Persimmon share price: where to next as Help to Buy comes under threat?

It has been a stellar decade for UK housebuilders. The chronic undersupply of new housing has continued to push prices, and therefore revenue, higher. Prices have risen at a faster pace than costs to improve margins and profitability. And the resulting jump in cash generation has transformed an industry once swamped in debt into dividend-powerhouses dishing out billions to shareholders.

The nine leading housebuilders - Barratt, Bellway, Berkeley, Bovis, Countryside Properties, Crest Nicholson, Persimmon, Redrow and Taylor Wimpey – have seen pre-tax profit leap from under £400 million in 2010 to over £5 billion last year, when investors banked a record £2.8 billion worth of dividends, according to investment platform AJ Bell. Persimmon became the first-ever housebuilder to report an annual pre-tax profit of over £1 billion after releasing its 2018 results, with more players expected to follow.

The major catalyst for this has been the government’s Help to Buy scheme. It provides loans to buyers, predominantly first-timers, to purchase a new-build property with a relatively small deposit. It was designed to bring home ownership into the reach of many people who were seeing their dreams of owning a home slip away due to soaring prices, while the wider economy was still recovering from the 2008 financial crisis. The scheme installed confidence among both housebuilders and mortgage lenders.

But, while housebuilders and their investors have only benefited from the scheme, questions are being raised about whether Help to Buy is helping those it was designed to assist. The industry has been criticised for putting profit before people by delivering poor quality homes, demonstrated by the scandal at Bovis in 2016 that severely dented its reputation. It has also been accused of sitting on land and eking out supply to ensure prices remain high, and profiteering from the taxpayer-funded scheme to reward shareholders and executives with bloated pay packets.

Six years since its introduction, the government has now accepted Help to Buy is far from perfect and has announced it will review the scheme. Media reports suggest Persimmon could be the first major housebuilder to be banned from benefiting from the scheme because of its controversial behaviour over recent years, including the £110 million bonus paid to its former chief executive (prompting his resignation), poor-quality builds and the use of complex leasehold agreements that buyers struggled to understand.

We have a look at how Help to Buy has propelled Persimmon forward, whether it is likely to be cut from the scheme, and what the government review could mean for the housebuilder and its peers.

How has Help to Buy impacted the UK housing market?

The Help to Buy scheme was introduced by former Conservative chancellor George Osbourne in 2013 to help people get on the housing ladder as rising prices continued to put ownership out of the reach of many. The scheme allows buyers to put down a deposit as little as 5% on a new-build home and receive an equity loan from the government to cover 20% of the property’s value (or 40% in London), helping people purchase properties that would otherwise be out of their budgets.

Help to Buy sent an important signal to what was a challenging market at the time. The loans meant the government had skin in the game and sent a signal that it was invested in house prices rising further. This provided housebuilders with the confidence to build and the banks the confidence to lend.

The popularity of Help to Buy has grown annually since being introduced in April 2013. Over one-quarter of all homes sold under the scheme were completed in the 12 months to the end of September 2018. Overall, over £10.6 billion worth of loans have helped purchase more than 195,000 properties worth nearly £50 billion:

^{(Source: UK government figures, 2018 runs to the end of September)}

The majority of housebuilders have become increasingly dependent on Help to Buy. Just under half of all those that bought homes from Persimmon over the last two years used Help to Buy, making the company particularly reliant on the scheme compared to the wider market, where it is typically used for two-fifths of all transactions. For further perspective, its peers - Bovis, Barratt, Bellway, Redrow and Taylor Wimpey - all generate between 36% to 39% of their sales through Help to Buy, while Berkeley is the odd one out by selling less than 6% of its homes through the scheme.

Read more about how the UK commercial property sector is performing.

Help to Buy: benefits and drawbacks

The success of Help to Buy has been mixed and opinion about the scheme is divided. As intended, the scheme has encouraged the industry to increase the supply of new houses. According to AJ Bell, the nine leading housebuilders built 80,000 new homes between them in 2018, 13% more than they managed at the previous peak of activity in 2006 and almost double the number of completions recorded in 2011. But that remains far from the government’s 300,000 per-year target and the industry is still producing considerably fewer homes than it was before the financial crisis, while growth in the number of new completions last year reached a seven-year low.

Many in the industry have been criticised for sitting on land to squeeze supply and maintain higher prices, preventing the government from reaching its targets. Persimmon has said it aims to bring land 'into production as promptly as possible' and points to the fact that annual production has risen over 75% over the past five years. Others in the industry have said it is limited because it takes too long to secure planning permission, or because they are constrained in terms of capacity. Barratt, the UK’s largest housebuilder, produced over 17,500 homes last year, close to its capacity. The industry is also not keen to rush production as this has clearly compromised the quality of homes that have been built over recent years.

The scheme has helped nearly 200,000 people – mostly first-time buyers – get on the housing ladder but many question the value for money they are getting, even at a time when house prices are seemingly only going up. Some argue the guarantee of government money means Help to Buy has simply inflated prices, which only benefits the housebuilders and the banks – not the buyer. That argument has gained traction as the sector’s profits have become more excessive, while executives and shareholders have taken billions out of their businesses that could, some argue, have been used to really boost supply to help solve Britain’s long and unresolved housing crisis.

Persimmon becomes first UK housebuilder to bank £1 billion profit

Persimmon became the first company to break the threshold after reporting a pre-tax profit of £1.09 billion in 2018. That was up 13% from the year before and once again grew at a faster rate than revenue, up 9.2%, and the meagre 2.5% increase in the number of new homes built. Persimmon’s margin expanded yet again and now stands at 29% thanks to higher prices, lower build costs due to a greater proportion of sales coming from smaller homes and those sold to Housing Association partners, and a reduction in the amount spent replacing land it has built on.

Persimmon has managed to outperform its peers on several fronts since the introduction of Help to Buy in 2013. Persimmon has not only increased the number of new homes it builds each year, at a faster rate than its peers (up 75% since 2012), but outperformed its rivals when it comes to improving profitability (nearly doubling its margin over the last five years) and making the best use of its cash (with leading return on capital employed of over 52%). The annual dividend last year was 3.3 times larger than five years earlier, and among the fastest growing payouts over the period alongside peers like Barratt and Bellway.

However, Persimmon is not without its criticisms. Despite trebling the amount of profit it makes on each home since Help to Buy was introduced, Persimmon has been accused of delivering sub-par houses and sacrificing quality for profit. Fewer than eight out of ten people that bought a Persimmon home last year would recommend the firm to a friend, which is not the lowest nor highest ranking among a sector that, as a whole, has failed to fully satisfy a large proportion of new homeowners. The departure of former chief executive officer (CEO) Jeff Fairburn last year following disapproval of his bonus drew further attention to the possibility that housebuilders are failing to keep up their end of the bargain, and excessively profiting at the taxpayer’s expense.

Help to Buy review and UK housebuilders: what will be the impact?

Aware that the scheme is not ideal, the government has announced it will review Help to Buy. The scheme was originally set to close altogether in 2021 but has been extended for two years to 2023. However, it has said the scheme will only be available to first-time buyers over the two additional years. Chancellor Philip Hammond has also said regional price caps will be introduced to limit the amount housebuilders can make on each property, limiting the price of a new build to 1.5 times the average value of a first-time purchase in the local area.

Several media outlets have cited an unidentified source close to housing minister James Brokenshire as stating 'Help to Buy will look different' after 2021, adding it will 'definitely not be funding leasehold properties' – whereby buyers effectively buy the right to live in the property without owning it, restricting the amount of modifications that can be made and limiting the appeal to make them hard to sell on, leaving many with properties worth far less than they purchased them for.

The same source has also hinted the government could begin deciding what companies can benefit from Help to Buy as it draws to a close, giving access only to those that have demonstrated they can deliver high quality homes at reasonable prices, stating the government will 'look carefully at developer performance over recent years'.

Will Persimmon lose its Help to Buy contract?

Still, these claims should be taken with a pinch of salt, as should reports that Persimmon is the main target. Firstly, Persimmon has said it has had 'no direct communication from government' regarding its Help to Buy contract. Secondly, issues over build quality and service are not confined to Persimmon and claims it sits on land to eke out profit are allayed by the fact it has a smaller land bank than its peers and significantly raised production over the last six years – having built over 97,000 homes since 2012. Thirdly, the anger over the excessive pay of Fairburn should have subsided after the CEO resigned and was replaced by David Jenkinson, who, after banking a £40 million bonus under the same scheme last year, has said he will not take an annual bonus this year to demonstrate the company is changing its ways. The current reason Persimmon is attracting unwanted attention and finds itself in the spotlight rather than its peers is because some are starting to draw a link between the fact Persimmon is the most reliant on the scheme, and the most profitable.

There is also an argument that the rumours spilling out of government are unverified for good reason - sent as a way of sending the industry an ‘unofficial’ message that it needs to clean up its act. That does carry some weight, because government will want to tread carefully to get housebuilders to do their job without stifling supply. The government wants the industry to produce 300,000 new houses annually by the mid-2020s compared to under 200,000 now and, considering four in ten new builds are bought using Help to Buy, ending or limiting access to the scheme seems a counterintuitive measure. The number of housebuilders responsible for the UK’s new housing supply has dwindled as a result of steady consolidation over the last four decades, meaning the government is now more reliant on the nine leading firms to supply new housing than the housebuilders are on the Help to Buy scheme. Plus, ending the scheme would only push down the number of new houses coming onto the market, further exacerbating the rise in prices.

What is the outlook for Persimmon and UK housebuilders?

Persimmon’s forward sales at the end of 2018 were broadly flat from the year before at just over £2 billion and the housebuilder has said it expects to sell roughly the same number of homes in 2019 as it did last year. It has warned the 'outlook remains subject to a degree of uncertainty', particularly because of the lack of clarity over Brexit.

‘Significant upside’ for UK housebuilders is Brexit woes improve.

The company is trying to provide buyers with more accurate timelines as to when they can move in, just one effort to improve satisfaction. Persimmon said it will not put its homes up for sale as early to allow them to be further developed before being viewed. 'Whilst we do not expect this will impact on the group’s completions for the year overall, these measures have contributed to a slower pace of sales reservations in the early weeks of the current spring trading period,' Persimmon said upon releasing its annual results. The average rate made on each property in the first eight weeks of 2019 was 4% lower than the year before due to these factors. Still, average selling prices were 2% higher, double the annual growth rate delivered in 2018.

Persimmon and the results of other housebuilders in the second half of this year will also come up against tough comparatives from the year before, when the government cut stamp duty to stimulate buyers in November 2017.

The company has said it will also continue to be selective with purchases of new land, targeting ones that can be developed quickly to deliver near-term returns. It argues this approach has been a 'key driver' to its 'superior margins', which could be under threat if the government carries through on its threat to introduce price caps.

Still, the government wants the industry to raise annual output by over one-third over the coming years and the industry is safe in the knowledge that the Help to Buy scheme will continue in its current form until 2021, with many believing it has become too big to fail and will continue even past the current 2023 deadline. While Persimmon and others may find some resistance against the amount of profit they make and be inclined to tone down the amount it pays management and investors, the foundations underpinning the industry are as strong as ever: the UK is still starved of new housing, high prices are offering huge margins and demand through Help to Buy has fuelled demand in a market that is otherwise in a slowdown.

What is the dividend outlook for Persimmon and UK housebuilders?

When the financial crash began to bite in 2008, the nine leading housebuilders held collective net debt of £4.4 billion on their balance sheets. In 2018, they saw their combined net cash piles rise by £500 million to total £3.5 billion while dividend payments reached an all-time high of £2.3 billion, according to AJ Bell.

Are share buybacks the fruits of labour or the consequence of short-term focus?

Although the industry is receiving criticism for the amount that is being returned to shareholders, there is little else to do with it. Although the industry has been undergoing consolidation for decades, there is no appetite for any major mergers and acquisitions (M&A) while Brexit continues to cast a cloud over matters for the next two years, and signs suggest housebuilders are becoming more selective with what land they purchase and which developments they chase rather than hoarding it. The criticism about how the cash is generated are warranted, and disapproval of any faults or low-quality builds at a time when Persimmon is raking in profit is justified – but returning excess cash to shareholders seems sensible.

What is the impact of Brexit on house prices?

Persimmon’s upcoming dividend payments from March 2019 to July 2021

Bumper payouts will keep the sector on the government’s radar. When it released its new strategy in 2012, a year before Help to Buy was launched, Persimmon said it was aiming to return £6.20 per share to investors over the ten years to 2021. But, following the introduction of the scheme, Persimmon has already returned £7.20 to shareholders since then, and said it will have returned a total of £13.00 by the end of 2021 – more than double its original target.

UK Housebuilders: dividend comparison

Overall, the nine leading housebuilders returned £2.3 billion to investors last year, up from around £1.8 billion in 2017, £1.5 billion in 2016, £1.2 billion in 2015, £600 million in 2014 and just £370 million in 2013, when Help to Buy was introduced. 'Surging dividends across the board will doubtless also catch Whitehall’s eye but at least growth in completions is now outstripping growth in prices, so that may defuse some of the accusations of profiteering on the back of the government’s Help-to-Buy subsidy,' said Russ Mould, investment director at AJ Bell, in February.

^{(Source: AJ Bell February 2019, citing Webfg and consensus analysts’ forecasts for 2019)}

How have Persimmon shares performed vs its peers?

Persimmon shares have managed to outperform the wider market over the last five years but has underperformed over shorter timeframes. For example, Taylor Wimpey, Bovis and Barratt shares have all risen at over twice the rate of Persimmon shares since the start of 2019 and the stock has been one of the worst performers over the past six months:

^{(As of close on March 12, 2019)}

How to trade Persimmon shares and housebuilding stocks

Overall, brokers are bullish on UK housebuilding stocks and believe the majority are undervalued. Persimmon, Taylor Wimpey, Barratt, Redrow and Bellway all have 'Buy' recommendations, according to Reuters, although there is a significant number that believe they are adequately valued:

Can Persimmon build on strong foundations?

From a financial standpoint, the last six years has been transformational for Persimmon. The company is building 75% more houses per year than it was back in 2012 and, in order to maximise the opportunity presented by ever-rising house prices, is making more than three times in profit per house. The resulting cash generation has left it with more cash than it knows what to do with, leading it to return large sums to shareholders with a transparent plan in place over shareholder returns through to 2021.

However, this stunning growth has been fuelled by the government’s Help to Buy scheme, which Persimmon has become particularly reliant upon by with nearly half of its houses being sold through the scheme. And, as housebuilders and investors swim in cash, there is clear evidence that Persimmon and others have become complacent in recent years by delivering sub-standard builds and poor service. Plus, any encouragement provided by the scheme to get the industry to build more houses seems to be waning, with growth in new-builds hitting a seven-year low in 2018. Persimmon expects to build roughly the same amount of houses this year as it did in 2018, but profitability should continue to benefit from higher prices and the firm’s relentless approach to margin improvement.

It is likely that the government will look to rein-in these profit-making machines, at least in public to demonstrate it is putting buyers and not business first. But the recent media reports suggesting the government is threatening to strip poor-performing housebuilders of their Help to Buy contracts is likely to be just that: a threat. The government is dependent on the largest players to provide the new housing that the UK needs and its ambitious target to have 300,000 new house built per year by the mid 2020s. Ultimately, it is not in its interests to discourage or restrict the industry’s ability to build but it is in the interest of both the government and industry to demonstrate the market is fit for purpose and that taxpayer-funded schemes are delivering for who they were designed for: the buyer.

For now, it isn’t about how Persimmon and others got to where they are now, but how they conduct themselves going forward.