Building Beyond Brexit With Persimmon

|
About: Persimmon Plc (PSMMF), PSMMY
by: Patrick Kroneman
Summary

Mortgage applications in the UK hit a 10-year high in July.

Assistance for buyers by the government looks to get expanded.

Dividend at current prices is over 12 percent.

A balance sheet like a fortress makes Persimmon withstand any possible Brexit outcome.

For those who don't live in Great Britain, like me, watching Brexit news is rather entertaining. Even more entertaining is the stock market in the UK which has some great deals. One of those deals is Persimmon (OTCPK:PSMMF, OTCPK:PSMMY), one of the UK's largest home builders. At the current price of $23.60, it's a steal.

Note: the main listing of Persimmon is on the London Stock Exchange. The ticker is PSN. For investors looking to invest in the GBP or seek more liquidity, this listing should answer to that need. In this article, all figures will be in USD unless stated otherwise.

Company profile

Persimmon PLC is a British construction company that focuses on residential projects. One of the largest homebuilders in the United Kingdom, Persimmon focuses on traditional single-family homes, with up to 90% of its home sales in this market. The company mainly builds lower-priced residential homes, with around half of its constructed homes selling for under EUR 200,000. It also participates in strategic land purchases around the United Kingdom for future housing development. The company annually completes over 10,000 homes. - Morningstar

So, Persimmon operates a rather straightforward business model. They sum it up excellently themselves:

Source: Persimmon Website

A construction company which builds houses is far from unique. So, why is Persimmon an attractive proposition? As stated by Morningstar, most of the homes Persimmon builds fall in the lower segments of the market. Normally, in most markets, the lower end of the scale has lower margins and is less attractive unless there is a lot of volume. However, during the Great Financial Crisis, the British government acted to help its citizens and its housing market. They did so by installing the Help to Buy program. Under this program, a variety of schemes made it easier for a potential (first time) buyer to do so. For example, there's a savings account where the account holders can save money and the government adds 25% of the sum to the balance. This goes up to an amount of 12.000 sterling, leading to a total of 15.000 GBP. Originally, the program was intended to end in 2017, but it has been extended a couple of times. Currently, it's projected to end in 2023. Under the assumption that Boris Johnson stays on, then he'll probably aim at more help to the housing market.

Past performance

This government program has been a huge boon for Persimmon since it especially benefits the bottom of the market. In a sense, this subsidy is being passed via the buyers to Persimmon and its shareholders. Just look at the chart:

Chart Data by YCharts

Help to Buy started to kick in during 2013. Since then, the stock has more than tripled, but uncertainties and company-specific events have been a drag on the stock price since 2018. Also note that given the fact that Persimmon pays a hefty dividend, the current yield is over 12 percent, this reduces price appreciation. The elephant that entered the room and caused a downward spike in 2016 is the ever pending Brexit. This gave consumers something to be concerned about and they have been largely avoiding long-term commitments such as those associated with buying a home.

Two other harmful events that hurt Persimmon were directly related to its own business. The first was a massive bonus for the CEO. This damaged the public image of the company and forced it to replace its CEO. The second relates to the quality of the buildings made by Persimmon compared to its peers. So, an external party was hired to do an extensive review of the business. For the figures of the first half of 2019, this meant that some sales were held back to give the customer a better product, as stated on the first page of the report. These actions were needed not only to improve the product and the public image but also to not be excluded from the Help to Buy scheme.

Current Valuation

With a share price of $23.60, Persimmon has a market cap of $7.14 billion. This equates to a TTM P/E ratio of just 6.72 and a TTM dividend yield of 12.84%. One would assume by looking at these figures that the company is highly risky and would ask oneself if such a high yield is sustainable. A look at the financial statements tells a different story.

Source: Seeking Alpha

In ten years, sales have roughly doubled but profits have grown tenfold. This margin improvement gives Persimmon ample room to absorb rising costs or other shocks such as a no-deal Brexit. As stated, the fact that the latest figures are down a bit is a result of delays in deliveries and increased spending on customer satisfaction items. Both should improve the company's strength going forward.

Source: Seeking Alpha

Again, the balance sheet is not signaling a business in distress. Most of the assets are current assets, with over one billion cash. Compare this to the liability side. The company doesn't carry any long-term debt and has no defined pension obligations. If anything, this balance sheet is a fortress and gives room for a host of different options. But I find the fact that management has kept it so conservative is highly appealing. A lot of execs supercharge a balance sheet with debt to boost return metrics such as ROE, but they hardly mention the added risk and reduced flexibility. For Persimmon, those metrics don't need a boost. Just look at them as-is:

Lastly, the cash flows:

Source: Seeking Alpha

The cash flow statement is as good as the other two statements. The operations produce ample amounts of cash, while capex requires just a fraction to keep the business running. This gives way to distribute large cash amounts to the shareholders. Keep in mind that in the UK, dividend payments are not taxed, so there is no leakage on those returns. In essence, Persimmon is a cash machine that requires little maintenance to keep the cash coming.

Key risks

For Persimmon, the main risk comes from a possible exclusion from the Help to Buy program. This would seriously hurt its competitiveness since other builders in this segment of the market will still be included. Since this threat has been made, however, the company has focused on improving the quality of the houses it builds. This exclusion seems at least for now off the table.

Rising interest rates are a risk. This would reduce how much clients can borrow, and it hurts the housing market. Currently, there is no sign of rising rates. The very opposite might happen since the Bank of England has cut its outlook on the British economy.

Then, there's the Brexit. At the moment, it is hard to predict what this would mean to Persimmon. Since the road to Britain leaving the EU changes every day, this risk is not quantifiable. What is certain is that a chaotic Brexit will cause more harm than a well-organized one. The more it damages the overall British economy, the more it harms Persimmon. But at the moment, the housing market still shows rising prices.

A bet on the housing market

If one looks at the housing market in the UK, there are essentially two very different markets. For one, there is the market in the Greater London Area, and the second is the rest of the UK. In most news articles, this distinction is lost, but, at the moment, there is a disconnect between the two. London, being one of the places most affected by Brexit, will likely be less appealing to soak in foreign investment. For example, due to restrictions on firms in the City in relation to the European financial markets. So, the London market is in a slump. Outside of London, prices are still rising, and this is the market in which Persimmon is mainly active. Looking at the mortgage figures of July, the housing market seems set for an upward trend. They are actually the highest in over two years. So, it's wise to look beyond Brexit headlines and stick to the figures.

Conclusion

Brexit, executive compensation, and lagging its peers in quality have been a drag for Persimmon. Addressing the issues, Persimmon is shifting its course. With the extension, and possibly expansion, of the Help to Buy scheme, this will boost Persimmon further. Helped by a bulletproof balance sheet to weather further possible storms and multi-year high mortgage approvals, Persimmon should outperform beyond the Brexit.

Disclosure: I am/we are long PSMMY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.