The Sceptre UK Fund was down by 2.6% in March compared to a 2.9% fall in the FT All Share index. Whilst it continues to be disappointing to lose money we are encouraged that the portfolio’s characteristics of low/no debt and positive cashflow companies have performed better than the market. We believe that the market is discounting a very severe downturn in most sectors and (encouragingly) has not effectively differentiated between “good and bad” companies in this sell-off.

“Defensive” sectors that have performed well on a relative basis, such as utilities and food retailer stocks, have very full valuations whilst the commodity stocks continue to make new highs on rising underlying commodity prices despite the overwhelming consensus for a global slowdown. This clearly leaves many other sectors that have fallen considerably, both on an absolute and relative basis, and may now offer particularly good opportunities in the medium term. Probably the two worst performing sectors are the financial and housebuilding sectors where valuations in terms of trailing multiples and dividend yields are at extreme levels. However, we believe that companies in these business sectors may face further disappointments and uncertainties as the end markets adjust.

The global banking sector has now written down $250bn in sub-prime assets and the UK banks are trading at forward PE’s of about 7.5, dividend yields of 8% and 1.7x tangible book value. Whilst this appears very “cheap”, their businesses have changed in the past year and there is neither real earnings visibility nor certainty that the “tangible” book will not be further written down. The banks have traded more cheaply - at 1.1x book value in the last recession (1990/1) and at PE’s around 5x. So, with little clarity of the magnitude of future cashflows and poor prospects for growth in the medium term, we feel no inclination to invest in the sector despite its poor performance over the past year.

The major listed UK housebuilders are down by almost 70% from their highs of about 12 months ago and the sector has also warranted a close look as, although cyclical, its business model is very simple and there is a good deal of industry data available to give some solid pointers on the potential cashflows we could expect. This data includes numbers of new units, average house price, average land plot price, margins and monthly data on mortgage approvals numbers together with the size and cost of the housebuilders’ own land banks – infact, probably the other end of the scale from the banks in terms of data and visibility.

Historically, buying housebuilders at book value has usually proved to be a profitable trade but we feel that this time is very different owing to the current book (cost) value of the builders’ land banks. House building is the only industry where companies appear to boast about the amount of inventory they are holding at each accounting period end. Most businesses will struggle to maximise stock turn and minimise stock days as they control working capital – not so for this sector. The housebuilders have always required land with detailed planning permission to be available and this has required lengthy lead times and the creation of land banks but, in recent years, these have been creeping up from the historic levels of 2 -3 years supply of building plots to 5+ years supply currently. This concerted effort to increase the land banks has caused a rapid rise in land prices with average land plot prices increasing from around £30,000 in 2004 to £47,000+ during 2007. During the past 15 years this land ownership has worked in the builders’ favour with house and land prices increases bolstering their returns, however in the current conditions of overly large land banks, declining house sales and declining prices/margins, we expect there to be many pressures on the sector’s profitability and a real possibility that land values (and therefore book values) will have to be marked down significantly. In our view, that may prove to be the best time to buy this sector and we will be waiting for further declines in sentiment around property and land prices – even if it means we are wrong and miss the opportunity.

Chris Broadhurst
CEO