Henry Boot

This is a property construction and land development group that operates mainly in the north of England. Being quite small (£140m mc) and family controlled, it tends to fall under the radar of most stock brokers and investment analysts (in fact there is only one house that covers the shares, and the are the house brokers).

The land development business is main reason why the shares are interesting (http://www.hallamland.co.uk/). The business model is to buy land cheaply, usually from from farmers under option or agency agreements, invest in getting the land through the planning system (can take 10-15 years), and then eventually selling it on, usually to one of the major UK housebuilders. The business has a long and good track record of doing this successfully. Current trading is depressed, both because of the economy, and also because the housebuilders themselves are not in a position to buy any new land.

However, the market does not appear to be properly valuing the land business. On the balance sheet, the only value assigned to the land development business is the inventory entry, which consists of the amount originally paid for the land (tiny in comparison to what is sold for) plus any capitalised planning costs that have gone into specific acreage that the company expects to gain planning permission on. As at the last balance sheet reporting date, this amounted to £54m. Over the three year period 2006-8, total land profits were over £70m. It also possible to verify that the £54m entry is extremely conservative by conducting a simple discounted cash flow model on the current land bank. I have used the following information and assumptions provided by the company: 1666 acres owned outright, 6500 acres under option (where the company has 15% ownership interest), 50% success rate, 50% usable land per acre (the rest is car parks, communual areas etc.), 10 units per acre, £40,000 site value per unit on sale. With a 30% tax rate this suggests a normalised profit to the company of £12.3m per annum. Spread this out over 15 years and discount at 10% to get a valuation of £94m. Alternatively, if I assume that all land sold is replaced with new inventory, and then value the cash flow on a perpuity basis (10% discount rate), the valuation rises to £112.

It is possible to verify that the market undervaluing the land business by deducting the value of all the compnay's other assets from the enterprise value and seeing what is left. Fortunately, the company's other assets are fairly straightforward and easy to value.

The other major asset is the property portfolio, which consists of a series of retail parks, warehouses etc mostly in the north of England. At the last reported balance sheet date, this was valued at £117.2m, following a year and a half of hefty rightdowns (-£20m in 2008 and -£24m in H1 2009). Additional to this, the company had just over £70m of property under construction which, when complete, would move to the propety investment portfolio. This is valued at cost, which means it might be reasomable to expect some writedown on completion, although I have been advised by the company that this is unlikely to be the case as they already have a large provision in the balance sheet (£11m). The other way of verifying that the propety portfolio is not overvalued is to look at the rent it generates. At the last reported valuation date, the gross rental yield was 9.3%, which is a lot higher than the major UK real estate majors. Although this would partly be expected given that these are lower grade properties in the north of England, it still suggests that the portfolio valuation is pretty reasonable.

The company has three other small assets. Firstly, there is a PFI contract to run the A69 for another 17 years. This is highly defensive, generating just over £2m in profit for the company per annum. Valuing this on a no-growth basis (i.e. 17 years discounted) suggests a value of £17m. In reality there is likely to be some growth suggesting a higher valuation may be fairer. Secondly, the company operates a plant hire business, mainly to the construction and housebuilding sectors. Unsurprisingly this business is on its knees right now. Profit will be negative this year, although cash flow will be positive as they are letting the fleet age by not investing. I value this business by taking a 25% haircut on the net assets, which gives a value of £9m. (note: historically the business has done £1-2m of profit). Finally there is a general construction business, which is also struggling right now. It has made money historically, but clearly the outlook is poor and there are very few assets associated with it (in fact net assets are probabyly negative due to the customer advances that are usually associated with this sort of contracting business). Therefore I give it a zero value.

On the liability side, I am taking the debt at face value at the last reporting date. I am adding £20m to the pension deficit, partly to be conservative, but also because there is a triennal review approaching.

Putting all this together we have:

Investment property and development = £190m
PFI asset = £19m
Banner plant = £9m
Net debt = -54m
Pension = -45m
Net to equity ex Hallam Land = 119m
Market capitalisation = 143m
Implied value of Hallam Land = 24m

From the above it is therefore possible to infer that the market is valuing the land business at merely £25m. As the above analysis has suggested, a conservative going-concern valuation for the land business is more like £95m. Adding this to the valuation suggests a fair value of £214m, or 166p per share or 50% upside.

Conclusion: I think this is enough to justify buying a position in the shares. However, although there is margin of safety here, it must also be conceded that there are factors that could cause loss of capital, in particul a double dip recession combined with a further leg down in the housing market. This would further depress the housebuilding industry and either impair or delay the realisation of value within the land business.