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Will a 10% rise in building costs hurt Barratt’s full-year results?

Show home poster from Barratt Developments on a new building

Barratt Developments [BDEV] will join peers Berkeley Group [BKG] and Vistry [VTY] in reporting earnings results this week, with the housebuilder set to release its annual figures on 7 September.

Investors will be looking to the company’s results to get an idea of how the UK housing market is faring amid a broad slowdown. The sector has been harmed by a pullback in house prices across the country and rising labour costs over the past few months, sending the Barratt share price down 44% year-to-date, as of 2 September.

Shares in the housebuilder have been hurt by the weakening housing market in the UK. Recent analysis published by HSBC predicted that house prices in London could fall by as much as 15% as rising mortgage rates and inflation dampen demand for homes in the capital. House prices outside London are expected to fall by 7.5% in the autumn, while new-build homes are forecast to fall by 5%.

Housing stocks slide in 2022

Shares in Barratt and Berkeley fell 1.2% and 2.7%, respectively, after the HSBC report was released on 2 September, while Vistry was flat.

The downbeat performance has extended to all major UK housebuilders, with the Persimmon [PSN] share price down 43.8% year-to-date and the Taylor Wimpey [TW] and Bellway [BWY] share prices down 38.3% and 39.9%, respectively, over the same period.

“UK housebuilders have struggled share price-wise this year, despite a housing market that has continued to look resilient. Despite this resilience, pessimism about the outlook for the UK economy, as well as rising costs [and] concerns about what a sharp increase in interest rates will do to housing demand, has prompted a slide in valuations,” our chief market analyst Michael Hewson wrote in a recent note.

House prices recorded sustained strong growth throughout the pandemic, which helped keep housebuilding shares buoyant over a turbulent couple of years. According to the Nationwide House Price Index, the average UK house price has risen 24% since the beginning of 2020 from £218,000 to £270,000, mainly due to low interest rates and strong government support for the sector.

Profits grow but inflation bites

Barratt Developments reported strong half-year results for the six months ending 31 December. While revenue for the period fell 11.1% year-on-year to £8.07bn, the company was able to grow profit before tax by 0.6% to £432.6m.

For the first half of the year, Barratt Developments recorded total build-cost inflation of approximately 5% as rising prices started to impact the industry. The group forecasts that total cost inflation for full-year 2022 will reach roughly 6%.

In its most recent trading update on 14 July, the company maintained this guidance. However, Barratt also acknowledged that it is experiencing a rise in building costs of up to 10%, which will likely be felt in results published in the 2023 financial year.

Although concerns over the weaker housing market are weighing on the Barratt share price in 2022, the company remains optimistic ahead of Wednesday’s annual results. In its July trading update, Barratt reported that it was expecting adjusted profit before tax to sit between £1.05bn and £1.06bn, beating a previous consensus of £1.048bn. If the expectations are met, this would be the first time the company reported pre-tax profit above £1bn.

It was also reported that home completions for the year had returned to pre-pandemic levels, with 17,908 homes completed for the year compared with 17,243 the year before.

Hewson highlighted Barratt’s optimism by pointing out that the company “expects to grow total home completions by between 3% to 5%, with forward sales of 13,579 homes worth a total of £3.62bn”. However, he added that “it would appear that investors don’t share this enthusiasm about the sustainability of its margins at a time when incomes look set to get squeezed sharply, in the face of double-digit inflation”.

Analysts remain upbeat on Barratt shares

These upbeat figures are expected to be partly offset in the forthcoming months as the company faces a steep rise in building costs, which have already risen around 10% in the last few months. Alongside this, future forecasts may be weaker if higher mortgage rates and constrained household budgets slow the housing market in the coming months.

Nevertheless, analysts remain upbeat despite the challenges facing the stock this year. Out of 18 analysts polled by the Financial Times, seven gave the shares a ‘buy’ rating, eight believe the shares will ‘outperform’ and the remaining three rated the shares a ‘hold’. Of 16 analysts offering 12-month price forecasts, there was a median target of 743p, which equates to an 81.2% upside on its 2 September closing price of 410.1p.

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