Description

Overview

Bellway is a well-managed and conservative UK homebuilder that has earned an average ROE over the last 20 years of 14%, which includes the GFC, COVID shutdowns, and the recent large safety charges that were faced by the industry. Bellway did this with a very conservative balance sheet with minimal gearing. Due to downturn in the housing market, inflating build costs, and the fear of the impact of high mortgage rates, Bellway trades at 0.72x P/B today compared with an average valuation of 1.43x over the last 10-years. We believe Bellway’s shares have the potential to triple over the next four years due to capital returns, retained earnings and a revaluation back to 1.43x P/B.

What Has Changed

LDMR wrote up Bellway in 2020 and 2022 and the pitches give a good overview of the company, industry and history. This pitch will focus on what has changed since their latest submission in October 2022 and one other industry observation.

Buybacks

Bellway announced its first buyback program on March 28, 2023 for £100m. This buyback plans to repurchase ~4% of shares outstanding over eight months (and has already bought back 2.9%). The average valuation since the buyback was announced has been 0.78x P/B making this buyback accretive to book value per share and intrinsic value per share. We think the buyback is an excellent use of capital as Bellway can buy their existing land and housing inventory at a 25% discount to what they paid for it. Lastly, we think it is a strong sign that management is shareholder friendly.

Time to See What Rates Would Do

A big fear in October 2022 was the unknown of how rising mortgage rates would impact the housing market. In the UK, the consumer gets a mortgage approval and typically locks in rates for 6 months while they shop for their home. In October 2022, the 5-year fixed rate mortgage at 75% LTV hit a rate of 5.6%, up from 1.3% just a year earlier. Many predicted scary outcomes but now 10 months have passed, the rate lock periods are over, and the outcome is rather benign. The house price index is down about 3% with all of that occurring from September 2022 to January 2023 and the index has been stable since. I think it’s safe to conclude the short-term impact of rising rates wasn’t nearly as scary as predicted.

Industry Behavior

We think it is also worth commenting on industry behavior. Supply in a few years depends on what the industry is doing now. Since October 2022, we have had the chance to see how the industry is reacting. We think the industry is behaving very rationally with many peers implementing share buybacks instead of expanding operations. Bellway reduced its purchases of new land by 72% in their last half year report. This is representative of industry behavior and Taylor Wimpey reduced its purchases of land by 80%, Crest Nicholson by 30%, and Persimmon by 63% in their last half year. While this industry behavior doesn’t solve the immediate problems, it does improve the chances of a better outcome in 2-3 years.

Financial Crisis

We think there is a recency bias to the GFC due to just how painful it was for homebuilders. We think those fears are unfounded and biased. But even if you think this will be just as bad as the GFC, part of the reason the stocks did so poorly is the high initial prices. Bellway traded as high as 2x P/B in early 2007. If at that peak moment, you could have instead bought Bellway at 0.72x P/B, you would have actually done just fine and been in the black on your investment just two years later in 2009. The low current valuation provides a significant margin of safety.

More importantly we think the comparisons are unfounded. The financial crisis was preceded by loose lending and a buildup of excess homes. Both of which are materially different today. The lending in the UK was never as bad as in the US and subsequently the UK did not have as significant a housing price decline as the US. We look at Lloyds Banking Group as a proxy for the UK and see that today 5% of their mortgages have LTVs of 80-90% and only 1% are greater than 90% as of 2022. This compares to 12% and 5% in 2007. In addition, the percentage of homes that are vacant homes in the UK has declined 21% from 2007 to 2022, leaving the housing market in a tighter position today.

Catalyst

Dividends (6.8% yield) and buybacks

Time

Stabilizing rates and housing market