UK Prime Minister Boris Johnson confirmed on Tuesday that construction of the HS2 high-speed rail link is set to go ahead as planned. The project had been hanging in the balance but has received the green light despite rising costs, the risk of the budget spiralling and the project benefiting London rather than less buoyant regions of the UK. The decision is in line with the recent strength shown by the UK construction sector where share prices have shown double–digit returns since the start of the year. The HS2 project is seen as a sign that the government is about to turn on the taps in terms of public infrastructure spending.
The volatility of share prices in the sector can make it a happy hunting ground for traders. With UK stocks typically being offered in Contract for Difference (CFD) form, there are opportunities for short sellers as well as bulls. The question is to what extent Tuesday’s decision marks the start of a boom in the industry?
A highly plausible reason for the project getting the go–ahead is that it sends out a politically important message that the UK is pushing on with its plans for a strong post-Brexit economy. The years taken to get a project to this stage mean that HS2 is the only ‘shovel ready’ option available to the Johnson government. The decision of whether or not to invest in a grand project is a binary one — HS2, or no HS2. The high-stakes atmosphere also supported by the sheer size of the project. Sir John Peace, former chief executive of Burberry to Experian group GUS Plc, put the plans into context:
“HS2 is the biggest single infrastructure project in Europe, let alone the UK – so going ahead with that sends out the right signals, not just nationally, but internationally.”
Source: This Is Money
Prime Minister Johnson also comes with a reputation for favouring large-scale projects. During his term as London mayor, he was responsible for huge investment in transport schemes including Crossrail 2, the Jubilee Line upgrade and the eponymous ‘Boris Bikes’. His name is also strongly linked with a list of schemes such as the Garden Bridge in London, and the Thames Estuary Airport, both of which he backed but didn’t materialise. Planning costs alone meant the Garden Bridge still managed to leave a black hole of £43m in public coffers. But such failures have not dented his appetite for public spending on infrastructure. Following the logic that one man’s spending is another’s income, it’s not too surprising to see the UK construction sector showing significant strength.
The Trading View UK Homebuilding (Industry) Index reports the basket of stocks it monitors is showing a year–to–date return of 8.81%.
The Trading View UK Homebuilding (Industry) Index
In contrast, the broader FTSE100 index is showing a negative return on a year to date basis:
The UK construction sector was primed for the ‘Boris Bounce’ that followed the December 2019 UK general election. The property sector is increasingly politically sensitive, and holders of property assets were increasingly alarmed by the risk of a Labour Party victory. The Labour manifesto included a range of nationalisation schemes that demonstrated an aversion to ‘excessive’ profits being made in sectors it considered socially important. When the election results were announced, not only did the construction industry ‘not get Corbyn’, in Johnson it got a prime minister with a passion for infrastructure spending.
Trading the UK construction sector requires a little creativity, but despite the absence of a recognised tracking index, it is still possible to gain exposure to the sector. A little time spent on building a basket of stocks can bring benefits. The cyclical nature of the construction sector business cycle brings with it ‘boom and bust’ characteristics. This means that there is plenty of price volatility and opportunities to short as well as go long.
Trading View’s Housebuilding (Industry) index holds 22 tickers relating to listed firms. The market cap ranges from RAI International Group plc (LSE:RAI) to Persimmon plc (LSE:PSM). The range of names and characteristics is useful. One of the ways of squeezing extra juice out of trades in the sector is to identify the better performers within the basket. As the recent share price surge shows, the whole sector can benefit from positive news but some more than others.
The outlook for the sector remains positive according to the Oscillators / Moving Average Rating used by Trading View. Of the 22 stocks in the basket, two are tipped ‘buy’ and 16 ‘strong buy’. Only four are marked as ‘sell’ or ‘strong sell’.
Trading View UK Homebuilding (Industry) Index Oscillators / Moving Average Rating
Three names with ‘strong buy’ status according to the Oscillators / Moving Average Rating are Vistry Group (VTY), Taylor Woodrow (TW.) and Persimmon. Since 6th January, these stocks have risen in value by between 13.44% and 16.79%.
Price chart — 7th January–11th February. VTY – PSN – TW:
One quirk of the sector is that valuations are often referenced in terms of price to assets (net asset value) rather than price to earnings (p/e ratio). Three of the four names marked ‘sell’ by the Moving Average Rating indicator appear in the top four rankings of Current Ratio (MRQ). The ratio, which is a liquidity ratio, measures those companies’ ability to pay short-term obligations.
Trading View UK Homebuilding (Industry) Index — Current Ratio (MRQ):
The monthly price chart for these names is much less impressive. While an index intrinsically provides diversification from single stock risk, those willing to form a basket of the better–performing stocks could replicate that risk management and enhance returns.
Price chart — 7th January–11th February. CRN – GLV – PSN – TW:
Each firm has been faced with the same macro-economic risks and opportunities, but the monthly performance has differed by over 34 percentage points. The potential to trade off–market triggers remains. The sector as a whole carries a high degree of exposure to the economic business cycle. The jury is still out on how post-Brexit Britain will perform in 2020.
Tuesday saw the Office for National Statistics announce that The UK economy saw no growth in the final quarter of 2019. Manufacturing contracted for the third quarter in a row and the service sector slowed around the time of the general election. The GDP growth over the entire course of 2019 was a subdued 1.4%. The good news for traders with short term investment horizons is that there is research pointing in another direction. The churn is caused by flip-flopping data opening up short-term price trends. Data points that are encouraging the strong performance of housebuilders include the confidence survey provided by the Institute of Directors. In December, Directors’ confidence has reached its highest level since the 2016 EU referendum. A net balance of 18% of Directors expected their investment levels to increase. Tej Parikh, chief economist at the Institute of Directors, said:
“A firm majority Government means that business leaders, whatever their personal views, now at least have a framework around which they can put in place plans to invest, hire, and expand... There are undoubtedly some exciting stocking-fillers for businesses in the Government’s agenda.”
Parikh continued and highlighted the possible windfall for the building sector:
“For the longer-term, ambitious proposals on broadband, infrastructure, and regional growth are music to the ears of many in the business community who want to finally see the dial shift on the UK’s lagging productivity growth.”
The risks that hang over the sector may be a concern for those riding the upward trend but also open the door to those trading short. Whether looking to exit or enter positions, two items to be aware of are interest rate rises and single stock exposure.
The January meeting of the Monetary Policy Committee of the Bank of England held rates at 0.75% The 7–2 voting majority belies the speculation in the run–up to the meeting, which suggested the Bank might implement a rate hike. John Hawksworth, chief economist at PwC, noted that the housing sector, which would suffer from a rate hike, was, in fact, one of the potential drivers of that hike, which still might come. The MPC next meets on 26th March, a date that those with long positions might want to make a note of. Of January’s decision, Hawksworth said:
“More data is needed to see if the economy has indeed enjoyed a sustainable ‘Boris bounce' since the election. Most recent business and consumer surveys do show a pick-up in confidence and the housing market also seems to have perked up in January.”
The single stock exposure risk is demonstrated by the demise of Carillion plc, which went into liquidation in 2018. The firm was once the second largest in the UK construction sector and had a market capitalisation of £2bn. Post-mortems of the firm’s accounts flag up an indicator that is still useful for those looking to trade the sector. The balance sheet of Carillion remarkably claimed that the building firm had intangible assets, which formed a significant percentage of the overall value of the company. ‘Goodwill’ was priced at £1.69bn in the firm’s 2016 accounts. Deducting that line item from the end of year accounts would have shifted the firm from showing net assets of £729m to net liabilities of £940m.
An alternative approach to trading the potential construction boom involves tailoring positions specifically to public spending initiatives. The public sector is the biggest customer in the UK. The £93bn of contracts awarded in 2019 was 17% higher than the previous year — nearly a quarter of the funds being allocated to firms in the construction industry.
Public sector spending in the construction industry — 2019:
UK government contracts are historically awarded to members of a pool of contractors designated as ‘Strategic Suppliers’. As of April 2019, there are 34 companies on the Strategic Suppliers list, but the roster of members is dynamic. Companies that joined the list in April 2019 included Balfour Beatty (LSE:BBY) while others were removed, most notably Carillion after its collapse. Recent spending patterns have seen a greater share of public spending allocated to firms that are not on the ‘Strategic Supplier’ list. Two–thirds of the Strategic Suppliers won less in 2018 than 2017, but from a trading perspective, one benefit of the list is it filters out the names that may benefit from a spending splurge.
The Tussell report ‘2019 in Public Procurement’ also shows the calendar of upcoming contract renewals. March 2020 is the peak month for contract awards meaning those trading names involved in this space can expect announcements to act as catalysts of price moves.
Oxford-based infrastructure support service provider, Amey, has picked up £3bn of government contracts since 2015. This makes it the second–largest beneficiary of public funding projects. The firm primarily operates in highway and rail transportation and facilities management so looks set to benefit from the go-ahead of HS2. The firm was bought by a private equity group.
Balfour Beatty is a multinational construction company that operates in the infrastructure sector. Since 2015 it has been awarded 76 contracts with a value of £2bn and is sixth in the rankings of private firms that are beneficiaries of public spending contracts. The HS2 announcement has been welcomed by those that long the stock (LSE:BBY), with the London–listed shares showing intra-day gains as high as 6.5%. Day traders will note the move was not dominated by a price gap at market open but instead spread across the day and offered multiple entry points.
Balfour Beatty — (LSE: BBY) — Intraday price chart — 11th February 2019:
The strategic suppliers operate in sectors across the UK economy, including telecoms, defence, IT, consultancy and facilities management and construction. The last sector named on that list looks likely to be attributed a higher–profile role by the current UK government. For the construction sector, good times are back. The benefits of the government’s approach are also trickling down to those that are not immediately connected to HS2 or government contracts.
Berkeley Group plc — Intraday price chart 11th February 2020:
Industry journal, UK Value Investor attached the headline ‘Is it too late to invest in UK housebuilders?’
to a research piece published back in December of 2019. The answer at that time turned out to be a resounding ‘no’ and after Tuesday’s HS2 announcement the answer may still be the same. UK Value Investor notes that:
“As a group, UK housebuilders have produced astonishingly good financial results over the last decade. This has given their shareholders equally astonishing returns, with average share price gains from the largest housebuilders at close to 1,000% since the 2009 financial crisis.”
Source: UK Value Investor
February will see some members of the sector report full–year trading results. Taylor Wimpey reports on 27th February and Bovis Homes on 28th February. These are dates when it will be possible to check on the health of those firms in particular but also the sector as a whole.
From a technical analysis perspective, there is also the issue of the 2007–08 financial crash, which still casts a shadow over the sector. Many firms in the construction sector have been battling with the 50% Fib retracement from the pre-crash highs. The price chart of one, Taylor Woodrow, is used by Interactive Investor to illustrate the strength of the 50% resistance/support level.
When the current trend does finally come to an end, there will still be opportunities to trade the reverse. The sector as a whole appears to be a likely source of high volatility price action for the foreseeable future.