House price buzz and solid recent trading from Barratt Developments PLC (LON:BDEV) set the housebuilding and building materials sector shares alight on Wednesday but analysts saw several reasons for investors to be prudent. 

Nationwide’s house price survey revealed that prices continued their post-lockdown recovery in August, with a 2% monthly rise that is the biggest gain in over 16 years, and cancels out falls seen in May and June. 

Barratt’s year-end numbers, coming two days ahead of those from rival Berkeley Group Holdings PLC (LON:BKG), saw pre-tax profits drop 46% to £493mln on the back of a 29% drop in completions and 28% drop in revenue. 

The residential builder’s board confirmed its previous decision to cancel both its planned second-half and special dividends, saving some £375mln.

While the results were weaker than some others in the sector, observed broker Peel Hunt, the group has “chosen to take a cautious approach to health and safety and site reopenings” and, more important than the past year’s numbers, recent trading has been strong. 

Since the start of July, the net private reservations per site per week have jumped to 0.94, from 0.68 a year ago, with forward sales sitting at £3.7bn based on 15,660 homes bagsied by customers at present. 

Given such strong trading, Richard Hunter, head of markets at Interactive Investor, said “such a conservative approach will come with a tinge of disappointment to investors who are currently income-starved to a large extent”.

However, he acknowledged that the pandemic environment which derailed the company’s progress could yet return. 

“A second shutdown, less buying activity given the current recessionary environment and likely spike in unemployment and the resumption of the UK/EU negotiations are all potential spanners in the works,” Hunter said.

“At the same time, the Help to Buy scheme will continue only in a watered-down form from next year and the availability of high loan to value mortgages has been crimped post-pandemic amid more cautious lending decisions.”

Russ Mould, investment director at AJ Bell, said the Nationwide house-price data may provide some short-term fizz for the sector but cautioned “there could be a lingering hangover to come”, due to the rising levels of joblessness.

“If Barratt is in for a period of weaker demand then it will need to maintain a strong balance sheet as a buffer, enabling it to come out the other side ready to take advantage of any eventual recovery.”

On the plus side, Hunter points out that the housebuilding sector, in general, is a much better shape than was the case following the previous financial crisis. 

“From a wider perspective, many of the tailwinds for the sector remain in place, with the current stamp duty holiday adding to the list of historically low interest rates, generally good mortgage availability and an ongoing housing shortage,” he says.

“The immediate question is whether the current return to form can be maintained in an environment where many of the potential negative factors are outside of the company’s control.”

A share price decline of 28% it the year to date is worse than the wider FTSE 100’s 22% drop during the period and proof of investor’s worries about the sector.

Mould noted that the current consensus analysts’ forecasts for the current year to June 2021 points to a dividend of 22.1p per share, enough for a yield of more than 4%. 

“That said, earnings estimates imply cover of 2.25 times, a little below management’s target ratio, to suggest that forecast could be a little optimistic unless profits exceed current expectations.

“Still, a 4%-plus dividend yield may be enough to entice income-starved investors, even if the absence of any distributions for fiscal 2020 means patience will be required as Barratt hunkers down.” 

He said the reticence to return cash now is understandable due to the acceptance of government furlough cash (even though it has been repaid), the fact that while the Government’s Help to Buy scheme supported more than a third of the last two year’s completions, around 16% of the past year completions would not be eligible under the new, tapered terms of the programme which will apply from next March.

Finally, Mould noted that planned spending on land is due to jump back to above £800mln from the £369mln seen in the past year, which was the lowest spend since 2011.

“Buying land cheaply is the key to long-term margins so management presumably feels now is a sensible time to buy and prioritise this in terms of current capital allocation, while preserving a net cash balance sheet (as the memories of the fright received during the downturn of 2007-09 have yet to fade), to ensure strong long-term margins and returns on capital.”