Jan 232013

Unscrupulous expertise breeds everywhere accuracy cannot be properly measured. Investment management is not immune. But at least it has one impartial yardstick: performance. Or, as Dylan Grice – Albert Edwards’ partner, who recently joined an investment firm – puts it: “After three years of trying to sound clever, it’s time for me to do something altogether more difficult, and actually be clever.”

Investment can be a rewarding endeavour. From yesterday’s Financial Times:

Although housebuilders were badly affected during the financial crisis – with smaller companies going bust and listed groups forced to raise more cash and write down land values – they were also able to exploit falling prices to buy land cheaply.

According to Knight Frank, land prices fell by as much as 60 per cent from the peak of the boom in 2007 to the end of 2009. It prompted many to gamble on a recovery.

Galliford Try, for example, raised almost £120m to buy land at distressed prices.

The bets have paid off. Even so, housebuilders have stayed focused on profitability rather than sales. They have built more lucrative family homes rather than apartments, targeted London and the southeast, and built on land bought at the lowest prices.

That has delivered sharp growth in margins: from about 9 per cent to 11 per cent last year.

They continue to buy land, as well. Barratt, for example, is buying at its fastest rate ever. Between them, the listed housebuilders have an average of five years’ worth of land in their banks.

And a few days ago:

[Barratt]’s focus on London helped to drive average selling prices 2.1 per cent higher to £185,000 in the six months to December 31, encouraging Barratt to forecast a more than doubling of interim pre-tax profit to £45m, up from £21.6m in the same period a year ago.

Operating margin for the half is expected to be 8.4 per cent – up from 6.4 per cent a year ago – as a result of sales on land bought cheaply in the wake of the financial crisis.

From my October 2012 presentation on Barratt at the European Investment Summit on valueconferences.com:

Barratt has been producing double digit EBIT margins for many years. They collapsed to 1.3% in 2008 but since then there has been a steady recovery, which has some more way to go. Over the last four years, the company has been buying land at cheap prices (-40% in 2008-2010). Profitability is being restored even at stable house prices. More than half of homes sold this year have been built on land bought after 2008, thereby ensuring restored profitability as the market recovers. And recover it will, as demographics clearly play in its favour. There has been an increasing gap between household formation (250,000 per year) and house construction (120,000) which is bound to be reabsorbed.

Return on capital has had a similar recovery. Most of the company’s assets consist of what they call Inventory, which is land under development and work in progress. The rest is basically the goodwill of the Wilson Bowden acquisition. Return on Capital (measured as EBIT/Equity) has been steadily returning to double digit.

The company’s Book Value per share is currently around 3, and 2.2 if you strip intangibles. At the current price there is still more than a 40% discount on book, versus a historical 40% premium.

Moreover, I calculate normalized Earnings per share at 40 pence (currently 7 pence) and I don’t see any reason why this company should not be at least at 10 times earnings. So in both ways I converge towards a full valuation at around 4 pounds, which is still a long way to go.

The stock was then at 1.70. It closed the year at 2.08, up 123% in 2012. It is today at 2.20.

A successful investment rewards the caput as well as the capital.

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