The investor's view: CroesusAt the beginning of the year, quoted housebuilding stocks in Ireland and Britain were riding high after several years of rising house prices and output. Because of the cyclical nature of housing markets, the stock market has tended to assign relatively low valuations to housebuilders.

By early 2007, the sector was being viewed favourably by investors, driven in part by merger and acquisition activity in Britain. In such deals the net asset value (or book value) per share is a useful valuation yardstick given that a housebuilder's landbank usually accounts for a high proportion of its tangible net worth.

Some British deals occurred at two times book value compared with the historical sector average of 1.3 times book value.

However, since then it has been all downhill for the housebuilders' share prices in Britain and Ireland. Negative sentiment emanating from the US housing market is partly to blame. The share prices of US housing-related stocks have been in decline for a year now and the underlying market has yet to reach a bottom.

An indication of just how tough trading conditions are for US homebuilders can be gleaned from the results of DR Horton, one of the largest US quoted stocks.

In its third quarter (April-June), its orders for new homes declined by 40 per cent to 8,559 units compared with 14,316 units in the third quarter of 2006. These results are consistent with those of other US housebuilders and confirm that the US market is still deteriorating.

In contrast to the US, the underlying conditions in the Irish and British markets remain very healthy. British prices and output have continued to rise this year. After a decade of rising prices, Irish house prices have declined modestly this year and output will be significantly below the peak reached in 2006.

Many view this as the start of a healthy adjustment to a lower level of annual output and stable prices.

It would seem that share price declines for the Irish and British housebuilders are due to the negative impact on investor sentiment of rising interest rates. Such declines have been quite severe, as can be seen from the table.

Persimmon, the largest UK stock, has fallen by 26 per cent year-to-date and this is reflective of the overall sector. Bovis Homes is also down 26 per cent and Barratt Development has fallen by 24 per cent.

Meanwhile, in Ireland McInerney is down 31 per cent year-to-date although Abbey has held up well with a fall of just 9 per cent.

Abbey recently announced results for its financial year to end April, where it reported a 4 per cent increase in earnings per share (EPS) to 118.7c. Completions actually fell to 677 units, a year-on-year decline of 17 per cent.

The impact on profits was mitigated by an improvement in the profit margin to just under 24 per cent so that pre-tax profits declined by just 3 per cent.

However, EPS actually rose by 4 per cent as there were fewer shares in issue as a result of company share buyback programmes.

Abbey management stated that the group has entered the current financial year with a good forward sales position. For 2008 and 2009, units completed in Britain and Ireland are likely to remain in the 700 to 800 range.

In Britain, the mix will change towards social housing given government policy to sharply increase the availability of affordable housing. Abbey has also begun work on its first project in Prague, where it has approximately 150 plots with planning permission.

At year-end, Abbey's British and Irish landbank stood at 2,608 plots, all of which had planning permission, which equates to approximately four years' supply. This landbank, together with a net cash position of €32 million on the balance sheet at year-end, goes a long way to explaining the relative resilience of the Abbey share price in the face of the sector's weakness.

As the table highlights, price/earnings ratios for these stocks are now very low.

Persimmon is trading on a p/e of 7.6 while Abbey and McInerney are trading on multiples of 8.1 and 6.7 respectively. It is unlikely that there will be a short-term bounce as long as the market expects euro and sterling interest rates to keep rising.

Nevertheless, housing output in Britain simply has to rise over the medium term given the failure to produce an adequate supply of new homes over the past decade.

In this context, British housebuilding stocks look attractive at current prices. Both of the Irish stocks have significant and growing British operations that provide them with ample scope to grow over the medium term, even if the Irish market slows significantly in 2008.