Where next for Persimmon shares after its bullish trading update?

The Persimmon (LON: PSN) share price is highly cyclical. It was 1,687p five years ago, before rising to 2,880p by 8 June 2018. It then slowly fell to 1,900p by 30 November 2018.

After recovering to 2,468p by 22 February 2019, it fell again to 1,841p on 16 August 2019. Next, it rocketed to 3,282p by 21 February 2020. However, the onset of the pandemic saw it fall 50% to 1,622p by 3 April 2020. But less than a year later, it had risen to 3,238p on 1 June 2021.

Since then, Persimmon's share price has fallen to 2,690p. And it could sink further.

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Persimmon share price: trading update

But Persimmon struck a bullish tone for the future. CEO Dean Finch said that ‘Persimmon continued to perform well through the period against a backdrop of healthy demand.’ He further commented that ‘healthy selling prices and our off-site manufacturing capabilities are mitigating inflationary pressures.’

And the numbers support his claim of a strong performance in the period. Average reservations per site of private new home sales are around 16% higher than in 2019. In terms of growth, Persimmon expects to deliver around 10% more completions in 2021 compared to 2020. £1.15 billion of forward sales are reserved beyond 2021, £200 million more than in 2019. Encouragingly, customer satisfaction is over 92% for the survey year.

Moreover, the group is in a strong financial position. It’s spent £380 million on new land for building year-to-date and has maintained a healthy cash balance of £895 million. Given these positive metrics, it might be surprising to the casual observer that the Persimmon share has fallen 16% in the past six months. But there are several potential explanations.

Persimmon's outlook

Persimmon believes that ‘the fundamentals of the UK housing market remain strong, with good levels of consumer demand and confidence, mortgage availability and low interest rates.’

But like competitors Taylor Wimpey and Barratt Developments, the Persimmon share price is highly cyclical. And the UK housing market might have peaked, with average prices rising 10.6% in the past year to August 2021 to £264,000. While Strutt and Parker believe prices could rise another 7% in 2022, this is far from guaranteed. In the near term, winter is traditionally quieter for the housing market. And while the ‘race for space’ may be continuing, the end of stamp duty holiday in September will take some heat out of the market.

One key concern for Persimmon is the effect of inflation and interest rates on UK house prices. The company said it will ‘continue to manage the inflationary pressures in the industry well and anticipate that margins will remain resilient.’ It acknowledged the ‘continuing concerns relating to the pandemic on cost inflation and the supply chain and their impact on interest rates, consumer confidence and the UK economy.’

But house prices are determined by mortgage affordability. The base interest rate has been held under 1% for over a decade, and the Bank of England held off from raising it last week. However, mortgage rates are already increasing in anticipation of rises in 2022. And as banks generally limit mortgage borrowing to 4.5x earnings, there comes a point where prices will stagnate as buyers become unable to meet the leveraging requirements.

With inflation set to hit 5% in April next year, and supply chain issues remaining stubbornly persistent, the cost and availability of building materials could become a profitability problem. Moreover, if there’s a housing market correction, Persimmon will get less money for the homes it sells.

But the builder believes it can ‘successfully manage these uncertainties.’ Persimmon does offer an attractive dividend yield of 8.9% and boasts a very reasonable price-to-earnings ratio of around 11. If inflation is indeed transitory, and interest rates remain low, the Persimmon share price could rise again. But unfortunately for the housebuilder, this decision is out of its hands.