THE INVESTMENT COLUMN : Choosing the building blocks of recovery
Saturday 06 January 1996
But from the beginning of November shares, especially in the pure building companies, bounced sharply, recovering much of their underperformance relative to the rest of the market. As the chart below shows, when sentiment changes in this sector, shares can move very sharply - Laing, for example, has seen its shares rise more than 25 per cent in the past two months on little volume.
What has driven the rise is the belief among investors that conditions cannot deteriorate any further, that the trend for interest rates is probably down, claims from building societies like Halifax that housing transactions are set for noticeable improvements this year and in 1997, and the dramatic underperformance of most building shares over the past two years.
Whether the rise is justified depends on how much you believe that housebuilders have really adjusted their cost bases and working practices to cope with what is likely to be a relatively low-inflation environment with house prices probably static in real terms. Recent profits warnings from Cala and Raine suggest not all the pain has yet been taken account of.
As a result the price/earnings ratios of the pure builders, ranging from 13.5 for Barratt to 17 for Bryant look pretty demanding in the context of a market rating of only 13. A 15 per cent average premium seems to expect more profit upgrades than appear likely. No one expects the first half of this year to be particularly rewarding for housebuilders so a great deal is being asked of the second-half recovery.
As ever, selectivity is the key, and the quality managements of Berkeley and Barratt, their ability to drive volume growth and (certainly in Berkeley's case) a strong product offer are attractive. Redrow is also a quality company but probably up with events.
As with the builders, the materials companies demand a careful company- by-company approach. Even if the housing market does pick up during the year, the spend on joinery and fittings is likely to lag consumption of heavier materials such as concrete, blocks and bricks.
Prices of aggregates held up pretty well last year, certainly much better than those for lighter products, which face more competition from imports and a much more fragmented market. There has also been quite a lot of consolidation of the heavy side of the sector (the Wimpey/Tarmac asset swap, Minorco's acquisition of Tilcon) which should make for greater efficiency and so rising profits.
CRH is probably the best quality company within the sub-sector. Travis Perkins and Polypipe also catch the eye. Wolseley and RMC are safe plays.
But for those looking for a bit more excitement, there are a host of recovery stories to choose from. Caradon is probably the most extreme example, a company with many good businesses that took its eye off the ball and could benefit from the appointment of a new chief operating officer.
Stores face more
The spate of price-cutting by some of the larger supermarket groups rather clouds the picture for investors who might have been considering the sector in 1996. Safeway's decision to cut the price of 70 lines by a third during January follows similar action by Sainsbury and Iceland in the last few days.
Most analysts are dismissing these campaigns as mere jockeying for position rather than a prelude to a full- scale price war. However, most are agreed that the price-cutting will not stop here. With Tesco piling on market share and Asda and Safeway improving all the time, Sainsbury is expected to launch a much more significant campaign by the spring.
Sainsbury is phasing out its Saver loyalty card next month. It is likely to use the money saved with these discounts to invest in lower prices across the board. But until Sainsbury makes its move uncertainty will continue to depress the entire sector.
Share price performances among the supermarkets have already differed widely over the last 12 months, with clear winners and losers emerging. Top of the pile is Asda, whose shares have risen by more than 70 per cent over the year as it has consolidated its position as a lower-priced alternative. Tesco has also risen strongly as it outmanoeuvred Sainsbury with its loyalty card and keener prices. Argyll has outperformed the FT-SE 100 on the back of healthy sales growth.
The clear loser is Sainsbury, whose shares have slumped from 477p in September to just 381p as the City became alarmed at its declining market share and inaction. Kwik Save and Iceland have also been struggling.
This month should provide more information on relative performance when most of the supermarkets release trading updates. William Morrison led the way yesterday when it reported a healthy gain in like-for-like sales of 4.3 per cent during December and a 3.1 per cent increase on the year to December.
Waitrose, part of the privately owned John Lewis Partnership, yesterday claimed it had enjoyed its most successful Christmas ever, with sales for the year up 14 per cent on last year and sales in the last week before Christmas up 30 per cent on the 1994 level.
The most attractive stocks are still Asda and Tesco, which are calling the shots in the war at the moment. But with price pressures likely to reduce margins, the immediate prospects for supermarket shares are not too encouraging. Until the pricing picture becomes clearer, investors are advised to leave the sector well alone.
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