Taylor Wimpey

Taylor Wimpey continues its downward plunge, from my purchase price of 130p down to a low of 90.5p today (recovering to close at 95.75p). Given my expectations of a house price plunge, followed by a UK recession, you might think that this share will continue to tank. But at what point should you buy? Sooner or later the value argument just becomes irresistable - but can that happen before the house price plunge has even occurred? Will TW plumb the depths of 50p, 20p, 10p?

This is my attempt to do an in-depth analysis of TW and identify where fair value occurs. Previously I have set a fair price of 215p on the share, based on expected earnings of £230m and a fair P/E ratio of 10. I still think that is not unreasonable, but due to its debt there is significant downside - perhaps that will outweigh any possible upside?

Worst case
Lets address the worst case first. This assumes that TW goes bankrupt, or is forced to sell itself to a Sovereign Wealth Fund, or similar catastrophic outcome. In that case, I will assume it will be valued at whatever its assets will achieve on the open market (which is not NAV).

Let's assume £200m for the brand. Well below what it's recorded as under Goodwill and Other Intangile Assets, but what can you expect? Brand loyalty to a housebuilder?

Sundry other non-current assets: £295m. Call it £250 since some of these may fall along with TW's value. That makes £450m for Non-Current Assets.

Current Assets: £538 for the simple stuff. £6018m inventory, split £119m I don't understand, £3879 land and £2020 development and construction costs. The land will be recorded at less than fair value - but let's assume a 50% drop on top of that down to £1440m. Development and construction costs you would hope that they could achieve most of... but let's take 80% for safety, to make £1616m. That's £3594 for Current Assets.

Assets = £4044m. Lets round that down to £4bn for simplicity's sake.

Now on to liabilities. These are easy - assume they all apply: £3964bn. Let's round up for simplicitly's sake, and we discover that in the worst-case Taylor Wimpey is worth precisely £0.

Best case
I'm not going to go too mad here, but let's assume the UK housing crash and/or recession don't happen. Prices stabilise at current levels, volume returns to normal. The US and Spain return to normality. Canada and Gibraltar remain robust.

Last year pre-interest, pre-exceptionals was £476m. Slap on some synergies, something for the recovery of the US and Spanish markets, and assume pre-tax, pre-interest earnings of £700m.

Interest payments of 6.5% on debt of £1.5bn (assuming they are not paying interest on payables) makes £100m. They actually paid £122m last year, so that's not realistic, especially since they took on more debt mid-year. Let's assume £150m finance costs, so £550m pre-tax.

Tax at 30% makes £385m post-tax.

Valuing on earnings... I still don't fancy a P/E ratio better than 10, so £3850m market cap. That's about 335p.

Middle case
Now for the tough part :-)

I'm going to make a whole series of assumptions.

• House price decline of 25% over 3 years.
• Volume well down on normal levels, averaging 60% of normal over 3 years.
• Taylor Wimpey cuts costs (they've already announced a 30% cut in staff numbers).
• Synergies are not fully achieved due to cut-back in build activity.

So, currently, on an average house price of about £200k, land costs are £50k, construction costs are £125k, and TW operating profits are £25k. In a tough market average house prices are £150k, land costs are £20k, construction costs are £110k, TW operating profits are £10k.

Current volume is about 22,000 houses per year, so assume a fall to 13,000. That means TW operating profit of £130m. Doesn't cover interest payments, but not too far off. TW depletes land banks to cover interest payments and achieve positive cashflow, paying off debt (cancelling the dividend).

But then: the market picks up. Prices are still subdued, but volumes begin to recover. TW is leaner and meaner. Volume is back to 20,000. Margins improve, so TW is now making £15k per house. Operating profit is back to £300m, which is £180m after interest payments (some debt has been paid back), and £125m after tax.

At a fair P/E ratio of 10, that means fair value is £1.25bn, or a share price of 120p (pretty much where I bought after the dividend was taken into account).

Conclusion

Dividing the future into 5 equally likely quintiles seems a fair way to calculate fair value. So here goes:

• Worst case. 0p.
• Rights issue. Middle cast diluted by 50% =60p.
• Middle case. 120p.
• Not as bad as feared. Earnings of £230m. 215p.
• Best case. 335p.

So that puts fair value as the average of those 5, which is 146p. This is significantly below my previously assessed fair value of 215p, and I am well aware that I'm probably being influenced by the current share price and indeed by the drop since I bought originally.

Comparing to the deciles that I based my previous valuation on, the difference is very much to the downside. Taylor Wimpey's leverage means that a wipeout is a very real possibility. My previous valuation gave it a likelihood of <5%,>

Having said all that, I think today's analysis is very much on the pessimistic side. Who knows whether the correct approach is more or less negative? Time will tell.

In the meantime I think I will happily purchase more at up to 100p (a 30% discount to my 146p valuation).