 4th largest with about 5% market share; this has gradually increased from their first appearance in the top ten back in 1995.  Bellway seems to pick up market share during periods of distress due to their unlevered balance sheet.

     

     

     

    Top ten UK homebuilders:

     

    1.       Taylor Wimpey

    2.       Persimmon

    3.       Barratt

    4.       Bellway

    5.       Berkeley Group

    6.       Redrow

    7.       Miller

    8.       Crest Nicholson

    9.       Gadedale

    10.   Bovis

     

    Barriers to entry:

     

    Along with the normal barriers associated with product differentiation, scale and branding the following are the biggest hurdles in the market:

     

    Entry and Expansion - it's relatively easy to enter the homebuilding market but difficult to reach critical mass and stay among the top ten, where scale provides benefits.  Over the past 25 years only two builders have remained in the top ten - excessive leverage has had the greatest effect on the survival rate of homebuilders during booms and busts.

     

    Land - acquisition of land and a quality land bank is crucial in the UK market; both take time and capital. 

     

    Financing - access to capital is a main barrier to a firm's entry and survival.  Many of the UK firms operate on a highly levered basis making them vulnerable in downturns.

     

    Knowledge - local knowledge and relationships take time to establish; even with a large amount of capital this barrier makes it difficult for foreign entry and expansion.

     

    Regulatory - federal and regional regulatory requirements take time and on average add up to about 10% of the development costs.

     

    Business Model:

     

    The standard model for most UK homebuilders, including Bellway, is to start with the required profit margin and reverse out the costs to determine affordability of land and project development.

     

    For example; from the per unit sales price most homebuilders target a profit margin of 20-25%;

    Less:  10% cost of regulation

    Less:  35% build costs, infrastructure etc (including funding)

    Less:  30% land value

     

    Bellway uses a capital allocation model where projects are presented by the various regional directors to head office, with the best prospects for return (after clearing the 20% hurdle) being funded.  Management ability to assure conservative unit pricing and costs is essential in maintaining margins.  Except for '09 and '10, where margins were compressed due to the crisis, we found CEO Watson and CFO Leitch to both be very disciplined operators.

     

    Balance Sheet:

     

    Bellway has a clean balance sheet with minimal use of debt.  Management is generally averse to borrowing but will use it when outstanding opportunities arise.  Under normal conditions they have the ability to replenish the land bank with cash generated.  They did raise equity in '09, when debt wasn't available, to take advantage of cheap land prices.

     

    Inventory (land bank) is the main asset and provides the margin of safety to the investment.  It's made up of five parts:  Land with planning, pending planning, work in progress, show homes and part exchange.  Land with planning and work in progress represent 90% of the inventory value.  In order to establish its credibility we spoke with industry competitors and independent evaluators and from what we have been told it is fairly marked to market.  To be conservative we still apply a 20% discount for liquidity.  In 2008 they wrote down the inventory by £131mm (about 8%) and another £66.3mm in 2009 (approx. 5%).  The other important component is the site mix (age of stock) and this is where BWY has an advantage over competitors.  According to the company most of the '05-'07 lower margin stock will be sold off by 2012-13 and the site mix will have over 50% of plots generating in excess of 20% margins.

     

     

    H1 2011

    FY 2010

    FY 2009

    FY 2008

    FY 2007

    FY 2006

    FY 2005

     

     

     

     

     

     

     

     

    Assets

     

     

     

     

     

     

     

    Cash & Near Cash Items

    93.30

    145.69

    43.21

    109.31

    25.38

    2.33

    66.44

    Accounts & Notes Receivable

    50.60

    13.00

    11.03

    13.64

    15.95

    12.08

    16.96

    Inventories

    1190.50

    1148.71

    1211.35

    1503.94

    1537.87

    1434.00

    1246.43

    Other Current Assets

     

    32.80

    40.56

    40.85

    29.30

    14.42

    20.12

    Total Current Assets

    1334.40

    1340.20

    1306.16

    1667.75

    1608.51

    1462.83

    1349.95

     LT Investments & LT Receivables

    7.80

    7.72

    0.00

    0.00

    0.00

    0.00

    0.00

     Gross Fixed Assets

     

    20.87

    28.72

    29.11

    27.53

    27.12

    29.22

     Accumulated Depreciation

     

    12.66

    13.09

    13.46

    12.45

    11.65

    11.59

    Net Fixed Assets

    8.70

    8.22

    15.63

    15.65

    15.09

    15.46

    17.63

     Other Long-Term Assets

    39.90

    36.36

    28.15

    13.60

    13.03

    15.91

    13.48

    Total Long-Term Assets

    56.40

    52.29

    43.78

    29.26

    28.12

    31.37

    31.11

    Total Assets

    1390.80

    1392.49

    1349.94

    1697.00

    1636.62

    1494.20

    1381.06

     

     

     

     

     

     

     

     

    Liabilities & Shareholders' Equity

     

     

     

     

     

     

     

    Accounts Payable

    188.90

    116.71

    95.68

    112.27

    165.00

    180.77

    88.82

    Short-Term Borrowings

    20.00

    0.00

    0.00

    52.00

    60.55

    17.02

    2.00

     Other Short-Term Liabilities

    9.60

    111.79

    150.47

    172.63

    248.39

    198.23

    236.66

    Total Current Liabilities

    218.50

    228.49

    246.15

    336.90

    473.95

    396.03

    327.47

    Long-Term Borrowings

    100.00

    100.00

    100.00

    295.00

    77.00

    159.00

    236.00

     Other Long-Term Liabilities

    25.50

    29.20

    38.78

    64.02

    49.86

    35.67

    21.47

    Total Long-Term Liabilities

    125.50

    129.20

    138.78

    359.02

    126.86

    194.67

    257.47

    Total Liabilities

    344.00

    357.70

    384.93

    695.92

    600.81

    590.70

    584.94

     Total Preferred Equity

    0.00

    0.00

    0.00

    0.00

    0.00

    0.00

    20.00

    Minority Interest

    -0.07

    -0.07

    -0.07

    -0.07

    -0.07

    -0.07

    -0.07

    Share Capital & APIC

    177.27

    175.67

    131.57

    131.30

    129.82

    126.16

    123.04

    Retained Earnings & Other Equity

    869.60

    859.20

    833.51

    869.85

    906.06

    777.41

    653.14

    Total Equity

    1046.80

    1034.80

    965.01

    1001.08

    1035.81

    903.50

    796.12

    Total Liabilities & Equity

    1390.80

    1392.49

    1349.94

    1697.00

    1636.62

    1494.20

    1381.06

     

     

     

     

     

     

     

     

    Net Debt

    26.70

    -45.69

    56.79

    237.69

    112.17

    173.70

    171.56

    Inventory - Land with planning

     

    724.99

    774.68

    920.78

    1041.79

    919.93

    0.00

    Inventory - Work in Progress

     

    370.91

    386.57

    497.71

    429.32

    452.03

    1234.37

    Inventory - other

     

    37.82

    42.11

    44.79

    36.84

    35.41

    58.75

     

     

     

     

     

     

     

     

    Net Capital

     

    989.11

    1021.80

    1238.77

    1147.99

    1077.20

    967.68

    ROIC

     

    5%

    4%

    15%

    22%

    22%

    24%

     

    Earnings:

     

    Earnings are driven by number of houses sold and average selling price.  The main cost affecting margins is the price of land.  Working off the expensive inventory has put pressure on margins along with a decline in volume.  Construction costs have been steady to down over the past few years and the company does not see labour costs being a factor for the next few years.  Although materials prices have been volatile this is only a small portion of overall costs.

     

    The targeted gross margin is 20-25% and should be achievable by 2012-2013.  Operating margins should also start climbing back to their longer term average of about 15%. 

     

    Important to note in the cost of goods sold is a 20% non-cash charge for land repurchases.  Think of this more as maintenance cap-ex.  According to the company, 20% of the sales number is allocated to keeping the land bank topped up.  Spending/investing anything less than this amount generates after tax cash.

     

     

    2011E

    H1 2011

    FY 2010

    FY 2009

    FY 2008

    FY 2007

    FY 2006

     

     

     

     

     

     

     

     

    Units Sold

    4922

    2332

    4595

    4380

    6556

    7638

    7117

    Avg Price

    175000

    168428

    163175

    154005

    169729

    173300

    169000

     

     

     

     

     

     

     

     

    Turnover

    865.00

    407.90

    768.34

    683.81

    1149.54

    1354.02

    1240.19

     Cost of sales

     

    357.50

    678.55

    596.68

    774.84

    1042.10

    947.92

    Gross Profit

     

    50.40

    89.79

    87.13

    374.70

    311.92

    292.27

    Gross Margin

     

    12%

    12%

    13%

    33%

    23%

    24%

    Operating Expenses

     

    22.30

    38.72

    41.55

    189.53

    59.18

    54.08

    Operating profit (loss)

    73.53

    28.10

    51.07

    45.58

    185.18

    252.74

    238.19

    Operating Margin

    9%

    7%

    7%

    7%

    16%

    19%

    19%

     Interest Expense

    -7.00

    -4.10

    9.10

    20.71

    22.68

    22.96

    21.34

     Net Non-Op Losses (Gains)

    0.00

    0.00

    -2.47

    61.42

    127.73

    -5.07

    -3.86

    Pretax Income

    66.53

    24.00

    44.43

    -36.55

    34.76

    234.85

    220.71

    Income Tax Expense

    15.30

    -5.50

    8.62

    -9.11

    7.76

    68.14

    64.97

    Income Before XO Items

    51.22

    18.50

    35.81

    -27.44

    27.00

    166.71

    155.74

    Net profit (loss)

     

     

    35.81

    -27.44

    27.00

    166.71

    155.74

     

    Valuation:

    As we mentioned at the start the numbers look better about 12% lower when we starting writing.

     

    Enterprise value:  £832mm

    Expected 2011 EBIT:  £74mm

     

    Current Earnings:  suggests an EV/EBIT of about 11.25x

    Assuming a modest 3% growth in sales (mortgage market improvements, gain market share) and slow return in margins could see 2011-12 EBIT around £90mm (9.24x) and 2012-13 close to £110mm (7.56x)

     

    Valuing BWY from its balance sheet:

    TBV:  £1040mm or about 25% from current market value.

    If we discount the inventory 20% for liquidity then TBV= £840mm or at market value.

     

    Looking at the business in run-off:

    If we assume things don't get much better for the company and sales and margins stay flat, given their current land bank they would have about 7 years of operations.  Since there is no investment in land, all cash is returned to the owners. 

     

    Using the expected final numbers for this year, after tax profits should be around £50mm; add back the 20% of sales for land purchases, £173mm, and total after tax cash for this year is about £223mm.  Discounting that number for the next seven years (starting with 3% ending with 9%) and the present value of running off the business (and paying down debt) is conservatively about £1.1bln or 32% above current market value.

     

    Conclusion:

     

    Obviously getting Bellway 12% cheaper makes the investment more compelling but even from current levels it's a good story.  There is a strong argument that housing completions are at the low end of the cycle and government assistance and recent changes to the planning are going to improve home builder's circumstances.  Bellway is considered in the better part of the market, building more affordable homes, especially when incomes are stagnant.  Under normal conditions, margins are likely to improve as old stock is sold off and better margined plots are developed.  Bellway has been better than the rest managing their inventory and should see margin improvement ahead of the competition.  Their management has done a good job through the crisis and this has translated into market share.

     

    Outside of the crisis the company has been able to produce a solid ROIC averaging 25% for 10yrs  pre-2008 and 20% for 10yrs including 2008-2010.

     

    The company's balance sheet is clean, with minimal use of debt.  The assets are verifiable but even discounting the current stock by 20% still produces value.  In the extreme scenario where someone buys the company to run it down a 32% after tax return could be achieved.

    Catalyst

    - earnings October 18, 2011
    - general economic improvement

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