Table Of Content

INDUSTRY NOTE Rating | Target | Estimate Change 7 January 2013 UK | Industrials | Building Materials Building Materials E Q New Year New Build U I T Y Key Takeaway R E Overweight Residential, Neutral Merchants, Underweight Construction S E Recall to UK Housebuilders Sector stance: Overweight. We believe that residential new A build is the sweet spot of the UK building and construction markets and we are not alone in R this view. We have BUY ratings on Barratt, Bovis, Galliford Try, Redrow and Taylor Wimpey. C However we are the only sellers of Berkeley Group, where we believe that the attractions of H the £13 return has distracted investors from seeing value elsewhere. The current premium E suggests to us it is time to take profits in Berkeley, but remain invested in the sector. U R UK Residential services. Sector stance Overweight. We prefer those with direct rather O than indirect exposure of the UK Housing market. Our top picks are BUY LSL which is P both a self help story and a direct beneficiary of any increase in the level of housing E transactions. Whilst we highly rate the business model of Rightmove, we rate the shares as UNDERPERFORM as we believe that the valuation suggests a growth story when the business in our view is becoming an income story. UK Builders Merchants: Sector stance Neutral. We were the first to become sellers of Wolseley following their autumn 2012 analyst visit to the US and we remain the only sellers. We believe its exposure to residential new build is lower than many perceive and we do not share the view that a return to peak margins is a foregone conclusion. In our view the shares have traveled ahead of arrival and we maintain our UNDERPERFORM rating on the shares. We have a BUY rating on SIG where we believe that maturing branches in France and energy and insulation regulation will lead to out performance. ***Jefferies Hoare Govett, a division of Jefferies International Limited, acts as a corporate broker UK Construction: Sector stance Underweight. In our view there are major headwinds for this company. facing the sector in 2013, however in our view two shares offer attractions in an underweight Anthony Codling * market: Keller, the early cycle global ground engineering company with significant exposure Equity Analyst to the US, where we do not believe that the early cycle or US exposure is fully reflected in the +44 0 (20) 7029 8677 [email protected] price of the shares; Morgan Sindall is a UK based contractor where concerns about future Sam Cullen * Equity Analyst dividends have led to a compelling valuation entry point even if the dividend is excluded 44 (0) 20 7029 8669 [email protected] from the calculation. * Jefferies International Limited Current Previous Current Previous Current Previous Ticker Price Rating Rating Target Target Est. 2013 2014 2015 2013 2014 2015 BDEV LN 208.80p BUY BUY 250.00p 204.00p EPS 13.80p 19.70p 23.70p 12.50p 15.60p 17.50p BKG LN 1,798.00p UNPF HOLD 1,500.00p 1,545.00p EPS 140.00p 160.00p 161.30p 133.70p 147.60p 158.80p *** BVS LN 586.00p BUY BUY 670.00p 607.00p EPS 38.30p 49.70p 59.00p 38.30p 49.70p 59.00p BWY LN 1,048.00p HOLD HOLD 1,100.00p 1,004.00p EPS 81.60p 102.40p 117.70p 78.40p 100.60p 116.50p *** GFRD LN 761.00p BUY BUY 920.00p 858.00p EPS 69.40p 75.20p 96.40p 69.40p 75.20p 96.40p GN5 ID €4.06 HOLD BUY €3.90 €3.70 EPS €0.24 €0.31 €0.38 €0.23 -- -- HWDN LN 172.00p HOLD HOLD 160.00p 160.00p EPS 14.70p 16.00p 17.00p 14.70p 16.00p 17.00p *** KLR LN 728.00p BUY BUY 820.00p 651.00p EPS 50.73p 58.49p 64.40p 50.73p 58.49p -- *** LSL LN 260.00p BUY BUY 310.00p 300.00p EPS 23.90p 25.70p 26.70p 23.90p 25.70p 26.70p *** MGNS LN 534.00p BUY BUY 650.00p 840.00p EPS 68.67p 70.40p 74.60p 68.67p 70.40p 74.60p PSN LN 829.00p HOLD BUY 850.00p 821.00p EPS 59.90p 67.20p 73.00p 59.90p 67.20p 73.00p RDW LN 168.00p BUY HOLD 200.00p 152.00p EPS 11.40p 16.00p 20.20p 10.70p 14.40p 18.00p RMV LN 1,460.00p UNPF UNPF 1,200.00p 1,200.00p EPS 74.20p 80.70p 89.20p 74.20p 80.70p 89.20p SHI LN 123.80p BUY BUY 137.00p 129.00p EPS 10.40p 12.00p 14.30p 10.00p -- -- TPK LN 1,124.00p HOLD HOLD 1,130.00p 1,120.00p EPS 96.90p 107.70p 124.60p 94.40p -- -- *** TW/ LN 68.55p BUY BUY 80.00p 72.00p EPS 5.20p 6.90p 7.90p 5.20p 6.90p 7.90p WOS LN 3,016.00p UNPF UNPF 2,500.00p 2,300.00p EPS 187.40p 212.60p 236.60p 182.60p 206.70p -- Jefferies does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that Jefferies may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Please see analyst certifications, important disclosure information, and information regarding the status of non-US analysts on pages 593 to 596 of this report. Industrials Rating | Target | Estimate Change 7 January 2013 Contents UK Housebuilders .......................................................................................................................... 4 UK Residential Services ................................................................................................................. 4 UK Builders Merchants .................................................................................................................. 4 UK Contractors .............................................................................................................................. 4 Recommendation Summary .......................................................................................................... 5 Valuation ....................................................................................................................................... 9 UK Housebuilders ..................................................................................................................... 9 UK Residential Services .......................................................................................................... 15 UK Builders Merchants ........................................................................................................... 16 UK Contractors ....................................................................................................................... 17 Macroeconomic forecasts .......................................................................................................... 18 UK Housing Market Momentum Map ......................................................................................... 19 UK Builders Merchants Momentum Map .................................................................................... 22 UK Contractors Momentum Map ................................................................................................ 27 Share price seasonality................................................................................................................ 34 UK HOUSING MARKET OVERVIEW ............................................................................................ 40 Current UK Housing Stock ........................................................................................................... 40 Occupied and vacant dwellings ................................................................................................... 45 Age profile of current Housing stock ........................................................................................... 47 Housing all grown up ............................................................................................................. 47 What is the life span of a house? ........................................................................................... 47 Housing Tenure ........................................................................................................................... 51 Tenure: Trends ............................................................................................................................ 54 Tenure and age ........................................................................................................................... 56 Tenure and economic status ....................................................................................................... 56 Tenure and Income ..................................................................................................................... 59 Tenure and housing costs ............................................................................................................ 61 Tenure and housing equity .......................................................................................................... 65 Household moving patterns ........................................................................................................ 69 Recently moved households ........................................................................................................ 70 UK Household formation ............................................................................................................. 74 UK Housing Supply ...................................................................................................................... 78 UK Housing Transactions ............................................................................................................ 87 UK HOUSE PRICES .................................................................................................................... 100 Regional House Prices ............................................................................................................... 107 House Prices and affordability .................................................................................................. 114 The CAFI – housing affordability ............................................................................................... 126 Rents and affordability .............................................................................................................. 130 Land Prices ................................................................................................................................ 135 Landbank by housebuilder ........................................................................................................ 137 Strategic Land ........................................................................................................................... 139 ROCE vs Margin (Short vs long landbanks) ................................................................................ 142 Planning .................................................................................................................................... 149 Land use in the UK ..................................................................................................................... 153 Housing, Government and Growth............................................................................................ 155 Housing Under supply in England .............................................................................................. 159 Build costs ................................................................................................................................. 163 Building Regulations ................................................................................................................. 167 MORTGAGE MARKET OVERVIEW ............................................................................................. 169 UK Mortgage Market Size ......................................................................................................... 169 Market participants .................................................................................................................. 170 Overall Mortgage Market statistics .......................................................................................... 171 First Time buyer Mortgage Market Statistics ............................................................................ 172 Market share of popular mortgage products ............................................................................ 173 Mortgage Approvals ................................................................................................................. 174 Mortgage Lending ..................................................................................................................... 177 Regional Mortgage Lending ...................................................................................................... 178 First Time Buyers ....................................................................................................................... 185 Homemovers ............................................................................................................................. 188 Buy to Let .................................................................................................................................. 191 Mortgage arrears and Possessions ........................................................................................... 194 Mortgage Rates ........................................................................................................................ 197 Mortgage rates and mortgage approvals ................................................................................. 201 Mortgage rates and share prices .............................................................................................. 203 BUILDERS MERCHANTS MARKET OVERVIEW ............................................................................ 207 Industry Summary ..................................................................................................................... 207 page 2 of 596 Anthony Codling, Equity Analyst, +44 0 (20) 7029 8677, [email protected] Please see important disclosure information on pages 593 - 596 of this report. Industrials Rating | Target | Estimate Change 7 January 2013 Market Drivers .......................................................................................................................... 209 Residential RMI Demand ...................................................................................................... 210 Non-Residential RMI Demand .............................................................................................. 214 New Residential Demand ..................................................................................................... 215 New Non-Residential and Civil Demand ............................................................................... 217 Market Characteristics .............................................................................................................. 218 Merchanting Demand Less Cyclical than Overall Construction ............................................ 218 Markets Consolidating, Larger Players Outperforming Independents ................................. 219 Inflation can be Beneficial .................................................................................................... 221 Leverage Higher than Assumed............................................................................................ 223 Structural Drivers in Insulation ............................................................................................. 225 CONSTRUCTION MARKET OVERVIEW ....................................................................................... 227 Industry Summary ..................................................................................................................... 227 Overview of Construction Markets ............................................................................................ 228 MAJOR CONSTRUCTION MARKET OVERVIEW .......................................................................... 238 UK.............................................................................................................................................. 238 North America ........................................................................................................................... 247 Western and Eastern Europe ..................................................................................................... 258 Nordics ...................................................................................................................................... 268 Rest of the World ...................................................................................................................... 276 COMPANY UPDATES ................................................................................................................ 285 UK Housebuilders ...................................................................................................................... 285 Valuation Summary.............................................................................................................. 285 Risk Factors .......................................................................................................................... 286 Barratt Developments [BDEV LN, PT 250p, BUY] .................................................................. 290 Bellway [BWY LN, PT 1100p, Hold) ....................................................................................... 302 Berkeley Group [BKG LN, PT 1500p, Underperform] ............................................................ 314 Bovis Homes (BVS LN, PT 670p, BUY) ................................................................................... 326 Galliford Try [GFRD LN, PT 920p, BUY] ................................................................................. 338 Persimmon [PSN LN, PT 850p, HOLD] ................................................................................... 352 Redrow [RDW LN, PT 200p, BUY] ......................................................................................... 364 Telford Homes [TEF LN, NC] ................................................................................................. 376 Taylor Wimpey [TW/LN, PT 80p, BUY] ................................................................................. 380 UK Residential Services ............................................................................................................. 392 Valuation Summary.............................................................................................................. 392 Risk factors ........................................................................................................................... 392 LSL Property Services [LSL LN, PT 310P, BUY] ....................................................................... 394 Rightmove [RMV LN, PT 1200p, UNDERPERFORM] ............................................................. 414 Savills [SVS LN, NC] ............................................................................................................... 432 Winkworth [WINK LN, NC] ................................................................................................... 436 Builders Merchants ................................................................................................................... 440 Valuation Summary.............................................................................................................. 444 Risk Factors .......................................................................................................................... 438 Grafton Group [GN5 ID, PT €3.9, HOLD] ............................................................................... 440 Home Retail Group [HOME LN, NC] ...................................................................................... 458 Howden Joinery [HWDN LN, PT 160p, HOLD] ....................................................................... 462 SIG [SHI LN, PT 137p, BUY] ................................................................................................... 482 Travis Perkins [TPK LN, PT 1130p, HOLD] ............................................................................. 498 Wolseley [WOS LN, PT 2500p, UNDERPERFORM] ................................................................ 512 UK Construction ........................................................................................................................ 527 Valuation Summary.............................................................................................................. 527 Factors ................................................................................................................................. 528 Balfour Beatty [BBY LN, NC] ................................................................................................. 530 Carillion [CLLN LN, NC] ......................................................................................................... 534 Interserve [IRV LN, NC] ......................................................................................................... 538 Kier [KIE LN, NC] ................................................................................................................... 542 Keller [KLR LN, PT 820p, BUY] ............................................................................................... 546 Morgan SIndall [MGNS LN, PT 650p, BUY] ........................................................................... 562 LONG VIEWS ............................................................................................................................ 575 page 3 of 596 Anthony Codling, Equity Analyst, +44 0 (20) 7029 8677, [email protected] Please see important disclosure information on pages 593 - 596 of this report. Industrials Rating | Target | Estimate Change 7 January 2013 Executive Summary The Home advantage We believe that 2013 will favour those with exposure to the new build markets, in and particular the new build UK housing market. Having had three years to get their houses in order, we believe it is time for the UK housebuilders to play their home advantage. We also expect that the UK Residential services sector will also be a beneficiary of a recovering housing market. Away from residential, we expect the construction markets to remain challenging, although those with a bias towards new build are likely to outperform those that do not, in our view. UK Housebuilders In our view, the UK housing market has been stable since January 2010, and after three years of stability, each housebuilder has their house in order and is poised for growth. It is our assessment that with one or two exceptions the sector is valued assuming that stability of the last three years continues. We sense that the UK government is ever more serious about getting Britain building, and if they follow through on the rhetoric, we believe that the share prices in the sector will also build. UK Residential Services To a large extent the fortunes of the residential services market are inextricably linked to the level of housing transactions, around which their services are based. However, the re- emergence of the Private Rented Sector in the UK is a growing source of profits and opportunity as strict mortgage lending requirements push owner occupation of homes out of the reach of many. With limited investment opportunities in this sector we would encourage investors to take the long view, we expect that being six or twelve months early into the sector will pay larger dividends than investing with the herd as transaction levels accelerate. UK Builders Merchants The index of the UK Builders’ Merchants has seen share prices rise 48% in 2012, reflecting the progress all the companies have made putting their houses in order since the economic crisis. We believe significant operational leverage remains across the sector and profit drop through will be meaningful as volumes recover. However, with estimate for developed countries construction markets largely showing continued declines in 2013, we are cautious on the prospects for significant volume recovery. With volumes likely to remain anaemic margin expansion is likely to be limited, as the major companies fight both against their underlying costs and pricing pressure coming from the independents. In low volume markets we prefer exposure to companies with exposure to products that have structural demand drivers, such as insulation. UK Contractors Whereas the UK housing market has been stable for the past three years, the UK Construction market has been in decline and the outturn to 2012 did not make happy reading, or fill one with confidence for 2013, which may be unlucky for some. The market remains extremely competitive and many private contractors are fighting for survival, which continues to put downward pressure on margins and volumes for the larger listed players in the market. In our view, many contractors are seeking to redefine themselves as the markets work against them. We believe the appropriate response is to know your enemy, hunker down and stick to your knitting. We favour the early cycle play Keller and the re-focused Morgan Sindall. page 4 of 596 Anthony Codling, Equity Analyst, +44 0 (20) 7029 8677, [email protected] Please see important disclosure information on pages 593 - 596 of this report. Industrials Rating | Target | Estimate Change 7 January 2013 Recommendation Summary UK housebuilders Key themes for each sector Barratt – BUY – Price Target 250p In our view Barratt trades at an unjustified discount to the sector. We see no reason why the shares should trade below our estimate of CY2013 Tangible Net Asset Value (TNAV) of 240p and our valuation model suggests that fair value is 245p. Barratt is viewed as one of the higher beta stocks in the sector; however our view is that the UK housing market is currently stable but poised for growth, which we believe would lead to Barratt’s shares outperforming the market. Bellway – HOLD – Price Target 1100p We reiterate our HOLD recommendation on the shares. In our view Bellway’s reputation for consistent returns is reflected in the price of its shares, which we estimate offers among the least upsides of the UK national housebuilders we follow from here. We are also mindful that consistency is not easy, and with the current situation of all change at the management level of the Group there are risks that the consistency does not continue. Our Hold recommendation therefore reflects a relatively full valuation and a chance to let the dust settle in the Board room. Berkeley – UNDERPERFORM (from Hold)– Price Target 1500p Berkeley is the consensus BUY in the sector, which in our view has led to the market having a blind and unquestioning faith in the shares. We do not doubt the attractions, but these attractions burn so brightly it is easy not to see the valuation opportunities elsewhere and in our view the attractions have led to investors taking their eyes of the fundamentals. Berkeley has re-rated and yet others who we believe will actually generate higher earnings ‘pound for pound’ than Berkeley trade at a significant discount to that of Berkeley Group. The arrivals lounge may be comfortable, but at the end of the day it is merely a waiting room, whereas there are other shares where the journey has only just begun. A fuller discussion of the relative earnings potential across the sector can be seen on page 8 of this report. Bovis – BUY – Price Target 670p We believe that Bovis has a straight forward growth plan which demonstrably driving earnings growth today and we expect that growth to continue in the future Bovis clear and logical growth plan: increase volumes, increase average selling prices and increase profit margins. Whilst this may be easier said than done, Bovis is both saying it and doing it. ASP growth will be driven by product and site mix as the group builds more family homes in the south of England. We believe that there is a compelling logic to these mix changes. The areas where Bovis is focusing its land buying account for 65% of the UK workforce (excluding Central London) and 80% of the employment is based in the private sector. Unemployment levels are also typically 300bp lower than the rest of the country. According to the Halifax house price index, house prices have also been firmer in these regions than elsewhere. Galliford Try – BUY – Price Target 920p Galliford in our opinion is under covered and therefore often overlooked when considering investments in the UK housebuilding sector. This dynamic , in our view translates into an attractive entry point to the shares. Our cross sector analysis of earnings generation and PER multiples over the next three years (see the UK Housebuilders Valuation Themes section of this report) suggests to us that Galliford offers the most bang for your buck in the sector. page 5 of 596 Anthony Codling, Equity Analyst, +44 0 (20) 7029 8677, [email protected] Please see important disclosure information on pages 593 - 596 of this report. Industrials Rating | Target | Estimate Change 7 January 2013 Persimmon – HOLD (from Buy) – Price Target 850p We continue to view Persimmon as the perfect proxy for the sector. The attractions are clear a strong and stable management team; a lengthy and broadly spread landbank which is underpinned by a well-positioned strategic landbank topped off with the intention to return 620p per share to shareholders by 30 June 2021. However, we are moving to HOLD from Buy on valuation grounds Persimmon’s shares increased in value by 75% in 2012 and in our view much of these gains relate to the proposed capital return programme announced on 28 February 2012. Our analysis in the UK Housebuilder Valuation Themes section of this report (page 8) suggests that we expect a number of other housebuilders to generate significant cashflows over a three year period and that investors are currently paying a premium to access Persimmon’s capital return programme. Those who are not already part of the programme may in our view, currently, find better value elsewhere. Redrow – BUY (from Hold) – Price Target 200p Our hold recommendation was made with reference to the level of the potential bid and the share price at the time of our initiation on 11 September 2012. With the potential bidders controlling north of 50% of the votes we were concerned that the bid would be passively accepted by tracker funds without due consideration to fair value. We were heartened by the efforts of the vocal few, who, in our view, ensured that the issue of fair value was high enough up the agenda to thwart what we believed was a low balled potential approach. Should another bid emerge we have confidence that fair value will remain a key talking point, and for the avoidance of doubt, we would not advise investors to accept a bid which was not at a premium to our Price Target. Taylor Wimpey – BUY – Price Target 80p In our view, following a strategy review in 2011, it has all the ingredients in place for a significant re-rating. Having started at the beginning with land strategy and cleaned up its operations with VIM, it has a clear strategy and one which not only has crystallised best practice from within, but also which echoes the strategies successfully employed by others (strategic land – Persimmon, and landbank optimisation – Berkeley Group). In our view, the price of the shares has yet to recognise the potential of the value strategy. We also believe that Taylor Wimpey is the least likely to embark on a long term capital return programme. Whilst such a strategy has, in our view, aided the share prices of those who have pursued it, should Taylor Wimpey keep its powder dry then we believe it will be in pole position to cherry pick the M&A opportunities we expect to see in the light of a recovering UK housing market. UK Residential services LSL Property Services – BUY – Price Target 310p At a micro level, in our opinion, LSL is focused on delivering growth in a challenging market, and is neither taking market growth for granted or relying on it to deliver earnings growth. We believe that we have seen the first fruits of this focus and that there is plenty of fruit still to be harvested. At a macro level the UK housing market remains stuck in a low-volume equilibrium, an equilibrium, which, in our view, cannot remain in the long run. We believe that the question surrounding the recovery of the UK housing market is a question of ‘when’ not ‘if’ and that LSL is well positioned to benefit from any favourable movements in the underlying market. Rightmove – U/P – Price Target 1200p We have a UNDERPERFORM rating on the shares a Price Target of 1200p. We highly regard Rightmove’s business model, which we view as robust and resilient, however, on valuation grounds we believe that the risks are to the downside rather than the upside. ARPU and EPS growth over the next five years is, in our view, unlikely to match that of the previous five, and this is at odds with the current trading multiples. Our Price Targets are calculated by applying a 20% weighting to each of the following: long run one year and page 6 of 596 Anthony Codling, Equity Analyst, +44 0 (20) 7029 8677, [email protected] Please see important disclosure information on pages 593 - 596 of this report. Industrials Rating | Target | Estimate Change 7 January 2013 two year forward PER and EV/EBITDA multiples applied to our FY2013 and FY2014 estimates and our Base Case DCF valuation. We also believe that the Group is highly cash generative and will not pursue growth for growth’s sake and therefore may, over time be viewed in a similar way to a utility dividend play. If we treat share buybacks as dividends Rightmove currently has a yield of around 3% and a PER of just over 20.3x against the UK utilities sector averaging a 5.4% yield and a PER of 14.5x. If Rightmove had a similar yield the shares would trade at 833p or a similar PER 1160p. UK Builders Merchants Grafton Group – Hold – Price Target €3.9 Though we believe Grafton has a solid business model, a good management team and is well placed for earnings growth when volumes recover, we are mindful of the challenges the Group is likely to face in 2013; we expect underlying volumes to remain weak. Without volume recovery we believe the Group will find is difficult to reap the rewards of the significant leverage in the business without further cost cutting. Following a summer of significant price appreciation, and considering the challenge outlook, we believe the shares are now up with events and downgrade our rating to Hold. Howden Joinery – Hold– Price Target 160p Our HOLD rating on the shares reflects our belief that the shares are fairly valued in the context of the stable underlying UK housing market and the current dividend policy. The risks are however to the upside rather than the downside. We think it more likely that conditions in the UK housing market improve rather than decline and as the size and scale of the cash calls on the business diminish there is the potential to return significantly more cash to shareholders. However, in our view some are already pricing in the cash return if not the housing recovery. Howden is also essentially a RMI rather than a new build player and currently we believe there are more attractions to the new build housing market than there are to the residential RMI one. SIG – Buy – Price Target 137p SIG is our most preferred stock in the UK merchanting sector, and our only BUY rating. The shares are currently trading at 26% discount to peers on a 2013 EV/EBITDA ratio and are the only shares trading at a discount to the historic average EV/EBITDA ratio. We believe the company will continue to benefit from the structural drivers that result in demand for insulation and its related products growing ahead of overall construction demand, whilst we also expect margins in the European business to start to improve as a greater proportion of branches begin to reach maturity. Travis Perkins – Hold – Price Target 1130p Though we believe Travis Perkins has some obvious attractions, a proven business model, a well-respected management team and further expansion potential, we are happy to remain Holders of the shares at this stage. The outlook for the UK merchanting market remains challenging in 2013 and we see limited opportunities for upgrades this year, as the Group continues to sacrifice some volume growth in order to focuses on keeping its margins in-line. Though greater volume growth may come from a healthier new build market, such work is likely to come at a lower margin. page 7 of 596 Anthony Codling, Equity Analyst, +44 0 (20) 7029 8677, [email protected] Please see important disclosure information on pages 593 - 596 of this report. Industrials Rating | Target | Estimate Change 7 January 2013 Wolseley – Underperform – Price Target 2500p Wolseley’s shares have more than doubled in price since their August 2011 lows of 1404p. Though we expect continued North American progress in 2013 we cannot justify being buyers of the shares at these levels. With headwinds to the US margin likely, in our view, joined by further declines in Europe, and the shares trading at a 34% premium to person an EV/EBITDA basis we are happy to retain out Underperform rating on the shares. UK Contractors Keller – Buy – Price Target 820p In our view Keller is poised for growth. We expect cement consumption in North America and Asia to deliver high-single-digit growth over the next three years and we expect construction activity to reach its nadir in EMEA and Australia in CY2012. In our view cement consumption is a proxy for construction activity. As a ground engineering specialist Keller operates almost exclusively in the new build arena, the market with the earliest exposure to construction market growth. We believe that as demand grows pricing will firm and pricing firmed leads to margin growth. Group operating margins fell from 11.2% in 2007 to 2.0% in 2010 and increased to 2.5% in 2011. The long run average group operating margin is 6.8%, we have a long way to go, but in our view, travel broadens the mind. Our margin estimates for the Group are currently 3.7% in FY2012, 3.9% in FY2013, 4.1% in FY2014 and 4.3% in FY2015. As markets recovery there is a risk that our estimates fail to keep pace with reality as new build markets in theory should outperform the overall construction market. Morgan Sindall – Buy – Price Target 650p The strategy has not changed, but now the entry point is more attractive. With the valuation debate being hi-jacked by discussion about dividends, where uncertainty will remain until the FY2012 results announcement on 21 February 2013, we have re-caste our Price Target without reference to dividends or DCF. We felt it time to re-centre the valuation debate around the fundamentals, irrespective of what the dividend may or may not become, we see fair value at 650p, around 25% ahead of the current price. If we have one eye on the fundamentals, we should have the other focused on the he long game. Although 2012 will be remembered as a tough year for the UK construction sector and at this stage we doubt 2013 will be any easier, we would encourage investors to play the long game. Regeneration sites take time to deliver value, and just as it is darkest before dawn, sometimes before dawn is the best time to invest in growth. Investors familiar with Berkeley Group will be aware that although it cuts its dividend in 2008, whilst the UK housing market was still in free fall, to buy land, the dividends today are higher as a result. The newly appointed CEO, who founded the business in 1977, owns just over 10% of the shares and has lived and breathed Morgan Sindall for the last 36 years. We would suggest that no other holder of the shares is more focused than he is on generating value from his investment. page 8 of 596 Anthony Codling, Equity Analyst, +44 0 (20) 7029 8677, [email protected] Please see important disclosure information on pages 593 - 596 of this report. Industrials Rating | Target | Estimate Change 7 January 2013 Valuation UK Housebuilders Table 1: UK Housebuilders valuation summary Barratt Bellway Berkeley Bovis Galliford Try Persimmon Redrow Taylor Wimpey Recommendation Buy Hold U/P Buy Buy Hold Buy Buy Current Price (p) 209 1,039 1,777 582 755 823 165 69 Current Mkt Cap (£m) 2,048 1,263 2,333 778 618 2,491 610 2,211 Net Debt (£m) 179 41 58 -8 20 -136 14 158 EV (£m) 2,228 1,304 2,391 770 598 2,355 624 2,370 Price to Book Current P/B 0.87 1.02 1.80 0.98 1.14 1.46 1.00 1.18 Multiples Recovery (x) 1.20 1.30 1.30 1.25 1.30 1.50 1.25 1.30 Steady state (x) 1.04 1.01 1.03 1.12 1.07 1.01 1.10 1.13 NBV CY 2013 NBV (p) 240 932 989 595 560 563 166 58 CY 2015 NBV (p) 268 1146 849 674 645 609 189 68 Implied share price Recovery (p) 288 1212 1286 743 728 845 208 75 Steady state (p) 278 1158 875 754 690 615 208 77 Average P/B (p) 283 1185 1080 749 709 730 208 76 PER Current PER 18.4 14.2 13.6 19.7 11.3 15.5 14.0 15.5 Multiples Recovery (x) 16.5 15.0 18.5 18.7 18.8 24.0 18.7 20.5 Steady state (x) 5.8 5.9 7.4 7.4 6.6 6.4 6.9 6.5 EPS CY 2013 EPS (p) 17 90 153 38 63 60 14 5 CY 2015 EPS (p) 24 118 161 59 88 74 20 8 Implied share price Recovery (p) 276 1354 2837 715 1179 1451 265 107 Steady state (p) 136 698 1195 438 581 474 140 52 Average (p) 206 1026 2016 577 880 962 203 80 Blended PER and P/B Price Target (p) 250 1100 1500 670 920 850 200 80 Upside (%) 19 6 -16 15 22 3 21 17 Value of construction arm (p) 118 Source: Jefferies estimates page 9 of 596 Anthony Codling, Equity Analyst, +44 0 (20) 7029 8677, [email protected] Please see important disclosure information on pages 593 - 596 of this report. Industrials Rating | Target | Estimate Change 7 January 2013 UK Housebuilders valuation themes At a macro level housebuilder share prices are highly correlated to the value of transactions in the UK housing market. This top down, macro filter is, in our mind very interesting as it has little to do with the underlying performance of each individual company. However, at a micro level, the value of a company’s shares should, in theory, reflect the cashflows it generates and ultimately returns to shareholders. These cashflow returns are not purely a function of the underlying market, although as we saw in the run up to the credit crunch and in the events which followed it, macro factors can at times seriously overrule the micro ones. The traditional way to value the housebuilder is price to book value (share price divided by the net tangible assets per share). In theory if the price to book ratio is greater than one, the market believes that the company will ‘add value’, but how do we assess this added value? One way is to look at the returns made on those tangible assets, such as ROCE and return on capital employed is making a comeback as a valuation metric. However, we believe that the traditional definition of return on capital is not appropriate for housebuilers, because the majority of capital is not employed to generate the returns in any one year. This capital ‘unemployed’ creates a drag on ROCE. In our view ROCE is only important for a housebuilder as it makes investment decisions, for instance what is the ROCE on this piece of land, or what is the ROCE on this cost saving initiative. In both cases the decision should be judged with respect to the ROCE over the life of the asset (the duration of the build out of the land), or the duration of the project, rather than in any one accounting period. The ROCE theorists, suggest that asset turn should take priority over operating margin, that it is better to generate cash and re-invest it, than to have higher margins but generate less cash to re-invest. We would therefore expect ROCE players to have lower margins, shorter landbanks, but higher ROCE. Looking at ROCE (including land creditors) would suggest that the advocates of ROCE are Berkeley, Galliford Try and Persimmon, rather than Barratt and Redrow. However of the three only Galliford has a leaning towards ROCE. Interestingly Berkeley and Persimmon also have longest landbanks and therefore, in theory the most tempered ROCE. With respect to operating margins Berkeley is in its own league and on a three year view only Barratt and to a small extent Galliford and Redrow trail the pack and these are the three with the shortest landbanks. In practice therefore landbank length does not appear to be a drag on ROCE, in fact Barratt and Redrow, those with the lowest ROCE also have some of the shortest landbanks in the sector. In the current period of stable house prices, we have to look hard to see the positive margin impact of a long landbank and it is of little surprise that Berkeley, with the longest (the one which has had the most benefit of underlying nominal house price inflation) also has the highest margins. If nominal house price inflation returns we expect to see the margin differential between the long and the shorter landbank company’s increase. page 10 of 596 Anthony Codling, Equity Analyst, +44 0 (20) 7029 8677, [email protected] Please see important disclosure information on pages 593 - 596 of this report.