UK home builders, which have fallen by an average of 30 percent in the past month in London trading, may be under priced as they now reflect a worst-case scenario that is unlikely to happen, according to UBS AG.
Share prices currently assume an "Armageddon" scenario that includes land writedowns of 50 percent, UBS analysts, including Mark Stockdale, said in a note, obtained by Bloomberg News. "We find it hard to believe this could occur." Taylor Wimpey Plc led a second day of stock gains in the industry, rising 16 percent.
Britain's house builders fell earlier last week on investor concern that some may be forced to write down the value of their land, carry out discounted rights issues and swap debt for equity to cope with a deepening housing slump. Some may also breach banking covenants as earnings dry up, according to analysts. Barratt Developments Plc has lost 39 percent of its market value last week and Redrow Plc 24 percent.
"We believe that the market is being somewhat irrational," the UBS analysts said. "We expect that banks would waive covenants as they are broken, agree new price and covenant packages for existing debt and support house builder cash generation. We cannot rule out rights issues or strategic investors, but we do rule out debt for equity swaps/bankruptcy."
Taylor Wimpey, the biggest UK home builder, rose 9.50 pence (19 US cents) to close at 70.50 pence last Friday. Barratt, the No. 2 by volume, increased 13 percent to 86.50 pence, while Redrow gained 16 percent to 163.75 pence. Other home building-related stocks such as heating and plumbing product suppliers Wolseley Plc and BSS Group also rose.
Taylor Wimpey's shares had fallen "well below" the price justified by a 50-percent land writedown, UBS said.
UBS stressed that it hasn't changed its forecasts ratings and share price targets on the home builders.
"We can see a lot of medium-term value. However, given the uncertainty and our view that investment thesis is now driven by recovery in 2010, we prefer to wait for trading updates in July before making any decision on valuations," the analysts said.