Barratt aims to build at higher margins over medium-term

Barratt Developments aims to build 3-5% more houses over coming years and at higher margins in line with the rest of the sector thanks to new housing designs that are faster to build and reduce costs and waste.

The UK's largest housebuilder provided three new medium-term targets for investors alongside final results that were in line with detailed recent guidance, with profit before tax up 9.2% to £835.5m and earnings per share rising 8.5% to 66.5p in the year to 30 June.

Barratt said it would now only acquire land when it could guarantee a "minimum 23%" gross margin, increased from the previous "minimum 20%", and would now aim for a minimum 25% return on capital employed.

After delivering the company's highest volume of new homes in a decade, chief executive David Thomas said the management team's focus on operating efficiencies and margin initiatives was "starting to deliver", with a gross margin rising to 20.7% in the year from 20.0% last time, and said the new medium-term operational targets were "reflecting our confidence in the business going forward".

However, with other house builders targeting around 24% gross margins, analyst Robin Hardy at stockbroker Shore Capital said it had been "a mystery" as to why Barratt aimed lower and had seemed unwilling to change. He said it will take at least three years before the new target works through and is "unlikely to have any material impact before FY2021 by which point the new homes market could be a very different place", especially if there are major changes to the government's Help to Buy as recent reports have suggested.

Barratt's unit sales growth target of 3-5% was up from a previous 2-3%, but Hardy suggested this could be somewhat of an empty promise as the company had not been hitting its previous target and "had barely grown its private development sales across the last three years".

After completing 28.7% more houses over the last five years, with 17,579 units delivered in 2018, the FTSE 100 group has capacity to grow to 20,000 annual completions under the current operational structure.

Barratt said volumes and margins will be boosted by new housing ranges that "maintain our high standards of design whilst being faster to build", which are currently under construction at 101 sites and will be rolled out 86 more sites and "will increasingly benefit margin going forward".

The board proposed to pay a final ordinary dividend of 17.9p that gives a total for the year of 26.5p per share, up from 24.4p the year before.

Net cash balance of £791.3m (2017: £723.7m), ahead of expectations, driven by strong year end trading, and the new year to June 2019 is expected to end with net cash around £550m.

Thomas said the group started the new financial year "in a good position with a strong balance sheet, healthy forward sales and robust consumer demand supported by a positive mortgage environment".

However, while average selling prices increased 5.0% to £288,000 last year, they are expected to fall in the coming year due to the softer London market.

The first two months of the new financial year have seen net private reservations per active outlet per average week in line with the prior year at 0.75 versus 0.74, with forward sales up 11.1% as of 2 September at £3,054.0m.

Forward sales of the core private developments, however, were down 4.2% with all of the increase coming from affordable housing and joint ventures.

Shares in Barratt were searching for direction in early trading on Wednesday at 535.4p, having fallen more than 16% in the year to date and not too far off a quarter from highs late last year.

Analyst Neil Wilson at Markets.com noted that while ROCE 29.6% is a shade lower than 29.8% reported this time a year ago, it has risen markedly to almost 30% from 11.5% five years ago and is still well above the 25% target.

"Housebuilders have come off their highs on expected slower growth but the results we’ve seen so far from Redrow, Persimmon and Barratt don’t really back that up," Wilson said, with Barratt continuing to trade at something of a discount to peers on around 8 times forward earnings.

"But with a healthy dividend there to be had, there is yet some upside potential, albeit there may be softness today as the figures were well flagged back in July. You can look to risks to the investment thesis from various angles – not least a radical rethink of housing strategy - but past performance by successive governments over the last 40 years doesn’t indicate we’ll see any real shift that should worry investors unduly. However, the risk of a Labour-led government overhauling the sector is a consideration and is reflected in the discount we see applied to the sector."

Peel Hunt pointed out that shares have fallen in line with the sector in 2018 there are only down 4% in the last three months versus a 13% drop for the sector, to now trade on a price-NAV ratio of 1.43x for the current calendar year and 1.34x for 2019 - 10-15% less than the sector average, with a dividend yield, including special payouts, of 8.3% and 8.7% respectively.

"Given the likely upward pressure on forecasts we continue to think the shares look good value," analysts said, retaining their 'buy' recommendation.

Liberum said the gross margins target of 23% would generate an operating margin of 20% compared to the 18% reported for 2018, closing the gap to the sector making 22%. The broker said the new targets were "encouraging" but kept its 'hold' rating.