Taylor Wimpey: Prospects Improve As Bank Of England Holds Rates (OTCMKTS:TWODF)

That housebuilders on the FTSE 100 (UKX) all saw an uptick in yesterday’s trading at the London Stock Exchange, is no coincidence. The Bank of England [BoE] mirrored the Fed’s decisions to hold interest rates unchanged yesterday. It managed it only by a hair’s breadth, with the Monetary Policy Committee [MPC] voting 5-4 to maintain rates at 5.25%. But it had the expected sentimental impact on these stocks.

Faster inflation decline than expected

The decision follows an unexpected decline in headline inflation to 6.7% year-on-year (YoY), compared to the bank’s expectations of 7.1%. Similarly, core inflation fell to 5.2% too, from 6.9% in July. Inflation is still higher than the BoE’s target rate of 2%, to be sure, but it says:

CPI inflation is expected to fall significantly further in the near term, reflecting lower annual energy inflation, despite the renewed upward pressure from oil prices, and further declines in food and core goods price inflation.

Subdued growth prospects

It has come at a price, though. GDP is expected to have declined by 0.5% in July and the BoE expects “Underlying growth in the second half of 2023 is also likely to be weaker than expected.” This is also backed by trends in the labor market. While it is still strong, the bank further says that “Indicators of employment have generally softened against the backdrop of subdued activity.”

The housing market, in particular, has been impacted by rising interest rates, higher cost of living and a weaker economy. For the 12 months to July, they essentially remained flat and are expected to decline between 8-10% in 2024.

Property stocks unevenly impacted

A weaker housing market is of course a bad sign for housebuilders. But it’s also the cumulative effect of a cost of living crisis that followed high inflation, its effect on consumer spending and economic growth and of course, the interest rate hikes that followed. According to my calculations from the official data available, over 40% of houses in England alone are bought on mortgage or loan.

But here’s the really interesting development. After FTSE 100 house builders like Taylor Wimpey plc (OTCPK:TWODF), Barratt Developments (OTCPK:BTDPF) and Berkeley Group Holdings (OTCPK:BKGFF) saw a hard fall from early 2022 onwards, they ended up over-correcting. As a result, despite all the ensuing macroeconomic challenges, two of them have actually gained year-to-date [YTD] (see chart below).

While Barratt Developments is the standout stock in the sector, with a 17% YTD rise, I think Taylor Wimpey is the one to consider now. Let’s look at why in greater detail.

Advantage Taylor Wimpey

First things first, it’s not as if Taylor Wimpey has not been affected by the ongoing slowdown. When I last wrote about it in June, it was expecting a softening in sales and it has seen a massive 21% fall in year-on-year (YoY) in the first half of its financial year (H1 FY23, ending July 2) and reported EPS dropped by 30.6%. Its outlook is weak too, with expectations of operating profit to range between GBP 440-470 million, halving from last year.

Competitive P/E

So why the bullishness on it? That’s because even at this time, its market multiples look competitive compared to peers. While it trades at a trailing twelve months [TTM] GAAP price-to-earnings (P/E) ratio of 7.4x, it’s still lower than Barratt Developments at 8.6x and Berkeley Group Holdings at 9.8x. Considering this indicates further potential upside for an investor who wants to buy into the UK property sector stocks right now.

High dividend yield

Second, its dividend yield is also noteworthy. The TTM yield is high in any case at 7.7%, but it’s even more so when compared to peers like Barratt Developments at 7.1% and significantly higher than the yield for Berkeley Group Holdings at 3%. This appreciably enhances its total returns, compared to price returns (see chart below).

Its forward yield of 8.2% looks even healthier. There are risks to the forward yield, considering the profit weakening expected this year, to be sure. At 59.4%, its dividend cover ratio is higher than the 50% and 54% levels seen in 2022 and 2021 respectively. But it’s still far from the worst.

I do think that dividend cuts can happen, considering the expected decline in profits, but how much by remains to be seen. The key point here is that there are still gains to be made, from its price, through dividends or both.

Housing market resilience

While there’s no denying the weakness in the housing market, or indeed the economy as such, the fact remains that it has been fairly resilient. No expected housing market crisis has happened and neither has an economic recession. In fact, even now, the average house price of USD 290,000 in the UK is close to the highest they have been since 2005 (see chart below). Of course, there’s always a possibility that the lagged impact of rate hikes will show up in demand over time, as Taylor Wimpey’s projections themselves indicate. But at this point, we can safely say, the extent is unknown.

Buy on the dip

Even if there were a much sharper slowdown, the fact remains that Taylor Wimpey has strong credentials as the second biggest house builder in the UK. This actually makes it a good time to start accumulating it for the medium term, while its price still trades at below levels seen even before the pandemic led to a stimulus for the housing market.

What next?

Going by recent trends, we can’t really say how much the housing market will actually end up declining. In the meantime, some of the problem areas for Taylor Wimpey are already being resolved. Inflation has started coming off, without the severity of the economic effect expected.

It’s now believed that interest rates have also peaked. And even if they haven’t, they are likely close. In fact, it’s also expected that by next year, the rate cut cycle will start. These developments in turn indicate the potential for a revival of the property sector, with a substantial proportion of house purchases made with loans.

In any case, even with the current surrounding uncertainty, the stock has actually managed to see price rises YTD. This is despite its weakening financials and the possibility of a dividend cut. There are really two reasons for this. One, prices overcorrected in early 2022 and they are far from going back up to those levels. Two, its P/E ratio and dividend yields both look rather attractive right now compared to peers.

I believe there’s some further upside possible for Taylor Wimpey plc even in the short term, as it plays catch-up with other FTSE 100 property developers. And the dividends add an extra boost. Its financial performance can indeed suffer this year but even then, going by its strong market position and past history of healthy performance, it would still be a medium-term buy at the current, relatively low prices.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.