Weekly Market Commentary | 16/04/2024 | SDY, NXR | As Safe as Houses

This week Jamie talks about the economics of the UK housing market and why he thinks that the house builders’ apparent cheapness is an illusion. He then discusses what he believes are better ways to invest in housing construction and rounds off by reviewing the trading updates of two companies, whose fortune is somewhat determined by the state of UK house building.

It was a quiet week on the market with little in the way of releases to get the heart racing. Probably the most interesting thing was the total eclipse on Monday in the US. Once again, the use of Google Trends (more on that next week) provided a unique insight with an enormous spike in the number of people searching for the phrase ‘eyes hurt’ in the hours following the eclipse. Perhaps one day people will listen when you tell them to not to look directly at the sun. I wouldn’t count on it though. I’m sure there is something deep to be said about the psychology of markets and why human nature will always lead us to folly and therefore occasional economic crises. But that can be for another time.

On the Economics of House Building

Apparently, the phrase ‘as safe as houses’ dates back to the mid-19th century during the railway boom. Starting in around 1830, there were a series of railway companies formed. The Liverpool & Manchester Railway was the first and very successful financially given that it substantially lowered the cost of transportation between those two cities. By 1840, there were several new railway companies formed with the government of the day quickly authorising the construction of 10,000km of new lines. What followed was a bubble as capital flooded to these new companies with investors hoping to repeat the success of the first endeavour. A speculative fervour ensued leading to too much capital pursuing too few gains. The classic bubble.

In the aftermath when much money had been lost, there was a return to more sedate forms of investments. Particularly popular were those in ‘bricks and mortar’ real estate because they were tangible and therefore the owner could at least see the investment. This was not the case for the shares of Nouveau railways companies, many of which didn’t even get around to building the train tracks that were promised. The most steady-eddy of all of these real estate investments were residential properties and hence the origin of the phrase ‘as safe as houses’.

280+ Dilapidated Cottage In England Stock Photos, Pictures & Royalty-Free  Images - iStock

For many years afterwards, however, the ownership of housing continued to be the preserve of the wealthy with the majority of people being some sort of tenant. Until the 1950s, the majority of people rented with less than 30% of houses described as ‘owner-occupier’. From then on, there was a relentless rise in owner-occupiers until it peaked in 2003 at just under 71%. Today in Britain, we are obsessed with housing. Since troughing in the mid-1990s, the values of residential property have been on an almost unbroken upward trajectory. In 1994, it was possible for most people to live anywhere. By which I don’t mean a shelf stacker at a supermarket could own a six-bedroom property in South Kensington, but rather that someone on an average wage could find and live in a property in just about any town in Britain.

Ten years later, it had become difficult for the ‘average’ person to live in many places in the South including virtually the entirety of the space inside the M25. A decade later, even high-paid graduates from working-class backgrounds had been rendered unable to buy much more than a one-bedroom flat in London, let alone a place to raise a family – I have personal experience of this one. Further out of London, more places had become unaffordable to the average person. As it stands today, a further ten years on, vast parts of the country are only affordable if the buyer has existing wealth or an income well above the average. So, you might think that the lot of the average person has deteriorated in the past thirty years.

For the house builders, much of this time has been a golden era. Normally, a house builder will buy parcels of land with the intention of building as much as seven years later. In effect, they sit on an asset, that has, for the most part, consistently appreciated in value for decades. It has always been very difficult to truly disaggregate what portion of house-building profitability comes from the appreciation of land values and what comes from value-added construction. Nonetheless, a good rule-of-thumb is that over very long periods of time, house building profitability can be summarised thus; an operating margin in the range of 10% to 15% and an asset turn of 1x to 1.5x. This gives a rough estimate of through-the-cycle return on capital employed of 15.5% with a low-end range of 10% and a high of 22.5%.

There are of course variances, for example, Berkeley Homes has typically sat closer to the top end of this range because its focus on brownfield has altered the economic dynamics slightly owing to the size of green belts in the UK. But removing financial analysis from the equation, common sense tells us that a company that regularly buys land builds on said land and then sells the newly constructed dwelling and land together shouldn’t be able to generate super-normal returns. I.e., a house builder should never be able to sustainably generate returns well in excess of its cost of capital.

However, over the past 15 years or so, the returns available to housebuilders has been perverted. Partly, this is because of the extremely low cost of debt owing to the corrupting nature of quantitative easing. Moreso however, I believe, Help-to-Buy was the culprit. Outwardly, it was intended to be a programme that gave potential new homeowners, the chance to buy a property without saving for the increasingly onerous deposit. It did so via an odd sort of debt called an equity loan whereby first-time buyers were given a loan that was proportional to the value of the property it was secured against. This meant that however minimal the cost of servicing the equity loan, the repayment would be subject to the changing value of the house. For example, a first-time buyer bought a £200,000 house; they do so with a £10,000 deposit, a £40,000 equity loan (i.e., 20%) via Help-to-Buy and a £150,000 mortgage. Five years later, they wish to sell the house, it is now worth £250,000, the mortgage has dwindled to £125,000 but the Help-to-Buy loan has remained fixed proportional to the value of the property (20%) and is now £50,000. Therefore, the help-to-buy loan has increased in size relative to the increase in the value of the house.

As mentioned, the intention was to give first-time buyers a leg up so that they may get on the property ladder. Nevertheless, there were other benefits extracted from an economic point of view. This benefit was created by ensuring that the Help-to-Buy loan was only available to first-time buyers buying a new-build house, not existing stock. The effect was that there was effectively a large number of forced buyers of new-build properties. Consider our example above; this person only had a deposit of £10,000 and was only allowed to borrow a maximum of £150,000. This meant that the most they could afford to spend on a house sans Help-to-Buy would be £160,000. Furthermore, were they to do so, they would have a loan to value on their mortgage of 1 – 10,000/160,000 = 93.75%. However, using Help-to-Buy, they could now afford a £200,000 house with the same mortgage and a loan-to-value of 1 – 50,000/200,000 = 75%. Not only could they afford to spend 25% more but the mortgage repayments were most probably lower because of the lower loan-to-deposit ratio. As a final kicker, the perception is often that a new-build property won’t need any work done to it (also often not actually true!).

This created a system where the premium that it was possible to charge for a new-build became elevated as a major cohort of buyers no longer considered purchasing existing housing stock. In turn, for a number of years, housebuilders were able to generate super-normal returns. Below is a chart of returns on capital employed of Persimmon, which I’m using as a proxy for House Building PLC. Recall from above that it states that over the very long-run, returns on capital in the sector should average out to around 15% (which feels about right). The chart shows that since bottoming in the Great Financial Crisis of 2008, the returns on capital employed in the sector spent around ten years higher than this, including a three-year stretch where c. 30% levels were enjoyed. That is a graphical representation of the effect of Help-to-Buy.

It wasn’t sustainable and is clattering back down. After years of being well above a sustainable level, it might be that we see returns stay well below for years to even things out. If that is the case, then the house building sector, which has been trading at much higher levels in recent years might not be anything better than fair value rather than cheap as some might be tempted to think given the declines.

There is a political imperative that could change this. Regardless of which party governs from Autumn this year, it is likely there will be a continued push towards house building since it creates an economic boon. Whatever flavour any stimulus takes, it might benefit the house builders but it is probably better at this point to invest in sectors that are ancillary to house builders, which benefit from the volume of house building more than the price of houses:

  • Suppliers of house builders can include the whole value range starting at aggregates such as those produced by Breedon (albeit as a business, Breedon is well exposed to infrastructure, which is a by-product of house building to a degree); brick manufacturers like Ibstock or Forterra; specialist parts such as from Polypipe; or full kitchens like from Howden Joinery.
  • Equipment rental businesses in particular are geared towards construction volumes since they exist to service excess demand and therefore generate good returns when construction is booming but poor returns when it is not. These include VP Group and Speedy Hire (q.v.).
  • Businesses that service the needs of the buyer include; estate agents such as Foxtons, or M Winkworths; banks of which Lloyds is probably the cleanest play, given its large mortgage book; and, retailers of durable consumer goods like Currys.

In summary, housebuilders have made too much money in the past. This was driven, as much as anything, by tacit support for the sector by the government disguised to help first-time buyers. They are probably not cheap despite the share price declines here. The caveat is that there is a widespread belief that there needs to be an increase in volumes of house building and it is possible that the government (of any colour) might do so in a way that benefits the major house builders. Nevertheless, you can also see value in areas that service house building as a sector. These areas are well exposed to a boost in house-building volumes. I have a preference for businesses that sell heavy, low-value goods at the start of the supply chain because the cost of transportation makes foreign competition unviable. I would suggest Forterra, Breedon, Ibstock and possibly Polypipe might also fit the bill.

This week, I look at two companies whose fortune is somewhat determined by the volume of house building, Speedy Hire and Norcros.

Speedy Hire, full-year trading update


Speedy Hire is an equipment rental business that was founded in Wigan in the late 70s. It followed a familiar path of a business that was small and well-managed operating in an underserved niche. Thereon it expanded by deploying ever more capital, opening new sites as a roll-out story. It has been listed a long time and to put it mildly capital returns have been lacklustre despite being a fair stock where you can derive an income.

As a business that services construction, it is unsurprisingly affected by the state of British construction. In the run-up to the Great Financial Crisis (GFC), it had a tremendous run. However, this was more a function of the construction boom generating a pronounced demand/supply imbalance in equipment rental. As is so often the case in economic factors, the supply of construction equipment rental rose to fulfil this demand. Next came the crisis and demand fell off a cliff. What was left was a supply glut. The performance of the business in the aftermath is reflective of this fact.

Trading update

It has been just two months since the last trading update from Speedy Hire. Last time, I lamented the style of update that saved the bad news until the last paragraph. This time, given that news was known, the company was rather more upfront about its travails and provided greater detail. The upshot was that the management expect full-year revenues and profits to be towards the bottom end of expectations. This is driven by a combination of softer-than-expected demand and higher cost inflation. There was a degree of positivity about the cash position, which had improved owing to in excess of £20m in free cash flow. However, I would caution about putting too much weight on this because working capital-intensive businesses like Speedy Hire tend to see cash drain during growth and cash increases during shrinkage. Therefore, the decent cash position is most likely a function of that, which is caused by fewer receivables on the balance sheet.

There was also a £2m exceptional loss because of the withdrawal of physical concessions at B&Q stores. The service to hire equipment will still be available at B&Q but will be solely available as a ‘digital hire’; meaning that B&Q no longer have equipment on site. This makes sense to me as a better way of doing it given that the digital-only model probably leverages Speedy Hire’s physical sites better than the old arrangement.

Opinion & Valuation

Speedy Hire is never going to be a sexy growth company, but management seem to be doing the right things. Ultimately, the success of the business will hinge on the construction industry and the house builders are probably a good proxy for this. Last time I wrote that it is cheap but that I wouldn’t be in a rush because, whilst the dividend yield means you are being paid to wait, it seems unlikely there will be much in the way of rerating without an improvement in the house building sector. Since that write-up, the shares have fallen a further 15%. It now looks to be pure value and, providing that this dividend is safe, and you are patient, I can see an argument for holding here. According to Sharepad, the PE ratio is now less than 5x earnings for two years out and the dividend, should it be paid, implies a 10% yield. There comes a point where you don’t need a full-on turnaround for an investment to make sense and, with Speedy Hire, we might be close.

The caveat here is if construction falls off even further from already depressed levels, where much of the equity market would seem vulnerable. This would most likely only happen were we to see a severe UK recession. In this case, the debt load in Speedy Hire could prove its undoing should a rights issue be forthcoming. Overall, Speedy Hire requires swallowing a couple of brave pills but you can definitely see a path to it becoming a good investment.

Norcros, trading statement


Finding a long history on Norcros proves challenging. It seems to have existed in its current form for about 25 years. Prior to 1999, the company was listed but was on the receiving end of a management buyout during that year. Over the next eight years, the company was restructured slightly through the sale of an adhesives business and a chemicals business, restructuring of the tiles business and the acquisition of a South African tile retailer.

It was relisted in 2007 with too much debt. During 2009, following the aftermath of the worst recession in decades, the company raised c. £30m in new equity to pay down debt. The timing of this equity raise was poor for existing equity holders, but what emerged was a business on a surer footing. Over the years, the company has continued to acquire and dispose of various companies related to bathrooms to refine to its current state.

Today, the company services the UK and the South African markets with a rough two-thirds, one-third split in favour of the former. Its product set includes shower panels, shower units (via the Triton brand), taps, tiles and other products related to bathrooms.

Trading Statement

As with Speedy Hire, the last couple of years have been difficult. In the UK, revenue declined 3.3% on a like-for-like basis albeit the operating margin here is said to have improved over the year. In South Africa, the business is having a torrid time with revenues down almost a quarter. It’s amusing that the management attempted to put a spin on this South African car crash by describing it as performing ’… resiliently, despite the challenging market conditions aggravated by the significant and unpredictable power interruptions’. Apart from that Mrs Lincoln, how was the play?

As with Speedy Hire, the company reported a cash build but once again, I would caution about placing too much weight on this fact as, like Speedy Hire, the cash position builds during contraction on account of working capital movements.


Norcros looks cheap here and the c. 6% dividend yield is attractive. As with Speedy Hire, we need to see a return to higher levels of housing market activity before it really motors. It is an odd sort of a business really though and one can’t help but wonder whether the South African business creates dyssynergies and it might not be better if the two parts demerged from one another. That seems unlikely however given the very deliberate building of a business that services these two markets. Additionally, the CEO is a South African so a move to focus solely on the UK feels unlikely.

Either way, unlike something like Speedy Hire, Norcros is a less pure play on UK house building but it is undoubtedly cheap on any sustained improvement in the sector.


Jamie Ward

Jamie owns shares in Forterra and Breedon.

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