Building market not as safe as houses

The Investment Column
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The Independent Online
Just what is going on in the housing and related construction markets? Barely a day goes by without a new report suggesting UK house prices are accelerating. The latest, from broker UBS, predicts an average increase of 10 per cent next year. Yet, with one or two notable exceptions, housebuilders and building materials producers see little or no sign of the elusive feel-good factor returning to their markets.

One reason is that while house prices have clearly moved ahead, especially in London and the South-east, new homes are not being built. In the first half, UK housing starts fell by 11 per cent and completions dropped by 10 per cent. Faced with such a shortfall in domestic volumes, even building materials producers such as Hepworth, with a strong export profile, are running hard just to stand still.

Barratt Developments, never slow to speak its mind, knows who to blame. Britain's second-biggest housebuilder this week attacked the failure of the Government's planning policy, with 90 per cent of local authorities missing their targets for dealing with planning applications. The result, Barratt fears, is a shortage of development land and increased pressure on land prices.

Housebuilders are not standing idly by. Rapid consolidation in this highly fragmented sector, which began in earnest three years ago, has gained momentum in the past 12 months with 23 deals completed, ranging in value from pounds 6m to pounds 320m.

More will follow as the big players become truly national operators, squeezing out the smaller local housebuilders. Barratt this week reiterated its goal of building 11,000 houses per annum by 2000 through organic growth outside its core South-east region. Wimpey, the biggest housebuilder, which recently gained Tarmac's housing arm, has a 12,000-a-year target. In volume terms, these structural changes are having a profoundly negative impact on builders' merchants as demand from small, local jobbers dries up.

For building materials groups, the patchy state of the UK housing market would matter less if their aggregates activities were preoccupied with large infrastructure projects or benefiting from better European markets. Neither is the case.

The UK roads programme is being cut to ribbons, paring contractors' margins to the bone, while everyone apart from Tarmac is bad-mouthing the Government's Private Finance Initiative for its administrative delays and funding problems.

On the Continent, the outlook is just as poor, especially in Germany. Apart from RMC, the building materials sector would have investors believe that the bad winter weather which decimated first-half profits was an act of God and that the underlying situation is improving.

But the overall German construction market is set to decline this year for the first time since the Berlin Wall came down and it will almost certainly contract again in 1997. The same goes for France and any other country that is politically serious about signing up for a single European currency.

Faced with such dire market conditions, British companies might think cost-cutting offers a quick fix. But apart from the horrendous expense involved in making our European neighbours redundant, the likes of Redland, RMC and BPB Industries still find themselves producing tiles, concrete or plasterboard in high-wage, hard-currency countries.

All of which makes stock-picking a highly selective exercise. Among housebuilders, Berkeley's track record of unbroken earnings growth through thick and thin is still worth backing.

Elsewhere, Taylor Woodrow's exposure to growth markets in the Far East makes it the pick of the contractors, but builders' merchants, aggregates suppliers and other building materials groups are best avoided.

Shire has some serious drugs

It is easy to poke fun at Shire Pharmaceuticals, the biotechnology group which floated in February at 175p. A company which boasts as its main product an anti-dementia drug based on Galanthamine, a compound derived from daffodils, and is searching for a cure for "male erectile dysfunction" will prompt a wry smile in certain quarters. But Shire deserves to be taken more seriously than many in a sector which generally appears to be based on very insecure foundations.

For a start, profits last year of pounds 2.87m give Shire a blue-chip tinge in a sea of mainly loss-making rivals. Admittedly the surplus, which replaced a loss of pounds 7.05m last time, was mainly due to a maiden pounds 1.88m contribution from Imperial Pharmaceutical Services (now renamed Shire Pharmaceutical Contracts), acquired a year ago.

But with 26 products on the market, Shire has a decent conventional drugs business ranging from migraine treatments to osteoporosis therapies, where it has half the UK market. That lot chipped in a solid 30 per cent rise in sales to pounds 8.96m in the year to June.

Less predictable is the pounds 11.7m from licensing and development fees, which soared from pounds 210,000 last year. The figures were swollen by an pounds 8.2m payment from Johnson & Johnson subsidiary Janssen, which is paying for the development of Galanthamine (to be branded as Reminyl) in exchange for marketing rights. Some pounds 4.8m of that figure was non-recurring and this sort of income will always be lumpy.

Thus far, Galanthamine is showing promising results in treating Alzheimer's disease, which could be a pounds 2bn market by 2000.

But the unique selling proposition behind Shire is that the financing of its development portfolio is completely underwritten, either by third parties or its own sales. That leaves pounds 25.4m of net cash free for acquisitions, of which two under discussion could account for half, and the purchase of drugs or projects from others.

Even with only a break-even result in prospect this year, Shire presents a low-risk way into the sector. The shares, up 3.5p to 190p, capitalise the group at pounds 116m and look better value than many rivals.