Leading shares are edging lower, with Standard Chartered leading the way down after a third quarter loss, a £3.3bn fundraising and 15,000 job cuts.
But housebuilders are also subsiding on concerns about weaker house price inflation and the effect of rising interest rates. Stronger UK manufacturing figures on Monday prompted some talk that the Bank of England could sanction dearer borrowing costs more quickly than expected.
As a consequence of these concerns, Liberum issued a gloomy sector note, helping to push Barratt Developments down 17p to 593p, Taylor Wimpey 4.8p lower to 193.4p, and Persimmon 30p down at £19.38. Liberum analyst Charlie Campbell said:
We believe the largest housebuilders’ valuations are too optimistic to withstand the gross margin pressure that we expect in the coming years as house price inflation is suppressed by a more vigilant regulator and build cost inflation returns. We cut our ratings on Barratt, Persimmon and Taylor Wimpey from Hold to Sell. There is better value in builders who can grow profits by raising output: top picks Bellway and Gleeson.
House prices are much more stretched than widely assumed because price/income multiples are now watched by a regulator with growing powers. Stricter controls on lending standards will depress house price inflation, which could cause gross margins to fall as build costs have started rising materially, especially labour. Falling gross margins will lower returns especially for those not growing output.
Rising rates will not derail the housing market, but sentiment is vulnerable. We believe investors may see the first US rate rise as a signal to reset portfolios. Housebuilders’ shares could also be vulnerable as returns-based models generate lower valuations as interest rates rise. The other main risk to the sector is that Help to Buy is repealed. The government will keep this in place while it generates job growth, but if house prices were to stall the scheme’s costs could rise materially.
Overall the FTSE 100 is currently down 7.05 points at 6354.75, with Standard Chartered 56.3p lower at 657.3p.
Associated British Foods, owner of Primark, groceries and sugar businesses, has slipped 36p to £33.98 after a 2% fall in annual earnings and a warning about currency pressures affecting the current year. It said the first US Primark store opened eight weeks ago was trading well.
Meggitt, hit recently by a full year profit warning, has recovered 9.2p to 366.3p after Barclays kept an overweight rating on the engineering group, albeit with a price target slashed from 610p to 420p. Barclays said:
Rarely do we find aerospace and defence companies which are simply too cheap. But post last week’s warning Meggitt is firmly in that bracket. At 10 times 2016 PE, 9 times enterprise value/EBITA with a comfortably affordable dividend yielding around 4.5%, the shares trade at a 25% discount to their own historical averages versus the sector in spite of a 6% earnings per share compound annual growth rate and unmatched cash progression. We too harbour concerns around near term visibility and capital deployment discipline, but this looks to be more than in the price.
Mining shares have slipped back despite Australia’s central bank keeping interest rates on hold and suggesting economic conditions had ‘firmed’ a little.
BHP Billiton is down 1.5p at 1024.5p, Rio Tinto is off 40p at 2281.5p and Anglo American has dropped 8.5p to 535.8p.
