Slump pushes builders close to the wall: Britain's largest housebuilders face a threat to their survival, Heather Connon reports

'WE HAVE to accept that the word 'recovery' will have to drop off our vocabulary and resign ourselves to operating in a low-growth environment for some time.'

The comment comes from Joe Dwyer, chief executive of Wimpey, Britain's second-largest housebuilder, but it could have come from any of his competitors. Four years into the worst slump since the war, the housing market remains chronically depressed.

Questions are arising about the ability of some of Britain's largest construction companies, already severely weakened by years of falling volumes, to survive.

The current gloom is all the more depressing given the cautious optimism of the industry at the beginning of the year. Then, housebuilders hoped that falling interest rates and the removal of uncertainty about the general election would encourage Britain to get on the move again. But the brief flurry of interest that followed the general election has petered out and sales have remained at 1991 levels.

That was one of the worst years for the building industry, with 135,000 new houses started - the lowest for 10 years and 39 per cent below the peak of 1988. In the first five months of this year, 53,400 were started, down 3.4 per cent on a year ago. If that trend continues, it will be difficult to achieve forecasts of 140,000 housing starts this year.

Few believe there is anything the Government can do to help. Interest rates have already fallen a third from their peak with no improvement, so further falls are unlikely to help. The stamp duty holiday, which ends next month, has had a limited impact.

Confidence is the key. Potential purchasers want to be sure that prices will not fall further and that their jobs are secure before they commit themselves. No one is betting on when that will happen.

Falling prices and volumes would be bad for the industry at any time. But this recession is exacerbated by the fact that it followed an unprecedented boom as low interest rates and relaxed government policies prompted a frenzy of activity, pushing house prices up by more than 25 per cent a year in some areas.

Too many housebuilders thought the boom would never end, and went on their own spending spree, bidding up land prices and adding thousands of plots to their landbanks. Between 1985 and 1988, average land prices rose from pounds 8,236 to pounds 19,865 a plot.

The folly of such action is now clear. In the past two years, quoted housebuilders have written pounds 500m off the value of their landbanks, according to County Natwest. Adding unquoted builders brings the total closer to pounds 1bn. The provisions have pushed many of the largest and most conservative building companies, such as Wimpey, Taylor Woodrow and Costain, into losses. Worse, it has slashed their asset value, making their large borrowings an ever larger balance-sheet burden and leaving them at risk of breaching their banking covenants.

Some already have. Crest Nicholson, YJ Lovell and Barratt Developments were forced into talks with their bankers following massive losses. Costain is due to issue a circular to shareholders detailing the outcome of its bank negotiations at the end of the month. Other companies, including Wimpey, Tarmac and Taylor Woodrow, have been forced to sell off large parts of their businesses to cut their debt.

Traditionally, housebuilders have been cushioned by their commercial interests, which generally lag behind the housing cycle. Contracting profits help counteract a housing slump, while housing generally recovers before commercial work turns down.

So far, commercial work has been more buoyant than housing in this recession. In 1990, for example, while private housing output fell 22 per cent, commercial work rose by 9.5 per cent. It is now firmly in decline, however. Non-housing output is expected to fall more than 11 per cent this year, and almost 5 per cent in 1993 while in 1994 it will remain relatively flat. That makes the lack of activity in the housing market even more serious.

Despite the large land write-offs, some companies are still saddled with expensive landbanks. Costain, for example, has written off pounds 75m - more than any other housebuilder - yet its landbank is still valued at pounds 22,000 a plot, or 30 per cent of selling price. Profits will remain depressed as they work through their expensive land, or they will have to make further provisions, falling further into the red and bringing talks with bankers ever closer.

The write-offs have left most companies, however, with realistically priced land. All have also been slashing costs to cope with the reduced activity, leaving their operational gearing high so a small increase in sales would mean a sharp rebound in profits.

Operational gearing is, however, irrelevant if there is no recovery in the market. The industry is now facing up to the fact that there will be little change in the market for the forseeable future. That is likely to mean another round of cost-cutting.

Angus Phaure, construction analyst with County Natwest, said: 'If the current level of demand is the same as the industry will suffer for the next two years, costs will have to be cut further. It does not matter if it damages the fabric of the business; if this is the level of demand for the next few years, they have to cut costs to a level where there will be a return to shareholders.'

For most companies, that would mean dramatically altering the shape of the business. That has already begun. Costain has virtually pulled out of commercial property and plans to float its profitable Australian mining business to cut costs; Wimpey has sold its waste disposal interests and its offshore construction arm and is withdrawing from commercial property; Tarmac is planning pounds 200m of disposals by the year-end.

Given the gloomy outlook, the lack of interest in the sector's shares is hardly surprising. The construction sector is at an all-time low relative to the market, standing at less than half its level at the beginning of the 1980s. This year alone, the sector has under-performed the market by 15 per cent.

Forecasts that business will never recover are generally most prevalent just before the market picks up, which should make building shares a raging buy. But investors have already had their fingers burnt twice.

Share prices were pushed up after the Gulf war last spring, encouraging many building companies to launch rights issues, but the fragile recovery quickly petered out. Similarly, a sharp bounce in the wake of the general election was quickly reversed as the City realised that the industry remained firmly stuck in recession. Evidence of sustained improvement will be needed before they are prepared to buy again.

(Photograph omitted)