Watkins Jones WJG

Does you digs it?

Dear reader,

I’m too young for them to be called Digs but old enough to know my ‘Accommo’ or Digs as older folk called them was no palace. Least not back then. Student Accommo nowadays appears to be luxurious affairs. Today’s picture imagines a Student’s ‘Resi’ complete with vast hot tub, minimalist design with wraparound views. Not a tin of baked beans in sight!

Watkin Jones (ticker WJG) is a leading developer and manager of housing and accommodation.

It has four segments. First residential “for rent homes” in urban areas of the UK targeting young professional and families. Second Student accommodation in key university cities across the UK, including London, Manchester, Birmingham, and Edinburgh. Critically it sells developments to Institutions who then deal with Joe Public - it does not sell direct. So a customer would be the likes of RESI which I’ve written about before, and which is currently winding down. Thirdly it develops Affordable Homes but this is a small segment. Fourthly it manages buildings and runs the services like concierge, maintenance and gardening. This is a highly profitable but small segment.

WJG say:

“We operate in attractive markets with long‑term growth opportunity. With growing demands for housing and a changing rental landscape, our developments are answering a critical national need.”

In that case WJG should be a slam dunk. So why the near vertical decline in August 2024? Let’s find out.

On August 21st a profit warning is the culprit. Clearly WJG are time travellers because in August they were able to provide a trading update for the year ended 30th September 2024. Bit sloppy.

Back in August markets guru Paul Scott points to “uncertainty around interest rate cuts being blamed for a failure to do deals, as interest rate hikes were previously seen as a problem” but goes on speak to their discount to NAV and hedges an amber/green.

Let’s look at those points, and try to decide whether it’s red or green or a shade inbetween. The update starts positively speaking to a growing pipeline, good traction, and in-build schemes on track. So far so good.

So we come to the dreaded rate cuts. But cuts are blamed for nothing. WJG tell us rate cuts should contribute to improved liquidity. Improved liquidity would be beneficial.

The actual problem is a lower number of transactions. Interest rate cuts causing difficulty for a housing developer would have been odd indeed! Its customers typically use Debt to part finance purchases and of course debt has been more pricey of late. So while rents are rising and demand is high, WJG doesn’t sell to Joe Public and doesn’t directly benefit.

The 1H24 gross profit of £18.4m is around 10% and 10% is in keeping with margins over the past 18 months, and is about half the prior margin average of around 20%.

Overheads have grown a little but what caught my eye was 2H22.

A £2.4m negative cost made me go Huh? But the answer lay in section “3.3 Business Combinations”. A divestment created this so there’s £17m extraordinary income hidden in that line of cost. Strange way to deal with income, never seen that before.

Moving down the list even mole-eyed readers will notice exceptional exceptional costs. One word: Grenfell. Named Cladding then Building Safety this refers to legislation introduced since Grenfell to sort out flammable cladding in high rise buildings. This has cost WJG £34m so far. But a £57m provision for future liability remains. However £11m of that has been negotiated as the liability of the customer, so £46m net.

Now, I don’t see this cost as being WJG’s fault. It is an unfortunate tragedy. It is furthermore unfortunate that the government changed its mind in 2022 as to what sort of buildings needed sorting out. It began with >18m buildings and shrank to those above >11m high. The net in England was widened too from 12 year old buildings to up to 30 years old building. The Welsh and Scots are lagging (unfortunate word) behind but there is no additional liability expected. There is recent talk that Labour will accelerate the remediation timeline which is currently 5 years. Another Grenfell would be politically catastrophic after all, let alone the terrible human cost.

So the primary danger is the £46m gets expensed sooner. Also if further buildings are identified then a further ~£2m per building could be required. However the £46m includes contingency costs.

With Cash and receivables of over £94m such an acceleration appears to present no issue to WJG. In fact, I find it incredible that Current Assets less ALL liabilities (including that £46m provision) is £1.3m. In other words if you asset stripped WJG tomorrow you’d have £1.3m left over before you touched any of its plant and equipment and other assets. In other words you pay 26.7p to get 36.1p of cash/debtors and 45.6p of property where you owe -44.8p this year and -36.4p in the future so have net 0.5p a share for your 26.7p. But then you also get 11.5p of fixed assets (diggers, cranes, cement mixers, building materials and so on but also leased properties) and 39p of other assets - contract assets, intangibles, reimbursement debtors for the cladding and deferred tax credits.

Valuation

WJG has generated a £200m on average revenue each half year at an 11% GM rate. This is a £22m profit and at a -£14.4m Admin Cost delivers roughly £15.2m operating profit over a full year. Finance costs of about -£3m and Tax -£3m gets you to a £9m net profit per annum even at depressed levels.

WJG’s peer Grainger has a 5 year average P/E of 15. A P/E of 15 based on a £9m run rate underlying basis puts WJG on a £135m valuation so double today’s share price and today’s market cap of £68.5m and forecast p/e of 7.6.

But it appears £200m is too high for 2H24. What if the number is £150m instead? At the same margin that’s a £16.5m gross profit and £2.1m operating profit and £0.4m net profit to September 2024 maybe.

With Inflation moderating, with 300k new homes a year required, vast net immigration (1.1m net people last year), an order book of £1.4bn, improving sentiment, further rate cuts and growth in its high-margin Refresh business there’s reasons to feel that FY25 is turning a corner. WJG says it is targeting a 12% GM %.

Demand and Supply suggests property builder can look forward to higher margins, growth and success.

If we break down the segments we notice Student Accomo is delivering good returns while Affordable Homes are proving nearly unaffordable.

The King’s speech has knee capped Nimby’s and sped up the release of land. WJG said availability and cost of land was a major reason for BTR margins being low so that’s positive for WJG.

Over half of the £1.4bn pipeline is “subject to planning” so speeding that up as Labour have announced would speed up the Forward Sold also.

WJG have a lot of property projects “subject to planning”

We have seen £5bn support in the Budget to encourage home builders today. 12,500 new homes were started in 2023 vs a 60,000 requirement means something needs to give. Housing is a key election promise and the King’s Speech contained proposals for a mortgage guarantee scheme.

Probably as with other parts of the market uncertainty over taxes and Labour’s budget is holding back investment decisions - until now.

A final point of note is the restructuring and new(ish) leadership. CEO Alex Pease took on the role permanently in November 2022 and appears to be a positive impact on the business.  

Conclusion

Current assets net of all liabilities being 0.5p a share was a surprise.

How many businesses can you buy where the cash, debtors and stock of property would cover all liabilities? A business where a long term run rate of £500m and 12% margin appears not unrealistic an expectation, which delivers a £30m a year net profit at 15x is £450m, and 6.6X today’s 26.7p

The strong demand and the restricted supply make for likely higher future profits. Growth in the high-margin refresh segment seems the obvious way to boost profits and to de-risk the cyclical building business is by running Accommo for Universities. Nowhere is that in the price either.

My interpretation of The Building Safety Act and the future secondary legislation is yes it could drive up costs - and prices - but its effect could likely create an important moat for WJG (and others) dissuading new entrants from entering, thus creating lucrative markets. My reading of the provisions is that nothing is absolute and further provisions might be required but this appears to be fairly limited at circa £2m per extra building, and the notes imply a maximum of a few so a possible £6m further provision if the current contingency doesn’t cover it, and nor does a customer in full or in part. The main concern actually appears to be a potential acceleration of the remediation work. Which isn’t a problem for cash-rich WJG.

So compared to other people’s view on this, there’s no amber. Just green for me.

Regards

The Oak Bloke

Disclaimers:

This is not advice - make your own investment decisions.

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