HL SELECT UK INCOME SHARES
New Holding - Persimmon
Fund changes
HL SELECT UK INCOME SHARES
Fund changes
Steve Clayton - Fund Manager
21 February 2020
We have taken a position in Persimmon within the HL Select UK Income Shares fund. The general election outcome has transformed the outlook for the UK economy and the housing market in particular, we believe. The prior chaotic situation in Parliament sowed uncertainty and confusion in equal measures, and raised the prospect of a sharp leftwards lurch.
We now have a Government with a strong majority, determined to be seen to be making a positive difference in the regions far beyond Westminster. From a housing market perspective, this is a better position than we have had for some time. We don’t expect a boom, but we do see a favourable backdrop to the market that should allow well-managed builders to trade in a consistently profitable manner.
Persimmon is one of the UK’s most substantial house builders, completing around 16,000 homes a year, the majority for private sale. Their operations span the UK regions, with divisions stretching from Launceston in Cornwall up to Perth in Scotland. The group has only limited exposure to the London region, preferring to trade in the more predictable regional markets.
The timing of our investment is influenced by the changed political landscape, but the choice of Persimmon itself is all about the financial structure of the group. Housebuilders buy land, design developments, obtain the vital planning permissions and then hire subcontractors to do the building works. The homes are marketed and sold, then the caravan packs up and moves to the next site.
To be successful, builders must buy land at the right price, design attractive developments to suit the location and then control the cost of construction to lock in the selling margin they targeted when planning the development. Persimmon’s greatest strengths in our eyes are its land bank and ungeared balance sheet.
The group has sufficient land to support many years of output, without the need for additional land purchases. This allows it to be picky on the price it pays for land, creating greater certainty of future profitability. With net cash in the bank, the group is extremely well financed, further improving the predictability of future returns – though as always, nothing is certain.
Well-priced land and robust finances is a great combination in a market where the product is affordable, at least for those with the deposit to get started on the ladder. The financial crisis a decade ago left many smaller builders unable to get credit. That has led to a more orderly market for land, allowing large players like Persimmon to acquire land at prices that offer fat margins on the houses and flats that will eventually be built. The group’s Return on Capital Employed has ranged between 25% and just north of 50% in recent years.
As a result, Persimmon has been throwing off cash and has a strategy based around returning the surplus capital it generates back to its shareholders. In 2018 it handed back £748m to shareholders in the shape of dividends, equivalent to some 235p per share. That’s a yield of around 7.3% at the current share price, although please remember dividends are variable and not guaranteed.
We expect that barring an external shock to the economy, Persimmon will have a supportive operating environment for some time to come. Its robust finances should enable it to provide an attractive income stream to investors.
We have exited from our position in Standard Life. The price had mounted a strong recovery from the lows of last year, but we have yet to see a sustainable improvement in the business’s performance, with outflows from its funds continuing. At the moment the group is supporting the dividend from its capital reserves and by selling non-core assets because earnings alone are insufficient currently. The longer the business takes to return to growth, the greater the chance that the group has to reconsider the amount of dividend they pay out.
We also trimmed our position in HSBC, where the bank is struggling to raise returns to a level sufficient to enable a return to dividend growth. Hopefully Coronavirus will fade into the background before too long, but in the meantime the interruption it is causing to Chinese economic growth must be distinctly unhelpful to a group which is strongly exposed to the Chinese and Hong Kong economies.
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