How safe are houses now?

SHARES BLUE CHIP : Wimpey has doubled its exposure to the moribund home-building market
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The Independent Online
IT WAS a highly imaginative way of issuing a profits warning. Last Wednesday, in a bold move, Wimpey announced an exchange of its contracting and quarrying activities for Tarmac's housebuilding business in one of the biggest asset swaps in British construction history.

The deal, which should be completed early in the new year, makes Wimpey by far the most dominant player in the new home market, with a 10 per cent share. Wimpey will build an estimated 13,000 units next year - twice as many as competitors Barratt and Beazer.

Shares in both Wimpey and Tarmac soared as the City concluded this was one of those rare beasts: a win-win deal. But buried in Wimpey's press release was news that market conditions in housebuilding had worsened since September. UK housing profits would be "considerably lower than last year" because greater use of incentives to make sales was eating into margins.

The next day, Barratt - Wimpey's nearest rival in the housebuilding market - spelt out four reasons why confidence among Britain's 17 million home owners had been shattered by the Government in the past two years: the re-introduction of stamp duty on house purchases of over pounds 60,000; two cuts in mortgage interest tax relief; two rises in interest rates; and in what its chairman, Sir Lawrie Barratt, called "the last straw", last month's cut in mortgage interest income support.

Why then, given the dire state of the housing market, is Wimpey increasing its exposure to the sector? In particular, is the asset swap with Tarmac a masterstroke on Wimpey's part, just as the housing cycle is about to turn up on hopes of a tax-cutting budget, lower borrowing costs and the return of the elusive feel-good factor?

Some advantages of the deal are clear. Wimpey gets rid of a poorly performing contracting business, which included a contract to build the new Bobby Moore stand at West Ham (right). The business lost pounds 5m last year and, according to analysts, is unlikely to get back into the black for several years.

Quitting aggregates - a business where Wimpey has never delivered adequate returns - also makes sense, especially as the current year is likely to mark the peak in UK profitability. Volumes are now falling as cuts in government-funded road building take their toll.

Less obvious is the quality of the assets Wimpey is buying. Operating margins in Tarmac's housebuilding division collapsed from 11.9 per cent last year to just 4.5 per cent in the first six months.

According to the broker Societe Generale Strauss Turnbull, Tarmac's operating profits will fall by almost half to pounds 32m this year, whereas Wimpey Homes, despite last week's profits warning, will still make pounds 37.5m this year - a shortfall of less than pounds 6m on a year ago. But the key concern centres on Wimpey's ability to run the enlarged housing business and achieve decent returns. No housebuilder in history has managed this feat, mainly because the size of the market means that producing more than 12,000 units a year involves regional operations competing with each other.

Wimpey's chief executive, Joe Dwyer, denies the Tarmac deal was done to achieve critical mass. But analysts are concerned that in becoming a mega- housebuilder, Wimpey limits the scope for cost savings, especially as the two housing divisions will be run separately - Wimpey targeting mainly first-time buyers of two-bedroom and three-bedroom homes, while Tarmac concentrates on four-bedroom houses.

Although management's time and attention can now be devoted exclusively to housebuilding, even Mr Dwyer admits that economies of scale will not be as high as they would be if the two businesses were integrated.

And whether the UK housing market recovers next year, as disposable income rises due to tax cuts and lower interest rates, is a moot point. There have been so many false dawns before.

True, Mr Dwyer is right to say the housing market cannot get any worse. But there is a world of difference between having an extra couple of hundred quid to spend on, say, home improvements, and taking out a 25-year mortgage in an age when the notion of a job for life has gone for ever.

No doubt some housebuilders will gain from the pent-up demand for new houses among first-time buyers and those with growing families - hence the City's recent enthusiasm for the sector. But Wimpey's shares already trade at a premium to the rest of the housing sector. For all their yield attractions, there is better value elsewhere.

Wimpey

Share price 125p

Price/earnings ratio** 11

Gross yield** 5.7%

1993 1994 1995* 1996**

Sales pounds 1,587m pounds 1,688m N/A N/A

Pre-tax profits pounds 25.5m pounds 45.1m pounds 34.5m pounds 65.6m

Earnings per share** 6.8p 8.7p 5.6p 11.4p

Dividend per share 5.3p 5.5p 5.5p 5.7p

*SGST estimates **post-Tarmac deal

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