by Tajinder Dhillon.
The British economy has been rattled by a cost-of-living crisis fuelled by higher energy prices which has resulted in the Bank of England (BoE) raising its policy rate by 200 basis points to 2.5% since the beginning of the year with further rises to follow. Currently, this ranks as the eighth largest annual increase in the base rate going back to 1900 (Source: Refinitiv Datastream).
Using the Interest Rate Probability App in Refinitiv Workspace, markets are pricing rates to rise to 4.5% by the end of the year which would result in an increase of 400 basis points in 2022. This would be tied for the fifth largest increase ever and the largest annual increase since 1972.
At a time where consumer confidence is at an all-time low, the incoming Prime Minister and Chancellor of the Exchequer introduced a mini-budget last week featuring ‘pro-growth’ economic policies to help stimulate the economy. These actions caused a frenzy in the market (Sterling falling to a 37 year low) as it was unclear how these policies would be funded and appeared to be in contrast to the tightening efforts from the BoE. To calm markets, the BoE stepped in and temporarily announced quantitative easing. Looking forward, if existing and new government policies continue to be funded by strictly borrowing without an offset, inflation risks are skewed to the upside which will only add pressure for further rate rises which will ultimately hurt both existing and first-time buyers.
The FTSE 350 Homebuilders Index which has declined 49.4% year-to-date and is the second worst performing industry. The industry is trading at an all-time low forward P/E of 6.5x, a 53.3% discount to its long-term average (Exhibit 1, top pane). Relative to the index (P/E of 9.3x), the same is true with the industry trading at an all-time low discount of 35% (Exhibit 1, bottom pane).
Exhibit 1: FTSE 350 Homebuilders P/E Ratio
The average home price of £292k according to Land Registry has remained resilient thus far (+0.9% m/m, +10.0% y/y), in sharp contrast to a three consecutive month decline in the forward price expectations index from The Royal Institution of Chartered Surveyors (RICS). As per RICS, New Buyer Enquiries, New Instructions, Agreed Sales, and Sales Expectations have all declined between four to five months consecutively.
According to Nationwide, the U.K. average price to earnings ratio is at a record high of 7.0x (London: 10.9x) as per Exhibit 2. The same is true for first first-time buyers who face a P/E of 5.9x. Said differently, house prices relative to household income are at extreme highs which will put further pressure on first-time buyers as mortgage rates are tied directly to the Bank of England base rate.
Today’s release from Nationwide shows homeowners currently budget 34.0% of take-home monthly pay for mortgage payments (55.6% in London), which is at a 14-year high and above the long-term average of 29.3%. The last time we were in a rate hike cycle was July 2006-2007 which saw rates rise from 4.5% to 5.75% and saw monthly budgets for mortgages increase from 38.9% to 46.0% of take-home monthly pay.
While this technically suggests homeowners have further capacity to allocate take-home pay for mortgages, today’s environment is far different given a doubling in household energy bills, rising petrol and food prices, resulting in consumer confidence nearing all-time lows.
Exhibit 2: U.K. Home Price to Household Earnings Ratio
As mortgage rates in the U.K. are tied to the base rate, we have seen a dramatic fall in the number of new mortgages approved since the pandemic in comparison to a surge in re-mortgaging activity in anticipation of higher rate rises (Exhibit 3).
According to today’s release from the Bank of England, August saw a surprise uptick of 49,395 remortgages (+2.0% m/m, +25.0% y/y) and a surprise increase of 74,340 new mortgages approved (+16.6% m/m, +1.7% y/y).
New mortgage approvals are a leading indicator for household demand and impacts homebuilders who are in the business of selling newly constructed homes across the country.
Exhibit 3: U.K. New Mortgages vs. Remortgages
Looking at the StarMine Analyst Revision Model (ARM), three of the four homebuilders in the FTSE 100 are currently ranked in the bottom decile. Persimmon PLC has an ARM score of 5 while Taylor Wimpey PLC and Barratt Developments PLC have an ARM score of 8 and 9 respectively.
ARM is a stock ranking model that is designed to predict future changes in analyst sentiment by looking at changes in estimates across EPS, EBITDA, Revenue, and Recommendations over multiple time periods. All StarMine model scores are ranked from 1 (bearish) through 100 (bullish) and a model score of 50 denotes a neutral signal.
We will use Persimmon PLC as a case study to explain how ARM works along with the various inputs including StarMine SmartEstimate and StarMine Predicted Surprise (PS).
Exhibit 4 highlights the current ARM score for Persimmon PLC along with detailed breakdown of each component.
Exhibit 4: StarMine ARM Model for Persimmon PLC
ARM has four components as previously described: EPS, EBITDA, Revenue, and changes in Recommendations along with individual scores for each component providing further transparency.
Refinitiv Workspace for Analysts and Portfolio Managers users can access ARM by going to the ‘Estimates’ tab on a company page and clicking on Analyst Revision Model.
After viewing the model summary widget, users can scroll further down to see a visual display of how estimates have trended over time across all four components. Looking at the second column (FY2023), analysts have downgraded both top and bottom-line numbers as we see a blended Revenue mean change of -5.4% and a blended EPS mean change of -4.4%. The blended mean change incorporates five lookback periods of 7d, 14d, 30d, 60d, and 90d.
For each measure, there is also a Predicted Surprise (PS) column, which compares the StarMine SmartEstimate (gold line) vs. Mean estimate (blue line). A PS greater than 2% or less than -2% is deemed significant as our research shows that StarMine will accurately predict the direction of the earnings surprise 70% of the time.
Persimmon PLC has a current PS of -9.3% for FY2023. Note that the gold line is lower than the blue line in every graph below, indicating that the SmartEstimate (explained below) is predicting further estimates from analysts to be lowered.
The StarMine SmartEstimate is a quantitative analytic which is used as an input to many of the StarMine models. The SmartEstimate places a greater weight on higher ranked analysts who are more accurate and timelier. Said differently, the SmartEstimate is viewed as a refined ‘consensus’ number and acts as a leading indicator compared to the traditional consensus mean estimate.
Exhibit 5 highlights the Predicted Surprise for FY2023 (198.36 SmartEstimate vs. 216.51 Mean). Refinitiv Workspace users can find the Detailed Estimates page by going to the Estimates tab on a company overview page. The widget also highlights that over the last 30 days, 5 of the 16 estimates are ‘new’ and that the consensus mean estimate has been revised down by 5.6% over the same period.
Exhibit 5: FY2023 SmartEstimate for Persimmon PLC
The Detailed Estimates page also provides a list of all analyst estimates for the chosen measure and period which provides further insight (Exhibit 6). Here we can see the ‘Earnings Accuracy’ for each analyst, which is a 1-5 Star Ranking based on a normal distribution – only 10% of analysts are able to achieve a 5-star ranking.
The data can be sorted by any column and in this example, is sorted by SmartEstimate Weight which highlights how the SmartEstimate is weighted by analyst.
The StarMine SmartEstimate also incorporates other data cleansing measures such as removing old estimates from the SmartEstimate (noted as X-Age) in addition to removing estimates who are not a part of a revisions cluster (noted as X-Cluster).
Another feature of the SmartEstimate is to inform users when a 5-star analyst makes a large change in their forecast which is at least 5% different vs. the consensus mean estimate. This is called a ‘Bold Estimate’ which is highlighted either green (positive Bold Estimate) or red (negative Bold Estimate). Bold Estimates are valuable as a 5-star analyst is much more likely to remain a 5-star analyst into the future.
Exhibit 6: SmartEstimate for Persimmon PLC
Source: Refinitiv Workspace
In conclusion, StarMine ARM is a rapid signaling model which incorporates real-time data from our I/B/E/S database and adds a layer of value by providing a SmartEstimate which provides a more up-to-date estimate during times of extreme uncertainty. ARM can be incorporated into any workflow on both the desktop and excel add-in which allows users to easily track model score changes for a portfolio or list of securities.
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