Grafton's rise reflects housebuilding strength

Investor: Quoted companies in the UK involved in housebuilding and the DIY sectors have been reporting buoyant financial results in recent weeks.

The UK housing market continues to defy predictions of an impending bust and conditions remain very favourable.

Rising house prices and strong demand for new homes has led to a re-rating of the UK-quoted housebuilding sector, which has now risen by approximately 40 per cent so far this year.

Repair and maintenance and home improvement activity has also been very strong.

Recent research in the UK showed that average spending on DIY projects in the four months to end-June is up more than 50 per cent on the same period last year.

The Focus Wickes DIY Monitor, a survey of 1,500 shoppers across the UK, found that the average spend on DIY projects was £2,610 (€2,400) in the four months to end-June. This is 53.5 per cent higher than the same period last year.

It appears that low interest rates and poor returns from stock markets are encouraging people to invest more in their homes. Decorating and lifestyle-themed programmes on TV are also boosting sales.

According to the report, nearly 60 per cent of women and just under 40 per cent of men surveyed in the study said they "always picked up a lot of ideas" from programmes such as Changing Rooms, Home Front and Home Doctor.

The survey also reported that nearly 40 per cent of the UK adult population are regular DIY shoppers.

While not directly applicable to the Irish market, the information in the survey will be of interest to investors in Irish- quoted building materials and merchanting companies.

The two largest stocks in the sector - CRH and Grafton Group - are due to report interim results in early September.

Of the two, Grafton is the company that has significant exposure to DIY through its Woodie's chain in Ireland, which is the market leader.

Grafton has also expanded successfully into the UK and has grown to be the fourth-largest player in UK merchanting with an estimated 4-5 per cent market share.

The Grafton share price has risen sharply so far this year, reflecting the strength in housebuilding and related activities in both Ireland and Britain.

The share price has been particularly strong in recent months, rising by close to 30 per cent over the past month alone.

As well as buoyant underlying business conditions, the share price also benefited from the announcement that it is to be included in the DJ EuroStoxx 600 index from September 22nd. Funds that passively track this index have probably already started to purchase the stock in the market, thus generating extra demand for the shares.

This strong share price performance means that the market is now valuing the company on a higher price-earnings ratio (PER) than heretofore.

At the beginning of the year, Grafton's shares were trading around the €3.60 level that implied a PER of approximately 9 and a dividend yield of 2.5 per cent.

With the shares now trading at €5, the PER has expanded to 12 and the historic dividend yield has shrunk to 1.7 per cent.

However, as the accompanying table shows, this rating is still in keeping with Grafton's UK competitors.

The company's most important quoted competitors are Wolseley and Travis Perkins, both of whom are significantly larger than Grafton as measured by market capitalisation. Travis Perkins trades on a prospective PER of 13.3 and Wolseley's is 14.3, compared with Grafton's PER of 12.0. Wolseley does, however, pay a more generous dividend and therefore has a higher dividend yield of 2.3 per cent compared with Grafton's yield of 1.7 per cent.

These valuation metrics for Grafton indicate that it is now valued on a basis that is broadly comparable to its UK competitors whereas it did previously trade at a discount to the relevant UK sector.

A further rise in the share price through another expansion in its price earnings ratio is now highly unlikely.

However, if the company continues to produce healthy growth from its current operations and remains successful at its policy of bolt-on acquisitions, shareholders in the company should continue to enjoy satisfactory capital appreciation and the shares are likely to remain a core holding across most portfolios that invest in the Irish equity market.