February 2008

When it comes to the crunch...

AS is my custom in the February column, I quote the Daily Telegraph league table of share performance for the calendar year 2007.

This time round, the property sector was topped by HK Land with a 25 per cent return. As its name implies, it invests mainly in Far East commercial property rather than in the UK.

Only three other property companies showed positive returns, while some top performers for 2006 were big fallers in 2007.

DTZ, the international commercial property consultants, were up 88 per cent in 2006 closing at 835p. The shares closed 2007 at 260p, representing a 70 per cent fall and putting the group second to bottom of the Telegraph property sector league.

Countrywide removed itself from the league in May, before the ‘credit crunch’ and all that. As the share price opened 2007 at 541p, and the eventual bid from Apollo was worth 630p, that represented an 18 per cent uplift over the course of less than six months.

The share prices of Savills, LSL and Humberts which remain quoted show how the credit crunch had already taken its toll by the end of 2007, not only on profits but on investor sentiment.

Savills showed a minus 58.8 per cent return according to the Telegraph, having closed 2007 at 280p. Its high was 700p and its low 277p. It opened 2007 at 680p.

LSL was not included in the Telegraph league, having floated in November 2006. By my calculations, its shares showed a 50 per cent fall, ending 2007 at 134p, against a 270p high and a 212p flotation price.

AIM-listed Humberts closed 2007 at 28p against a 107p high.

However, Rightmove was a leader in the Media sector, with a 17.5 per cent return. Its shares closed 2007 at 464p, against a 630p high and a 371p low.

During 2006, the shares rose under one per cent to 395p, partly due to the writedown in its investment in the HIP business.

These figures provide background to the round of pre-results trading updates released to shareholders last month.

It fell to LSL to open the batting, and, sticking to cricket terms, the wicket wasn’t a good one.

Its trading update for shareholders, published on January 3 ahead of its full year results due February 27, confirmed how the ‘credit crunch’ and the Northern Rock crisis has slashed house sales in the ‘mass market’.

Compared with the final quarter of 2006, the number of transactions during the final quarter of 2007 was down 40 per cent.

LSL group finance director Dean Fielding said: “Based on sales agreed, our figures show a 40 per cent drop in transactions compared with a year earlier, and comparing the second half of 2007 with 2006, the figures were down by a third.

“If the current market conditions continue until June this year, then the annual volume of transactions could be as little as 900,000, compared with an average of 1.3 million during the past few years.

“This fall off in volume has obvious implications for the estate agency business as a whole.”

However, LSL forecasts the market might return to more normal conditions during the second half of this year and that there will be no significant fall in house prices, except in specific areas where there is oversupply of new build flats.

“For the market to return to more normal conditions, we will need more than one interest rate cut and for cuts in base rate to be passed on to borrowers,” said Mr Fielding.

LSL Property Services closed branches and cut staff as the market fell away last autumn.

Simon Embley, chief executive of LSL, said the cuts in branches and staff was ‘simply good housekeeping’ and started in September when LSL saw trouble looming.

Altogether 12 branches have been closed so far, and 200 staff cut from the estate agency division. A further 115 jobs in administration and surveying have also gone.

“Most of the staff cuts were through natural wastage and non replacement rather than redundancies. We saw problems ahead and began trimming early, said Mr Fielding. “Unless the market deteriorates even further, I do not expect further major cuts.”

Savills’ residential business centres on the top end of the market, which still seems insulated from the ‘credit crunch’ But not for long, perhaps, as falling stock markets, falling City bonuses and probable tax changes for non-domiciles, dampen the eagerness of wealthy people to splash out on property.

Savills expected full year profits for 2007 to be ‘slightly ahead of expectations’ in a trading statement issued on January 8, ahead of its full year results due on March 23.

Chief executive Aubrey Adams said the prime UK residential market had proved ‘more resilient’ to the credit squeeze than lower-priced property, although conditions in the UK and US residential and commercial property markets are ‘challenging’.

Asian and European markets, where Savills have built up business, have also proved more resilient.

City analysts, who had predicted £81 million in pre-tax profits for Savills for 2007, now expect £85 million.

The share price hit a 250p low earlier this year, but has since recovered to about 300p.

Even with the recovery, the price suggests City analysts expect a profit fall in 2008, as much of Savills earnings comes from commercial property consultancy, and that sector looks problematic.

Against that, Savills enjoys a strong balance sheet and so can afford to weather market shocks.

Shareholders in AIM-listed Humberts Group have been biggest losers in our little sector as the share price slumped to a low of 11p after another profits warning on January 21, boardroom departures and an admission that the group is raising more cash to pay for recent acquisitions. The shares reached a high of 100p early last year.

The only real winner from the current property slump seems to be Rightmove.

That’s because agents still have to advertise property even if sales are down and as Connells chief and Rightmove director Stephen Shipperley explained last issue, website advertising is cost effective and if agents need to cut advertising, press advertising should be the first to go.

Rightmove‘s trading statement ahead of its results at the end of this month, expects full year profits at the top end of predictions between £29.3 million and £32.2 million, up from £17.7 million in 2006.

Revenue is expected to be up 69 per cent to £56.7 million. What’s remarkable is that last August, Rightmove increased its charges to existing agent customers by about 30 per cent from £250 to £325 per month per office. Yet it retained 92 per cent of its customers in 2007.

For every pound agents spent advertising with Rightmove, they spent £9 on press advertising, which suggests websites have yet to exploit their full potential.

The main risk to Rightmove, apart from competition from other websites, is that the downturn in the housing market results in a cull of estate agents and therefore reduces its customer base.

But Rightmove has plenty of cash in its balance sheet; indeed at the end of last month, it completed a buyback of some of its shares.

This means earnings will be distributed among fewer shares and that will boost returns to shareholders.

The buyback was a complicated process involving setting up a holding company. But the net result will benefit shareholders.

And finally, a word of caution over prices...

IT’S easy to predict that the base rate will fall this year. So will the cost of mortgages and the housing market will pick up again.

But it isn’t necessarily so, according to Robin Savage, analyst at KBC Peel Hunt.

He said: “I expect a spring which won’t happen. I don’t think we can yet call the bottom of this housing cycle and annual transactions may even fall below 900,000.”

He cites the credit crunch as the main reason, and reckons mortgage lending figures will provide an important indicator.

“One of the reasons why house prices and transactions rose during the past decade is that more money was pumped into the market,” he explains.

“If mortgage lending this year falls below 2006/7 levels then that will hold back the market. The major lenders may well report higher lending figures but that will be due to re-mortgaging away from Northern Rock and other lenders who exited the market.”

Mr Savage also questions the reliability of house price indices as they only reflect the prices of properties sold, not those held off the market due to lack of demand.

Property prices may appear stable but the truth is they are falling in real terms compared with the cost of living.