Stockwatch: This share merits renewed attention

Is there further upside for FTSE Small Cap land investor and construction stock Henry Boot (BOOT) following a period of consolidation over the last nine months?

Alternatively, should you better trust “market technicals” where this and other property/house-building stocks have come off the boil, as the Bank of England edges towards interest rate rises and house prices are consolidating?

While Boot is not overtly a housebuilder, over 40% of recent years’ operating profits have derived from land sales to housebuilders, so a key element of this stock’s trend amounts to taking a view on that sector.

The investment rationale also involves major construction projects where Boot continues to boast a strong pipeline; and not only did analysts upgrade forecasts for Boot ahead of its 2017 prelims, the results were a marginal beat too.

So, despite fundamentals and sentiment being rather tricky to read across several activities, the stock merits renewed attention.

More capital growth than income stock

As a circa £400 million company nowadays, Boot has always appeared more conducive to capital growth than the multi-billion-pound housebuilders – where yields on Barratt Developments (BDEV) and Taylor Wimpey (TW.) are over 8%, about 1.5 times covered by earnings, and would appear to limit downside if forecasts broadly hold.

Single-figure price/earnings (PE) multiples on such stocks also reflect caution, the housebuilding cycle may be top-heavy after years of monetary stimulus and Help to Buy, with PEs probably higher on a cyclically adjusted basis.

Yes, the government continues to promote home ownership and pressure councils to approve developments, but the niggling fear is profits having benefited from astute land purchases after the 2008 crisis.

Meanwhile, Boot has risen nearly 80% over 2017 to early 2018, its yield chugged along at roughly 3% with about 3x earnings cover. Not surprisingly, profit-takers clipped the rally by 12% when markets sold off in February, the shares currently at 306p – up only about 3p – after latest 2017 results.

‘A strong pipeline of schemes’

I initially drew attention at 220p in April 2015 on a rationale of exacting value from an “opportunity portfolio” of land, management declared was larger and more valuable than for many years; and I re-iterated its attractions at 206p in August 2016 after the EU referendum result hit property/housebuilding stocks.

  • Stockwatch: 20% upside here

From the 2016 results onwards, Boot’s narrative has emphasised all-round progress from its three divisions of land sales, property investment and construction, with “a strong pipeline of schemes to be delivered over 2017-2019.”

Thus, 2016 pre-tax profit rose 22% on revenue up 74%, and latest 2017 prelims show pre-tax up 40% to £55.4 million on revenue up 33% to £408 million, with earnings per share soaring 49% to 32.1p.

The recent uplift is said primarily due to development schemes being delivered more quickly than anticipated, for projects such as an Aberdeen exhibition and conference centre and the residential conversion of a Terry’s chocolate factory. The estimated value of the commercial development pipeline now exceeds £1 billion.

Premium to tangible NAV has recently hit 74%

Possibly sellers felt it best not to push their luck too far when the stock approached 350p in January then February saw a markets rout. End-2017 net tangible assets per share turned out at 199p, with scant intangibles and no goodwill on the balance sheet.

So, a likely reason the stock is up only marginally after excellent 2017 results is 306p representing a near 54% premium to net tangible asset value (NTAV). To push this measure higher in the short run demands evidence, and asset revaluations are likely.

Yet note 4 to the accounts gives a fair value hierarchy of investment properties, with only a £9.1 million increase booked in respect of £133 million investment properties. Meanwhile, strategic land acreage has risen 11.7% to 13,273 acres which presumably appears within £145 million inventories under current assets; and, since it isn’t substantiated, then it seems fair to trust balance sheet values than imagine hidden assets.

Boot’s valuation is, therefore, quite a tricky mix of variables: a forward PE multiple is in single figures; a prospective yield possibly near 3%; albeit a less than comforting premium to net assets.

Looking back, when I drew attention at 220p, the premium was 52% to the end-2014 balance sheet figure, so perhaps this is a threshold that might be sustained. That’s speculative, however, and is best viewed in context of recent years where monetary stimulus and Help to Buy have supported growth in land/construction values.

Thus, investors are anticipating quite some NAV growth in 2018-19, based on this £1 billion pipeline. 2018 is said to have started well: amid land sales, building sites and schemes at record levels, there is “confidence that we can continue to deliver sustainable returns to our stakeholders well into the future.”

The chairman adds that industry expectations are for economic growth similar to 2017 over the next two years, supported by a generally strong global economy. He does, however, hedge such remarks with awareness of “the cyclical nature of our marketplace, and also the current uncertainty regarding negotiations to leave the EU.” In truth, no-one has a crystal ball as to the next recession.

Yield expansion to limit downside risk?

It would be comforting to see a higher yield, if questionable what extent Boot can re-rate its payout, the more likely way means being a share price fall. On fundamentals, gearing has been trimmed from 14% to 11% and net debt of £29 million is unlikely to weigh on the group; net cash generated from operations is up 81.3% to £36.3 million; and the cash flow statement shows dividends absorbing a total £12 million.

End-2017 cash was a modest £10.3 million, though, as £24.1 million was spent on investment properties, a key demand for cash within Boot’s business model. So, it looks more likely the board will keep establishing longer term growth prospects beyond 2019 that the company can capitalise on, than significantly raise payouts.

If the UK economy slows down, cash preservation would be wise in order to take advantage of better-priced land/property acquisitions. I really wouldn’t look to a materially increased dividend, as a prop.

Which emphasises the ongoing narrative

Return on capital employed (operating profit divided by total assets less current liabilities) is up from 14.4% to 18.6%, aided by an impressive performance within property investment/development (where operating profit more than doubled to £30.4 million); and yet the 2017 financial review guides ROCE at 12% to 15% going forward.

I’d still be inclined to mark up forecasts from February’s consensus for £46.5 million, though much depends on how Boot’s narrative evolves and the timing of projects underway – which appear to have made for a tough comparator for 2018.

Provided shareholders keep attuned to the UK economy and Boot’s updates (last year the AGM statement was 25 May), then holding for further gains is justified. But mind an aspect of “market technical” risk where fresh buying may be deterred by a more challenging UK environment for property development as interest rates turn up, making this stock liable to drift sideways at best.

It looks premature to assert a ‘sell’ stance, but on a capital protection view, also wise to consider locking in some gains as part of managing a long-term holding.

If the market was to plunge, conceivably Boot could merit buying. But that’s not where we are; instead, possibly at the mature phase of a business cycle, with this stock at a large premium to NAV and modest yield, with no margin of safety. So, a conservative conclusion is Take profits.

Henry Boot – financial summary       Estimates year ended 31 Dec 2012 2013 2014 2015 2016 2017 2018               Turnover (£ million) 103 154 147 176 307   IFRS3 pre-tax profit (£m) 13.4 18.4 28.3 32.4 39.5   Normalised pre-tax profit (£m) 13.0 18.2 27.9 32.3 39.2 45.1 46.5 Operating margin (%) 13.7 12.3 18.6 17.8 12.7   IFRS3 earnings/share (p) 6.9 8.5 16.2 17.3 21.3   Normalised earnings/share (p) 6.7 8.4 15.9 17.5 21.1 25.2 25.8 Earnings per share growth (%) 3.9 25.6 90.5 9.9 20.5 19.6 2.4 Price/earnings multiple (x)           12.1 11.9 Annual average historic P/E (x)   26 24.0 13.8 11.7 12.6 10.7 Cash flow/share (p) -6.1 -1.0 6.9 0.7 16.0   Capex/share (p) 0.2 0.3 -8.1 -10.2 1.5   Dividend per share (p) 4.4 4.9 5.3 5.8 6.3 8.0 8.4 Yield (%)           2.3 2.4 Covered by earnings (x) 1.5 1.8 3.0 3.0 3.4 3.2 3.3 Net tangible assets per share (p) 131 140 145 162 172 199 Source: Company REFS            

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