Have Persimmon built to high?
Date
5/29/2016 6:03:17 AM
(MENAFN- ProactiveInvestors - UK) Trader Talk, Sat
Strong oil prices, fading concerns about the Greek debt crisis and reducing uncertainty surrounding the EU referendum boosted global equities after several weeks of lacklustre trading.
Banking stocks were supported by an agreement from Greece's creditors that allowed the eurozone to extend 10.3 billion in rescue loans to keep Athens afloat this summer, raising hopes that the impasse between Germany and the International Monetary Fund can be resolved. Many in the markets, however, remain sceptical about the longer-term outlook for Greece.
Elsewhere in the eurozone, however, the 'flash' estimate of the purchasing managers' composite index dipped to a 16-month low of 52.9 in May from 53.0 in April, confirming expectations that GDP growth in the region is slowing.
Oil prices continued to strengthen, despite the resurgent US dollar, as data from the US Department of Energy revealed that total crude inventories fell far more than expected last week. Brent, the international crude benchmark, traded above $50 a barrel for the first time since early-November 2015.
A strong report on US new home sales in April showed a 16.6% jump last month, well ahead of expectations, while prior months were revised higher. The dollar index was propelled to its highest level in two months, after rallying steadily since a 16-month low at the start of this month, fuelled by speculation that the Federal Reserve could raise interest rates again in June or July.
Last week's minutes from the Fed's Open Market Committee meeting in April, left little room for doubt that policymakers were strongly considering a hike, with several members voicing their hawkish comments. The Fed fund futures market reacted by pricing in a more than 30% probability of a rise in June, up from only 4% a week ago and a greater than 50% chance of a move in July.
On a domestic front, morale among British consumers edged up in May as the odds narrowed that Britain would remain within the European Union. Market research firm GfK said its overall consumer sentiment indicator rose as expected to -1 in May from -3 in April, which was the weakest reading since December 2014, yet while optimism about the economy in the year ahead inched higher, it was much weaker than a year earlier.
Sterling touched a four-month high against the Euro, whilst also making substantial gains across all of the major currencies, as the most recent poll showed that the 'Remain' camp has a 13 point lead over the 'Leave' campaign and is leading with 55% of the votes. Bookmakers are shorting their odds, with a price of 1/7 in favour of Britain staying in the EU. Equity markets are efficient and loathe uncertainty, so as the outcome becomes more certain, investors are attempting to price in the result.
Technical analysis of the FTSE 100 illustrates this week's strength, although initial resistance at 6280 is capping the gains and according to the overbought stochastic, the rally could be running out of momentum. That said, volumes are low and both the RSI and MACD have some way to run, so a challenge of 6430 appears possible in the near term. Support meanwhile, is seen from the 200-day moving average at 6150 and the recent low of 6030.
In conclusion, it has been a week of improved sentiment, with Greece, the EU referendum and oil prices all bolstering appetite for risk among investors. Looking ahead, the major headwind comes from the market's perception of a hike in US interest rates. According to policymakers and the strength of recent data, an increase in rates looks almost a foregone conclusion in July, yet that has not been fully priced into markets and could generate some choppy trading over the next six weeks.
A sector that would not benefit from a tightening in interest rates would be the much-hyped housing market, where sellers appear to be able to name their price and sealed-bids have become a common occurrence. The chancellor's stamp duty surcharge on second-home purchases, designed to cool the market, prompted a short-term frenzy of buying before 1st April deadline, but there could be further restrictions to follow.
Bank of England officials are scrutinising risks stemming from property-market investment, in a further sign the growth of buy-to-let has caught the central bank's attention. The Financial Policy Committee 'will continue to monitor closely recent developments' and 'potential threats to financial stability from buy-to-let mortgage lending,' Governor Mark Carney wrote in a letter to Chancellor of the Exchequer George Osborne, dated 26th May, noting Osborne's 'intention to bring forward secondary legislation', could further deter investors.
Many UK-listed house builders have recently reported record profits and bumper capital returns to shareholders, yet recent evidence suggests the sector could be nearing a peak. Mortgage lending dropped back sharply in April, with a total of 78,301 loans approved last month, down almost 5,000 from 82,971 in March, while the value of loans also slumped to 10.9 billion from 16.1 billion.
Housebuilders gross profit margins have recovered from lows of about 12% in 2009 to more than 20% today, but as rising house prices, profits and dividends enter their seventh year, it is increasingly clear we are getting late in the current housing cycle.
The demand for building materials has resulted in brick prices rising almost 25%, cement rising almost 17% and plastic doors and windows rising about 10% during the past five years, according to the latest data from the Office of National Statistics. Wage inflation is also at its highest since 2008 as skilled roles such as electricians and plumbers rise sharply, while labourers will also see their pay packet rise through the living wage.
Persimmon (Epic: PSN), the UK's largest housebuilder, has witnessed average selling prices rise from 160,000 in 2009 to almost 200,000 at the end of last year. Results on 23rd February revealed pre-tax profits jumped by more than a third to 638 million, over four times the 147 million achieved five years ago.
Income investors have also been attracted by promises to return lavish amounts of capital to shareholders and Persimmon increased its dividend to investors on 1st April to 110p per share, significantly higher than the planned payment of 10p per share. The additional windfall means shareholders are now on track to get a cash return of 2.76bn, or 9 a share, by 2021, a 45% increase from the original plan set out in 2012 to pay out 1.9bn by 2021, or 6.20 a share.
Cyclical industries, however, struggle to keep their long-term promises and just because you call something an income stock, it doesn't change the underlying fundamentals that drive profits and cashflow in the business, a notion that has been witnessed in the mining sector, as pay-outs have been cut back this year.
Due to the recent growth in earnings, Persimmon trade on just 11.2 times, but with expected earnings growth declining to less than 10% next year, it puts the company on a PEG of over 1. Furthermore, Persimmon's average earnings during the past 10 years are about 65p, which puts them on a cyclically adjusted price earnings of 29 times, making the shares look very expensive.
The chart of Persimmon illustrates the recent move back up towards the all-time high of 2255p experienced earlier this year, before the chancellor announced his intent to cool the buy-to-let market. The oscillators, however, have rolled over in overbought territory and the bearish divergence suggests that momentum is fading.
At the time of writing the share price is 2121p, which given the euphoria surrounding the sector combined with the evident headwinds it faces, could present a good level for investors to bank profits. Traders may also consider short-selling the shares, with a stop-loss at 2205p, as targets seen at 2015p, 1909p and 1740p.
This report was written by Michael Allen, equity specialist. The writer does not hold a position in Persimmon. The material in this report has come from web-based data sources and Persimmon's corporate website.
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