The Investment column: No quick fix for housebuilders

What is wrong with housebuilders? Here's a sector that generated double-digit earnings growth last year, and is widely expected to repeat the trick in the coming year. Yet investors, who normally love a good growth story, continue to value the majority of the construction sector at a level normally reserved for the most bombed-out conglomerates. In the past 12 months, the sector has underperformed the rest of the stock market by almost a fifth.

A good example is Abbey, the tiny Anglo-Irish housebuilder, which yesterday reported that interim profits more than doubled to IRpounds 7.56m. In the coming year it hopes to build 800 houses - double the number of sales it completed in 1997. Yet, despite a good run, this kind of growth stock languishes on a forward p/e ratio of no more than 10.

The reason, of course, is that nobody expects the growth to last. Investors badly burned their fingers on housebuilding stocks in the last recession and, to a lesser extent, in 1995. The widely held belief is that the current boom will inevitably crumble as higher land prices squeeze margins at the same time as rising interest rates dampen demand. Evidence of a shortage of skilled brickies and a sharp increase in wage costs hasn't helped investors' confidence.

Paradoxically, then, a slowdown in the housing market could ease fears of an unsustainable boom and prove to be good news for housebuilding shares. Yesterday's statistics, which showed that housing starts in November were flat on the same month in 1996, support the view that as many houses will be built in the coming year as in 1997. Some even think starts may fall slightly. Land price and wage inflation, meanwhile, are not much of a worry outside a few hot spots in the South-east.

All this, combined with house price inflation in the coming year of about 5 per cent, amounts to a gentle slowdown. Of course, margins will shrink slightly as the particularly cheap land prices of a few years ago work their way through the system. This can hardly be called a bust. But housebuilding shares are discounting a much sharper fall in margins. These fears look overdone.

So housebuilding shares are cheap. While interest rates are on the rise, however, sentiment is unlikely to turn. And another round of consolidation is unlikely while depressed share prices rule out anything but a cash- funded bid. At some point, the housebuilding sector will come good. Just don't expect it to happen any time soon.