Investment Column: Bellway builds case for holding on

Lloyd's insurer Kiln has little cover for investors; Fibrenet is a quality call but hold on for now
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The little Newcastle upon Tyne housebuilder set up by John T Bell with his sons in 1946 will this year complete the sale of its 100,000th home. Now called Bellway, it is one of the biggest nationwide builders and it has ambitions to keep growing.

The little Newcastle upon Tyne housebuilder set up by John T Bell with his sons in 1946 will this year complete the sale of its 100,000th home. Now called Bellway, it is one of the biggest nationwide builders and it has ambitions to keep growing.

That means, unlike some of its peers, it is not content simply to bask in the glow of sharply rising house prices, which are making for easy gains in profits across the sector. Bellway, of course, was able to report a stonking set of numbers yesterday, with turnover up 21 per cent and pre-tax profits up 36 per cent to £77.4m for the six months to 31 January. The average selling price of a Bellway home - its speciality is the smallish family home - rose by 9 per cent to £156,900.

A significant part of the profit uplift, though, comes from a 250-strong rise in the number of homes sold in the period. The company is on course for 6,600 this year, up 5 per cent, with 7,000 next year and a target of 10,000 per year by 2010.

So this is a long-term growth stock whose share price, at a measly 7 times earnings, reflects the market's fear that a slowdown in the housing market could mean meltdown for housebuilders' profits.

Some estimates suggest that house price inflation, currently running out of control at 18 per cent, has to keep above 4 per cent to hold profit margins at the current level. Since Bellway is increasing volumes, too, its profits can continue to grow even if inflation is below that level. But if rising interest rates snuff out demand and slam house prices into reverse, then even Bellway will be in for a torrid time. It is difficult to see share prices rising in a sector where profits are falling, even one where the shares are unfairly lowly rated.

A vicious house price slowdown is not yet the most likely situation, but it does get likelier the longer the boom continues. We said Bellway was worth holding last August and shareholders have a 25 per cent gain since then. With the reporting season over, the sector could be in for some skittish trading, and it seems a good time to take some of those recent profits. But unless there are real signs of armageddon in the sector, Bellway's organic growth strategy makes it a worthy hold.

Lloyd's insurer Kiln has little cover for investors

It is unsurprising that Kiln, the Lloyd's of London insurer, has had a good year. Amid fears of terrorist attacks, companies and individuals have been rushing to specialists like Kiln for property and personal cover.

But nervousness does not account for all of the insurer's success. While its lines do not differ that much from some other Lloyd's companies, its profitability has streaked ahead, reflecting better underwriting judgment and tighter risk controls than many of its rivals. Last year Kiln's combined ratio (of claims to premiums) was just 77 per cent. The rating, which must be below 100 per cent to signify profitability, is the best in its market.

Kiln writes reinsurance, aviation, accident and health cover alongside its property and terrorism cover. It has been helped by a sharp rise in rates in recent years. The main issue now is whether the market is softening. The company said rates renewed in recent weeks have been slightly below 2003, but it added that many of the lines it majors in are still on the rise, while others are holding firm.

Kiln has a number of income sources that will partly offset any deterioration of rates, including a stake in a non-Lloyd's insurer, WR Berkley. It also has a stable form of income managing the investment of some Names at Lloyd's. However, the company trades at a premium of more than 30 per cent to its sector, at 1.4 times its net assets. Its conservative dividend policy puts it on a disappointing prospective yield of just 1.8 times this year. Avoid.

Fibrenet is a quality call but hold on for now

The alternative carriers - the phone companies who established, at great cost, telecoms networks to rival BT - have proved one of the past decade's most value-destructive sectors. Fibernet is still some way off the point where it generates cash from the business it set up, with high quality fibre-optic networks in the UK and Germany and supplying telecoms services to big users of data connections, such as AT&T, Royal Bank of Scotland and Deloitte. But it looked a little closer to that point yesterday than anyone expected.

Profit margins have improved, showing that business customers will pay up for Fibernet's mix of high-value services on long-term contracts. Forward sales are strong and interim operating losses narrowed to £2.3m from £3.7m. The company has a £20m cash cushion to get it to profitability.

The Investment Column has one of its most disastrous records on Fibernet, reiterating buy recommendations all the way down from the peak of the telecoms boom, only to bottle out a few pennies from the bottom. The company, though, has always been a high-quality business, and it has bent to the prevailing economic wind, rather than broken under the strain.

With the shares, at 140p, trading in line with a toppy-looking sector, they are a hold.

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