New Holding - Berkeley Group

Charlie Huggins (CFA) - Fund Manager

13 February 2020

We recently added a new holding in Berkeley Group, the UK house builder, to the HL Select UK Growth Shares fund. The position accounts for 2.6% of the portfolio and was funded by selling down our FTSE iShares ETF tracker.

What makes Berkeley special?

Berkeley is no ordinary house builder. The group operates primarily in the wealthiest parts of the UK – namely London and the South East, where house prices are supported by higher than average incomes and a shortage of new housing supply.

Within these locations Berkeley focuses on large, complex urban regeneration projects. These sorts of project typically take many years (often decades) to complete, requiring extensive remediation and alterations to the local infrastructure; and significant upfront capital investment. The risk, complexity and capital-intensity of these projects is well beyond the scope of most traditional developers, and many have now left this area of the market. This means Berkeley is now the only developer undertaking major brownfield regeneration at scale in London and the South East.

Another key strength is the quality and size of Berkeley’s land bank, which currently stands at a record 57,000 plots. The company often acquires land without planning consent and uses its expertise and market knowledge to bring this land through the planning system. This is often much cheaper than buying land that already has planning permission, which has led to very healthy returns. Over the last ten years Berkeley has generated an average return on equity (ROE) of 28% versus a sector-average of only 12%. The group is highly opportunistic with land purchases, only acquiring when it considers the terms to be attractive.

This business model has translated into very strong margins and cash flow which in turn has supported regular cash returns to shareholders. Berkeley recently announced an increase of £455 million to its capital return plan and, in total, expects to return around £2bn to shareholders between now and September 2025. Please remember that capital returns are variable and not guaranteed.

Strong management team

Berkeley’s management team is one of the best in the business, in our view, and its strategy has remained consistent for many years. The CEO, Rob Perrins, has been in the job since 2009 and the Chairman and founder, Tony Pidgley retains a very large influence.

The group has navigated the housing cycle brilliantly in the past, funding its growth mainly through internal cash flow. Unlike the other listed house builders, it significantly curtailed its land purchases in the years leading up to the financial crisis. This meant it entered the crisis with a strong balance sheet and had plenty of firepower to snap up cheap land in the years that followed.

Maintaining a strong balance sheet and liquidity profile is crucial for companies operating in cyclical, capital-intensive industries. At 31 October 2019, Berkeley held in excess of £1 billion of net cash on its balance sheet. Berkeley’s ability to sell its homes well in advance of completion is another great strength, providing very good visibility of cash flow. Cash due on forward sales, which will be collected in the next three years, currently stands at £1.9 billion. This balance sheet and cash position underpins our confidence in Berkeley’s capital return plan.

Increasing our UK domestic exposure

This purchase increases the fund’s UK domestic exposure, and there is no doubt that Berkeley’s fortunes will be closely tied to the UK economy. While the share price is likely to suffer in an environment of falling house prices, we would expect the company to capitalise on any land price weakness, just as it did in the aftermath of the financial crisis.

The last few years have presented a highly uncertain economic and political backdrop. But there are grounds for optimism. Although the Brexit puzzle still needs to be solved, the election of a large Tory majority government has removed a lot of the factors that were sapping consumer confidence. This, combined with the likelihood of continued low interest rates and the on-going housing shortage, points to a more favourable market backdrop for Berkeley in the coming years, although as ever there are no guarantees.