Berkeley Group Holdings: London's NVR

Berkeley released interims today showing continued strong performance with adjusted profit before tax up 10%, increased forward sales and estimate future land bank gross margin. They increased the dividend return programme the introduced in 2011 from £13 to 16.34 per share, with £12 to be distributed over the next 6 years.

I mentioned in a previous post about Berk's unique operating model and the favourable macro fundamentals that are certain to provide tailwinds in the coming years, however I didn't touch much on management or the ability of this company to create value.

Is this a value creator? Does the company create value throughout time? How can we even measure this?

Michael Mauboussin explains how value creation stems from the ability of company to earn returns on capital above their cost but throughout time. Consistently. This is the test, Can Berkeley continue to generate ROIC's in the 20s and if not what is the long run average ROIC for such a business.

                                   

Berkeley has consistently generated high ROIC, well above it's cost of capital. This is simply due to their operating model. They buy plots of brownfield land, land previously used for industrial or other commercial purposes, to redevelop and sell residential homes on in the South East and London.

Competition for brownfield sites is considerably lower than standard green belt plots which are chased by all UK builders. Berkeley's management has skill in choosing land, placemaking. They have purchased land at 10-15% of the final selling price.

The unique operating model is very similar to NVR, the US Homebuilder who purchase options on land rather than outright purchasing plots. Berkeley also do this and claim they have around 'we hold a pipeline of strategic long-term options for in excess of 5,000 plots'. This keeps the capital required to run the business minimal to maintain those high ROIC's.

How can we prove management have skill in choosing brownfield sites and gaining planning permission?

One way is to use Buffett's value add measure of $1 of retained earnings being greater than a nominal $1.

Berkeley Market cap 2011 - £1.35bn 

Sum of Net Income (inc 2015 H1) - £1.314

Sum of Dividends - £0.5954bn

Retained Earnings = £718m 

Mkt Cap 2011 + Retained = £2.068bn 

Current Market Cap = £4.89bn 

Total Value Added = £2.828

From 1996 the record is even more outstanding:

96 Mkt cap - £32m 

Retained earnings April 1996 - Oct 2015 = £2.398bn

Total Value added = £4.89bn - £2.43bn = £2.46bn 

Berkeley has created £2 of value for every £1 retained over a 20-year period. Clear value creation. 

OK, yeah, some of this value has come from the huge increase in house prices in these areas. The House price index shows a CAGR of around 8% over the 20 year period in question. So Berkeley management have definitely added some value from operations.

How long can this continue?

Macro factors tailwinds:

• Continued, sustainable for London and South East property 
• Constrained supply in housing 
• Continued support, and increased pressure, of government pushing the redevelopment of brownfield sites in London
• Increasing approvals of planning applications
• Help to Buy scheme improving mortgage approvals. 

Seems like its here to stay at least for the next couple of years.