Description

Vistry Group (VTY – London)
NVR with a Posh British Accent

1) Introduction

The UK housing market is egregiously undersupplied to the tune of millions of homes. However, due to regulatory impediments, high capital demands, cyclicality, and now elevated interest rates, new construction has continually failed to rectify the imbalance. As a result, there is wide support across all levels of the UK government for financial aid to potential homeowners and for initiatives to increase home construction.

Against this backdrop, UK homebuilder Vistry Group (VTY.L) is transitioning to a pure-play “partnerships” business model that combines the financial and land resources of local authorities/housing associations, the central government, and even financial institutions with those of the homebuilder to create a capital-light home construction enterprise at the center of a virtuous cycle for all stakeholders. Unlike traditional homebuilders, “partnerships”-model builders pre-sell over 50% of their homes at affordable prices mostly to cycle-agnostic local councils/housing associations, shortening cash collection times and considerably reducing the business’s cyclicality and interest rate sensitivity. Vistry’s shift from a hybrid traditional/partnerships housebuilder to a pure-play “partnerships” business will not only make it the UK’s largest affordable housing manufacturer but will also drastically improve its revenue stability and visibility, return on capital, and earnings potential.

The best analogy, valuation comparable, and example of expected returns for Vistry should be US-listed NVR. For those unfamiliar with NVR, please see the great Norbert Lou’s (charlie479) first VIC post, or simply look up its price chart and number of shares outstanding since inception. The fact that Lou’s post from 2001 is still relevant to NVR and VTY today speaks not only to the durability of the capital-light housebuilding model and its return profile, but also to the genius of his write-up itself. If it wouldn’t offend our fellow VIC members, we’d almost be inclined to write a Vistry VIC thesis by citing Lou’s NVR post and adding “but VTY is better and cheaper.” In fact, we know Mr. Lou was a shareholder in Countryside Partnerships (CSP.L), which was acquired by Vistry in late 2022. Perhaps, he’s still involved?

To add to the similarities between the two companies, a former NVR board member was added to Vistry’s board earlier this year, courtesy of large US shareholders who are directing VTY to follow NVR’s value-creation roadmap.

At present, Vistry is valued on traditional homebuilding metrics (TBV) by market participants who remain anchored to historical operations and perceptions, while simultaneously failing to recognize its shift to a pure-play, capital-light partnerships model that should be valued on earnings and/or free cash flow. Even so, the company trades on single-digit multiples of earnings and free cash flow.

In addition to a compelling valuation for a fantastic business, Vistry, through its transformation to a pure-play partnerships model, is freeing up over £1B in cash by repurposing its traditional Housebuilding segment. This cash should be returned to shareholders via buybacks over the next three years. (That’s ~40% of its market cap, or over £300M per annum for ~3 years.) Moreover, as a pure-play partnerships-model business following an NVR playbook, Vistry should be capable of returning even greater amounts of capital to shareholders each year for almost a decade.

2) Investment Thesis

We recommend investing in VTY as the true earnings power of the business is being obscured during its transition phase, and any near-term volatility in the traditional homebuilding environment (which the company is transitioning away from) should be mitigated by considerable share buybacks.

At Vistry’s current price of ~777p/share, the market values it at ~3.25x operating earnings, assuming management’s guidance of ~22K home completions per annum generating £800M operating income at a 12% operating margin. Given the visibility of the Partnerships business and the well-managed transformation already underway, we believe management’s guidance is easily achievable within its 2–3-year time frame.

The current market mispricing is so acute that our fair value estimate for a worst-case scenario, with no growth or capital returns valued on an anemic sub-5x EBIT, still comes to 2,300p/share, a ~24% IRR over five years. With a more reasonable estimation of the business and its trajectory, we see a Base Case of 48,500p/share, roughly 6x the current price, for a ~44% IRR over five years. However, should Vistry follow the same path as NVR, shareholder returns would be well above even those of our impressive Base Case scenario.

There are several reasons for the current mispricing:

1. 1. Unlike traditional homebuilding, the Partnerships business is cycle-agnostic and largely immune to interest rate changes. Homebuilding in the UK is quite like homebuilding in the US: Land is purchased, building permits are approved, homes are built, and then those homes are sold to homeowners. This process is capital-intensive, with considerable debt financing for each participant, and thus highly sensitive to interest rates.

By contrast, in the partnerships business model, the homebuilder literally partners with housing authorities and local governments who donate land for regeneration purposes, minimizing the builder’s initial capital outlay and providing a large land bank without the risks associated with typical land speculation. The builder then builds a mix of affordable housing, rental units, and private homes on the donated land, incurring costs only for project management, materials, and labor. Over 50% of the homes it builds are affordable homes pre-sold at a lower margin to housing authorities, shortening cash collection cycles and increasing visibility on forward earnings while reducing its exposure to the cyclicality of open-market home demand. The remainder of the rental units or homes are sold either to REITs for rental income or to private homeowners for a slightly higher profit.

Ultimately, less than 25% of Partnership home sales are vulnerable to housing market fluctuations and cycles. For example, Countryside Partnerships, now the crown jewel of Vistry, actually grew earnings from 2007 to 2010 despite the Great Financial Crisis, and from 2019 to 2022 despite the COVID-19 pandemic. Moreover, given the demand for affordable housing, there are multiple government initiatives providing financial support for homebuyers and builders. As such, Vistry’s Partnerships business should exhibit steady growth through a cycle by focusing on lower-risk segments of the housing market that have greater cycle-agnostic demand – and thereby enjoying greater operational visibility and lower capital intensity than peers. 

2. 2. Vistry’s shift to a partnerships model may on the surface look like a pivot to a lower-margin business, but ROIC improvements are being obscured. In exchange for guaranteed pre-sales of lower-priced homes to local housing associations, the Partnerships division generates a lower operating margin (10%-15%) than traditional homebuilders (20%-25%). However, Partnerships shares the financial risks of its business with multiple stakeholders. As such, it can generate ROIC well above 40% with higher turns on inventory, compared to 20% for private homebuilders. As Vistry’s traditional homebuilding segment winds down and operating margins decline toward the partnerships model average of 12%, its ROIC should trend upwards and its capital-light reinvestment runway (as well as excess cash generated and returned to shareholders) should become apparent, causing a re-rating.
   3. Financial participants still value Vistry like a traditional homebuilder instead of on earnings like other capital-light builders. Traditional homebuilders trade on multiples of book value (1x-3x), whereas capital-light homebuilding businesses typically trade on multiples of operating earnings or cash flow (12.5x-20x). Notably, the biggest traditional UK homebuilders (Taylor Wimpey, Barratt Developments, Persimmon, and Bellway) trade below 1x P/B (around 12x-15x earnings). Vistry, now the largest partnerships builder, trades at more than a 50% discount to those peers on earnings, and even a 15% discount to them on book value.  In absence of the partnerships transformation, such relative valuation would be reasonable, as VTY’s Housebuilding division was sub-scale in comparison to these players. However, we see this as a clear sign of mispricing as investors value the entirety of the business based on its historical Housebuilding business and not its future earnings engine. As Vistry transitions to a pure-play partnerships-model business and continually repurchases shares, investors should increasingly value the business on its (consistent) operating profit and cash flows.
   4. Vistry has over a decade to capitalize on the severe UK housing supply imbalance, a longer time horizon than most expect. The UK government has identified the need to build 4.75M new homes to ensure an acceptable standard of living for the majority of its citizens. That’s almost 20% of its current housing stock. By comparison, the US needs ~7M new homes, or only 5% of its current housing stock. Importantly, housing supply and demand in the UK are egregiously out of balance even with the impact of Brexit weighing against net migration into the country. Should a Labour government reverse course on Brexit and allow more immigration from continental Europe, demand for housing (and government financial support) would likely increase.

Today, roughly 15% of UK homes, or half the 1980s average, belong to public housing entities. The government estimates an increase in homebuilding to 300K-340K new homes per annum by 2025 should start to close the housing gap, with roughly half of those being affordable. (Last year, UK homebuilders delivered ~220K new homes, of which ~60K were affordable.) At that rate, the UK’s housing supply would meet demand by the mid-2030s. During the 1950s and 60s, when the UK saw its highest levels of homebuilding, units built for local authorities and housing associations amounted to half of total supply increases. Today, these entities claim just a small percentage of new home supply. However, their share is expected to increase as tens of billions of pounds in subsidies are allocated over the next few years, with Vistry’s help. The company sees its pure-play Partnerships business delivering ~22K homes per annum, up from its current Housebuilding plus Partnerships total of 16K-17K. To meet government projections, Vistry could increase its Partnerships building rate above 30K homes per annum and maintain that pace for at least 10 years.

5. 5. Vistry’s relationships with local authorities are a “reputation moat” that generates supply-side network effect entrenching its dominant market position. Since the end of the British Empire (1945), the UK has lead the world perhaps only in its bureaucrats’ ability to create red tape (see BBC series The Thick of It). Local regulations and restrictions represent a considerable impediment to increased UK housing construction. Risk-averse local authorities, leery of profiteering, are reluctant to let “just anyone” in (see Clarkson’s Farm on Amazon Prime). Jokes aside, by meeting the housing needs of these local authorities in a reliable, trustworthy manner, Vistry enhances its reputation in the marketplace, which in turn helps it approach other local authorities and cut through the red tape (such as complex permitting procedures) that typically ties up smaller or traditional homebuilders. 

In fact, the company already has a long and positive track record with roughly 60 of the ~325 local authorities in the UK, more than any partnerships-model builder. For example, Vistry dedicates considerable in-house resources to work hand-in-hand with these authorities to steer the course of a housing development, while many of its competitors simply fill in paperwork with these overburdened authorities. These close relationships generate a supply-side network effect: Each new local authority can more readily trust Vistry because of all the others who already do – and that means new entrants find it hard to break into the market. Moreover, since Vistry is now the largest affordable homebuilder in the UK, it should be able to bring on new local authorities more easily than ever before, widening this already formidable, irreplicable moat.

6. 6. US investors and a former NVR board member now on Vistry’s board promote shareholder-friendly capital allocation and aggressive strategy implementation. Although Vistry is a UK company, over 25% of it is owned by activist US shareholders (through their considerable prior ownership of Countryside). Following its acquisition of Countryside, Vistry indicated its intention to force the market to recognize the Partnerships business’s value – and to split the businesses apart, if that recognition was not granted. After a year that saw board member churn including the addition of a former NVR board member, management announced that it would unlock shareholder value by redirecting Vistry’s traditional Housebuilding resources (such as land, labor, and capital) into the Partnerships division to create a much bigger pure-play partnerships-model business. Additionally, the capital freed up by this transition would let the company return £1B in excess cash to shareholders via a buyback, with another £300M going to reduce debt. Moreover, beyond an initial buyback, management anticipates capital returns to amount to 50% of its annual operating income. With near-term operating income of £800M expected by 2025, and with considerable stability and growth thereafter, Vistry could, at a minimum, return over £400M per annum to investors, mostly via NVR-style buybacks. (To date, NVR has repurchased over 75% of its shares.) Doing so would result in a buyback yield of ~15% at today’s share price.
   7. Underpriced shares are their own catalyst, allowing Vistry to buy back shares accretively with no need for multiple expansion to realize returns. Given the nature of the business and the capital allocation priorities of management, we think investors should re-rate Vistry higher based on earnings. However, VTY isn’t dependent on valuation multiple expansion to generate substantial shareholder returns. On the company’s own disclosures, management anticipates repurchasing 100M shares at 1,000p per share over the near term, starting with £55M this quarter. The share price currently sitting well below that level simply gives Vistry an opportunity to purchase more shares than it anticipated. With this level of capital returns, the excess over 2-3 years, and the programmatic return of 50% of operating earnings per annum, perpetual undervaluation is actually a benefit, and not a risk of continual disappointment waiting for investment returns via multiple expansion from changes in outside perceptions that might not occur.

Lastly, to quickly lay out the risks to Vistry, the largest micro risks are execution issues with the pivot to a pure-play partnerships-model business, scaling up modular home manufacturing facilities, and integration issues with Countryside. The largest macro risks are the levels of undersupply in the UK housing market, government support, and construction regulations that could impede home building.

3) Business Analysis

Overview: An Amalgamation of Multiple Top-Tier Partnership Businesses; Countryside the Jewel

Vistry Group was created in early 2020 following Bovis Homes’ (BVS.L) acquisition of Galliford Try’s (GFRD.L) Partnerships business and Linden Homes (traditional housebuilding), two separately run franchises. The Bovis and Linden Homes brands have been around since the early 20th century. Galliford Try’s Partnerships business included the Drew Smith brand, which it acquired in 2017. While these brands were maintained, Vistry combined their operations and strategies, yielding scale merits.

VTY was setup with two divisions: Housebuilding and Partnerships. Given the transition from Housebuilding, our analysis will stay centered on the Partnerships division.

Vistry’s late-2022 acquisition of Countryside (CSP.L) boosted its Partnerships home completions from ~4.5K to ~8K per annum. Additionally, Countryside implemented a modular construction methodology, building ~5K homes per annum in prefabricated sections. Now called Vistry Works, these facilities are expected to ramp up from ~5K to ~8K homes per annum. Over time we expect Vistry Works will grow to represent a greater share of Vistry’s total completions, driving material, labor, and supply chain efficiencies.

Last year, Vistry completed ~12K homes: ~7K from Housebuilding and ~4.5K from Partnerships (including ~650 from Countryside). Countryside Partnerships completed ~4K homes in 2022. With its transfer to a 100% partnerships-model business, Vistry is expected to increase its total annual output from 16K-17K homes to ~22K per annum within a few years.

How the Partnerships Business Model Works

We’re not going to discuss traditional housebuilding in detail, as the process is well understood: A site is located and prepared with all necessary approvals and paperwork. Land is bought outright or via option contract. Construction, on average, for a single home takes 5 to 7 months.

In the partnerships model, a public/private partnership between the homebuilder and local government (or an already-established housing authority) is formed, usually as a joint venture (JV). In other instances, the partnership may be a contractual one, where Vistry develops on donated land without forming a separate entity, though the sharing of resources is similar. The typical structure of a partnership, with each partners role and contribution, is shown below:

Figure 1: Housing Partnerships - London First. Edits by Author.

There are several different varieties of partnership JVs:

• A Development-Led JV will have a local authority partner with a developer to purchase land in exchange for a cash receipt. The agreements will include a timeframe for the developer to build on the site. At completion, the local authority may take a share of the “super profit” over and above the developer’s profit. (In some cases, the developed affordable housing may be provided in lieu of a profit share.)
• An Investor-Led JV will have a long-term investor (such as a pension or real estate fund) forward-fund a development and take a share of the development risk, with the local authority taking on the long-term operating risk for the completed development. The investor takes a long lease on land owned by the local authority, and then finances the development with a housebuilder. Upon completion, the local authority agrees to lease the developed homes over a term agreed to by the investors; at the end of the term, the assets revert to the local authority for a nominal sum.
• A Limited Liability JV sets up partnerships on a development-by-development basis, although local authorities may secure a strategic development partner. At completion, the council with its partner may choose to retain or sell the assets. If retained, the assets may be transferred to the investor, the council’s housing company, or a JV between them.

Partnership Model Economics

By involving several entities, a partnerships-model homebuilder can reduce the capital intensity of a development and simultaneously de-risk the operation. The table below shows how partnerships model economics differ from traditional housebuilding economics:

With land donated or capital provided by a local authority, housing associations, and/or financial participants, a lower-priced house with lower after-tax profits can yield substantially better returns on capital for Vistry than one built via the traditional business model. The remaining burden of capital-at-risk is also shared with a national regeneration fund. Vistry receives a priority profit for each project via a final balancing land payment to the local authorities at the end of each project. This allows the value of the final project to be changed so the company can meet its agreed-upon margin targets even in the event of unforeseen cost inflation.

Given the shorter timeframe of this style of housing development, cost inflation adjustments for small projects are minimal. Contracts for larger developments can have phased viability assessments on non-private home sales that mitigate the impact of inflation via contracted pass-through mechanisms that ensure a base return largely irrespective of increases in building costs and/or land values.

Essentially this is a cost-plus model where margins are negotiated first based on a home price that is in a range of affordability set by the local council/housing association. Price changes to the home afterwards are essentially immaterial as adjustments are focused on maintaining Vistry’s modest margins, even including inflation.

The only risk to margins is from the sale of homes to private homeowners, which comprise less than 25% of Vistry’s home completions and are subject to traditional housing market forces. Here the private homes are sold at a higher margin than the pre-sold units, and thus provide only a minimal uplift to margins in the best of times. In a tougher market, they’re sold to match margin levels of the homes pre-sold to partners.

Management: Impressive CEO with considerable ownership; US shareholders and former NVR board members

Vistry CEO Greg Fitzgerald was previously CEO of Galliford Try from 2005-15 and Bovis Homes in 2017. In 2020, Bovis purchased Galliford Try’s Partnerships and Linden Homes brands, which then became Vistry.

In the early 90s, Fitzgerald led the formation of a housebuilding business with Midas Construction. The business was sold to Galliford Try in 1997, and Fitzgerald subsequently co-founded Gerald Wood Homes, which was also sold to Galliford in 1999. At Galliford, Fitzgerald led the acquisition of Linden Homes in 2007. Following the GFC, he implemented a £125M rights offering to take advantage of a fall in land prices.

After retiring from Galliford in 2015, he was offered the CEO role at Bovis Homes to lead a turnaround. He invested £3M of his own capital into the company and turned it into Vistry, essentially purchasing the homebuilding businesses he was already very familiar with. Mr. Fitzgerald owns ~10% of Vistry. His compensation package totals ~£2.5M, comprised of ~£755K salary and a ~£1.7M equity bonus.

Of note are two board members, Jeff Ubben and Paul Whetsell. Jeff is the Managing Director and Founder of Inclusive Capital, which came to own ~6% of Vistry through its acquisition of Countryside. Jeff had previously attempted to take Countryside private with an offer of ~£1.5B. His pressure on Vistry’s board resulted in two board members leaving. He joined the board in mid-2023 along with Paul Whetsell, who had been a board member of NVR from 2007-18. While Inclusive Capital shut down in late November 2023, its capital in Vistry is locked up for an additional 4 years, as are a couple of the fund’s other high-conviction positions.

US shareholders (generally with an activist bent, as former shareholders of Countryside) and the executive team own over 35% of Vistry.

Customer Dynamics: Severe Shortage of Affordable Homes; Local Authorities Looking to Improve Communities

Vistry’s customers include not only homebuyers, but also real estate investors, local authorities, and housing associations who manage housing affordable (or mixed-tenure) developments. At present there are over 1.2M households on council waitlists for an affordable home. Across all tiers of UK housing, there is an estimated shortfall of ~4.75M homes. A typical Vistry Partnerships development is 50-50 affordable/PRS (Private Rent Sector); of those homes allocated to the PRS sector, some are sold to REITs and/or rental companies, with less than 25% sold outright to private homeowners.

Local Authorities and Housing Associations

While housing associations are nonprofits that own and manage affordable housing, local authorities are regional government agencies that control land and public housing in a particular area. These entities have a government mandate to alleviate the housing shortage but lack funding and know-how. They typically handle the delivery and management of resident and community facilities, and can be not just a homebuilder’s customer, but also its regulator and even its source of land on which to build.

During the post-WWII housing boom, local authorities and housing associations were responsible for almost half of the new housing supply in the country (see Figure 2 below). In the 1980s, almost one in three people in the UK lived in social housing. That figure has declined to roughly 15% today, but the government is trying to help social housing make a comeback: Homes England provided ~£1.7B in home ownership grants in 2022, with a 9-to-1 leveraged impact – in other words, the grant money was spent by homebuyers on their 10% down payments. The agency is expected to provide ~£17B in aid from 2023 through 2028.

Figure 2: House of Commons.

There are two main types of local housing authorities:

1. In-house/local authority. Under the in-house/local authority structure, the local authority borrows from the Public Works Loan Board (PWLB) to fund a development. That development is then governed by an agreement with the housebuilder. The local authority is responsible for sourcing funding, finding a construction partner, managing the development, and delivery.
2. Wholly-owned company (WOC). Within a WOC framework, the local authority funds a development with a combination of debt and equity. It’s the 100% shareholder of the WOC, which serves as a trading company whose future profits can be paid as dividends to the council or reinvested for future development.

Many of these authorities and associations are staffed by members of the local community, and as such tend to be highly risk-averse. Moreover, they typically solicit bids when choosing a builder, a process that can take years. Criteria for winning a bid typically comes down to track record, and community engagement. Finally, inadequate planning resources at these entities have been a further bottleneck to developments.

However, Vistry’s Partnerships business model incentivizes government authorities to approve housing plans more quickly, since over 50% of a Vistry-built housing development is delivered to these associations and authorities, who are not dependent on interest rates to finance it. In addition, Vistry’s solid reputation helps it quickly gain their approval, while its size and experience let it aid them in planning and executing a development. At the same time, smaller builders and new entrants are stymied by the lengthy and difficult approval process, giving Vistry a massive competitive advantage.

Financial/Real Estate Investors

Another subset of Vistry’s customers are real estate investment companies. These can be REITs comprised of rental properties, or PE-backed housing funds, such as those from Blackstone or Regis Group, PLC. A recent Blackstone-backed deal for 2,900 homes at a value of ~£820M shows how these entities can operate at scale. The Blackstone deal was marked at ~£282K per house, with 65% of them sold upfront, and with a cash payment to Vistry of ~20% (£160M). Similarly, UK pension funds have set up funds specifically to allocate capital to such partnership deals.

As little as 20%-25% of a development’s homes would be sold to these pension funds, REITs, and rental companies, who typically have robust balance sheets and can access interest rate-sensitive debt capital at better rates than private homeowners can.

Homebuyers

As little as 20%-25% of a Vistry development’s homes is sold on the open market to homeowners. (For traditional homebuilder developments, this figure is 75%-80%.)

Multiple UK government initiatives currently promote private home ownership. “Help to Buy” was a program that gave qualified homebuyers a low- to no-interest loan on 15% of a home’s value, with 5% down provided by the buyer. It ended in March 2023, but a replacement is expected.

Shared ownership is a similar scheme in which a potential homeowner can put down 5%-10% of a home’s price, with the rest financed by (1) housing associations, acting as landlords, and (2) grants from Homes England, the UK’s government housing agency. Rent is fixed below market price, and the homeowner can increase his ownership stake in the home over time.

Renters also have a “Right to Acquire” their rental unit from local authorities and housing associations. Within the rental sector are “Social Rent” and “Affordable Rent,” two categories of rental properties with rents held below market price by government regulations, and with differing lines of support for tenants.

Supplier Dynamics: Scale Merits from Being the UK’s Largest Partnerships Homebuilder

Land

Vistry has ~140K plots in its land bank (or 6-7 years’ worth, at a ~22K development rate). These include ~75K owned and controlled plots (~30K of which were transferred from its Housebuilding segment) and another ~65K in strategic land. Roughly 40% of Partnerships land comes from the public sector. Land supply consists of not just greenfield plots, but also existing locations in need of regeneration. In London alone, there are over 1M plots out for tender. Around 10% of the land in England is classed as “urban,” and 1% has domestic buildings on it, according to the UK National Ecosystem Assessment. The UK government estimates that there are almost 30K hectares in town and city centers ideally suited to regeneration, which could provide over 1.2M homes. Importantly, Vistry is the sole strategic partner for Homes England, which has £17B and 9K hectares for possible development (1 hectare ≈ 2.5 acres). Other entities, like Network Rail, have over 30K hectares available for regeneration.

Vistry has relationships with over 90 registered providers of affordable housing and over 60 local authorities (out of ~325 in the UK), each of which has land either for regeneration or greenfield. The company’s reputation and relationships with these entities should allow for sufficient land acquisition.

Further, under the partnerships business model, these local entities hold the land on their balance sheets and Vistry’s land acquisition costs are minimal to none. Land is provided on a deferred payment basis upon the completion and sale of each project, essentially eliminating inventory/land management risk.

Labor

At present, Vistry has sub-contractors and laborers to sustain a 16K-17K home per annum pace. With several competitors producing at similar levels, there appears to be sufficient labor to scale up operations. Further, those constructing with a traditional homebuilding model have responded to the high interest rate environment by lowering their pace of completion in recent years, creating some labor slack in the sector. Additionally, the construction industry in the UK has seen multiple insolvencies this year, potentially providing more workers.

A pure-play partnerships business with its steadier growth and long time horizon on housing developments spanning several years can attract the necessary labor from competitors and the construction industry, all of whom rationalize headcount in a downturn or fail to provide consistent work.

Materials

As the UK’s biggest pure-play partnership-model homebuilder, Vistry can buy construction materials in larger volume than rivals can, and with greater pricing power. Also, Vistry was able to extract ~£20M in procurement costs, going forward, from its acquisition of Countryside, as that company used cheaper timber frame designs and even had facilities (which became Vistry Works) that made prefabricated homes. As mentioned earlier, Vistry is expanding the capacity of these prefab manufacturing facilities up to ~8K homes per annum and is planning on applying the timber frame and “modern methods of construction” in all of its developments, lowering its costs across the board.

Notably, the UK governments criteria for developer selection heavily favors partners with the capability to build homes in modular fashion. Recent mandates require a minimum of 25% of the affordable homes built with the UK Government’s direct aid must use modern methods of construction like the modular housing VTY utilizes to construct its homes. 

Given the partnerships model’s smoother, more predictable development pace, Vistry’s planning and procurement is becoming easier and more cost-efficient than in the past.

Competitor Dynamics: Network of Relationships with Local Authorities Keeps New Entrants Out

The Partnership brands under Vistry have a highly regarded reputation among their customers, due to decades of community engagement and solid operations. This reputation is a considerable advantage in dealing with risk-averse local authorities. Vistry has relationships with ~60 of the ~325 local authorities in the UK, more than any other affordable home/partnership builder. For instance, Countryside has a track record of successful community engagement spanning over 40 years, and a 40% win-rate on all projects it bids for. These relationships generate a supply-side network effect: Each new local authority can more readily trust Vistry because of all the others who already do. VTY is essentially the “platform” connecting all these entities that share the same goal.

Managing community relations is done by an in-house team working closely with local authorities and residents throughout a regeneration project. This can in turn keep out new competitors: It takes years for smaller or new entrants to develop relationships with these overburdened authorities, whereas Vistry coordinates and facilitates its partners’ development plans. Importantly, this time-consuming relationship building is a completely different skill set to traditional homebuilders’ core business, which explains the small size of these partnerships businesses at competing firms.  

At present, Vistry completes 16K-17K homes per annum and should fully transition to partnership-model homebuilding over the next few years. That transition should see its output then ramp up to ~22K in another year or two. By contrast, Barratt Development lowered its total homebuilding pace from 17K to 14K per annum given the weakness in traditional homebuilding, and only completes ~4K partnership homes per annum. Taylor Wimpey completes ~14K homes per annum with ~3K partnership home completions per annum. Lastly, Persimmon completes ~12K homes and only ~3K partnership homes per annum. This sums to a total of ~10K partnership homes per annum by these three major builders. Roughly ~60K affordable homes were built in the UK in 2022. By contrast, the UK needs ~150K new affordable homes per annum for the next decade to fill the gap in the market.

Vistry, even before scaling up its operations, is the largest affordable housing builder in the UK. Once fully transitioned to a partnerships model, it will be more than twice the combined size of its major competitors’ affordable housing businesses. With such a large network and considerably risk-averse client base, Vistry’s Partnerships business is highly defensible against new entrants, and is unlikely to be successfully replicated.

Market Trends: Undersupply in UK Housing Expected to Continue Despite Government Action

UK Housing/Government Support

The UK government estimates the country needs ~4.75M new homes (an estimated ~20% increase in its housing stock), with about half being affordable, to start to close the housing gap. To eliminate the housing backlog and reach parity with western EU countries on housing metrics, the government estimates it needs at least ~655K new homes per annum over ten years. As shown below, the pace of construction the government originally targeted to start to close the housing supply gap is 300K-340K new homes per annum, with ~150K of those being affordable. Current construction has been running at 220K-240K per annum with ~60K affordable, or about 30% below the required level.

Figure 3: House of Commons.

The government has allocated ~£17B to support housing development in 2023, far more than the ~£12B it spent per annum from 2010 through 2018, but still below the £15B-£20B per annum seen in the early 2000s. It expects that each pound of public funds spent on housing will be leveraged ~6x through private market mortgage loans. Notably, at the end of 2022, the government retracted its 300K new housing target, having failed to hit that mark in years. However, with a general election in early 2025 (if not called earlier) and an anticipated Labour Party win, more support for public housing is expected, even considering the UK government’s high debt/GDP levels.

Social Housing Providers

In the UK, approximately 205 large providers account for ~95% of the social housing sector’s stock. The vast majority of these providers are not-for-profit. As shown below (and discussed above), local authorities (LA) and housing associations (HA) were once responsible for ~50% of new housing stock in the UK, but today they account for less than 10%:

Figure 4: House of Commons.

According to the government’s Global Account of Private Registered Providers, total investment in new social housing stock increased to ~£12B in 2022 on an asset base of ~£190B. Most of these entities funded their growth through operating surpluses, debt, and capital grants. Revenues from rent amounted to ~£22B. They have ~£90B in debt (~4x debt to EBITDA) and EBITDA/interest coverage ratios well above 100%. As such, these entities (i.e. Vistry’s customers) are well-capitalized.

Social housing providers are expected to benefit not just from higher levels of government financial support, but also from new rules that are expected to (1) loosen restrictions on allowable uses of their operating cash flow, (2) lower taxes on housing transactions, and (3) allow increases in rent ceilings. All of these moves should spur new affordable home development.

4) Why now?

Vistry Partnerships is a uniquely positioned business at a critical juncture:

• It boasts a high ROIC, large and expanding barriers to entry, and a long time horizon for earnings growth, yet it’s hidden inside an industry with none of those features.
• At the moment, the company is undergoing a transformation by winding down its traditional Housebuilding segment and repurposing all resources to its Partnerships business, temporarily obscuring the company’s earnings and cash generation potential.
• Vistry plans to return £1B in capital (almost 40% of its current market cap) to owners over the next 2-3 years via buybacks, and 50% of operating earnings going forward. Additionally, roughly £300M of excess cash will be used to wipe out the company’s debt.

At present, Vistry generates £400M+ in annual operating earnings (despite this being a particularly difficult time for traditional housebuilding), putting the company on a valuation of ~6.5x 2023 EBIT (~0.7x TBV). That’s well below traditional UK homebuilders at ~13x EBIT (~1.1x TBV). This discount should turn into a premium as a pure-play Vistry Partnerships generates operational and financial performance far more impressive than that of its rivals. Given the superior visibility and earnings stability of its Partnerships business, Vistry is very likely to achieve its near-term £800M operating earnings target in 2-3 years, for a forward valuation of ~3.25x EBIT (i.e. operating profit), well below that of a truly comparable business, NVR, which typically trades on a normalized 12.5x-15x EBIT.

Once Vistry is past the transition stage, we expect it to continue its steady growth, with the excess earnings from its capital-light operations directed towards shrinking the share base. We note that US-based NVR has generated an IRR of ~25% over 30 years, through predictable, slower, capital-light growth and the repurchase of over 75% of its shares.

A few key points below illustrate Vistry’s value potential at this point in time:

1. Transition to Pure-Play Partnerships-Model Creates Highly Visible, Durable Revenue Growth Through a Cycle: Housebuilding is cyclical largely due to (1) interest rates, (2) economic conditions, (3) supply factors, (4) credit availability, (5) construction and land costs, (6) speculation and investment activity, and (7) government policies. This leads to an industry generally characterized by low through-cycle growth, low visibility, and low barriers to entry – as well as high cyclicality, high capital intensity, and high sensitivity to interest rate changes.

Meanwhile, a housing partnerships developer sells to entities that are (1) not interest-rate sensitive, (2) nor especially concerned on economic fluctuations, (3) are experiencing a possible multi-decade structural shortage of affordable homes, (4) have minimal need for debt financing, (5) have ample land in need of development, (6) pre-buy over 50% of a development, thus minimal speculation, and (7) have billions in financial support from the government. The partnerships model exhibits qualities that are almost entirely in opposition to the factors above that make traditional housebuilding cyclical. As such, it should be no surprise that Vistry should have higher through-cycle growth, higher visibility, and higher barriers to entry.

Vistry has conservatively guided to long-term revenue growth of 5%-8% per annum, which is largely cycle-agnostic and should be consistent year in and year out with large projects spanning years. Notably, we believe there is upside to these estimates as Countryside, the largest partnerships brand within Vistry, was ramping its partnerships business’s year-on-year growth to 10%+ prior to its acquisition. With the company building 16K-17K homes today, and the complete transfer of all operations to a partnerships model, a ~22K home completion rate can be achieved within a year or two. Given the UK’s acute affordable housing shortage and an aggressive management with a track record of successful strategic positioning, we anticipate an upward adjustment to guidance on revenue growth and annual home completions once the transition to a partnerships business model is complete.

2. Margin Declination as Housebuilding Winds Down Masks Improvement in ROIC: Traditional housebuilding typically garners a gross profit margin above 25%, compensating for its higher capital intensity. Partnership-model homebuilders not only sell lower-priced homes, but also target a lower gross margin (15%-20%), given their customer base of political organizations providing housing to lower-income citizens. Prior to Vistry’s partnerships model transformation, its revenue was 55% Housebuilding, 45% Partnerships, and its operating profit was 80% Housebuilding, 20% Partnerships. With the entire company focused on Partnerships, Vistry’s operating profit margins are expected to decrease from ~19% in 2022 to ~12% by 2024, assuming the gross margins cited above with a ~5% of sales SG&A overhead.

While this appears detrimental, the capital requirements for partnerships-model developments are far less than those for traditional housebuilding, so Vistry’s ROIC is expected to increase from 20%-25% to 40%+. Further, we believe that its gross margins should increase from ~15% to almost 20% over time, equating to operating margins of ~15%, given scale merits and savings from the implementation of Countryside’s modular construction methods. Conservatively, Vistry anticipates only 12% operating margins once fully transitioned to the partnerships business model, which is lower than traditional housebuilding margins but with far more stable growth and capital efficiency. 

3. Capital-Light Nature of Partnerships Underpins Considerable Returns to Shareholders: Despite margins in the low- to mid-double digits, Vistry is able to generate ROIC well above 40% as the capital-intensive elements of housebuilding are paid for by multiple partners. Moreover, by pre-selling over 50% of a development’s homes and by using modular designs, Vistry’s partnerships-based turns on inventory are at least double those for traditional homebuilding, where a built home can sit on a balance sheet for months (or in a market downturn, maybe a year or more).

As such, Vistry is able to fund its operations with little to none of its own cash, turning over its asset base quickly and generating substantial cash returns despite lower margins. In fact, its FCF conversion from EBIT is upwards of 90%. We anticipate the company will return 50% of its operating income to shareholders once fully transitioned to the partnerships model, equating to a minimum £400M per annum in buybacks by 2025. (That’s an almost 15% yield on today’s market cap.) Management has stated its intention to return £1B in capital to shareholders during this transition period (almost 40% of VTY’s market cap over 2-3 years), starting with ~£55M in 4Q 2023.

4. Returns and Business Position Highly Defensible, with Scale and Regulatory Barriers: Given Vistry’s return capabilities, aside from the UK housing market supply crunch easing (which is over a decade away even with demographic changes), the next largest impediment to realize those excess returns would be new entrants. However, Vistry is twice the size of all its competitors combined, and it has a long track record with many more local housing authorities than they do. With these authorities being highly risk-averse, a builder’s track record and size are crucial to gaining their support. Moreover, with its large size, Vistry can bid at lower prices while maintaining margins and can more easily begin new developments with authorities than peers can. Lower margins, to the tune of almost 50% less than a typical home sale, certainly dis-incentive traditional housebuilders.

On the regulatory side, bidding for and planning a housing development can take years, so new entrants (or even traditional housing builders without a track record in social housing) face strong headwinds in trying to secure new partnerships. Simply put, the company is solely focused on, and already has scale in, a hard-to-implement sub-sector of the housing market, that on the surface is unattractive to other traditional homebuilders to enter. All of these factors give Vistry a formidable moat that keeps out competitors and lets the company deliver excess returns to shareholders.

5. Highly Competent “Skin-in-the-Game” CEO, Activist US Shareholders, and Former NVR Board Member Encourage Superior Outcomes for Shareholders: Vistry’s management, board, and key shareholders all seem to share a focus on creating and delivering shareholder value. CEO Greg Fitzgerald owns over 10% of Vistry’s equity. He has a long track record of excellent capital allocation in the sector, and most of his compensation is equity-based. Vistry’s next-largest shareholders are US-based Browning West, Inclusive Capital (which has shut down, but whose VTY position has a 4-year lock-up), Abrams Capital, and David Capital. In aggregate, these funds own 25% of the company. In yet another tell, these US shareholders placed Paul Whetsell, a NVR board member from 2007-18, on Vistry’s board. Given this cohort’s disposition, we anticipate it will aim to ensure that Vistry delivers excess capital returns to shareholders, and that any actions taken by the company are to shareholders’ benefit.

5) Risks/Thesis Pressure Points

Execution Risk. Vistry has almost entirely integrated Countryside and is in the midst of fully transitioning to a partnerships business model. With most of the Countryside integration out of the way, the risks of the partnerships transformation are front and center. While Vistry completed ~12K homes last year, Countryside completed ~4K, totaling ~16K (with ~8K via a partnerships model). At a current run rate of 16K-17K homes per annum, the risk of scaling up to ~22K is minimal. Management indicated current capacity is ~25K. However, shifting resources to the Partnerships business could have some execution issues. While laborers and sub-contractors can be shifted easily, the pipeline must be filled by Vistry working with local authorities/housing associations on more simultaneous developments than it ever has before. Because management in the past has executed multiple internal initiatives and M&A transactions simultaneously, we think it can handle this risk.

Supply/Demand Risk. Vistry is purposefully addressing the UK’s undersupply of affordable and social housing. With 24M homes in the UK and demand for over 28M, undersupply is at 20% of total housing stock, requiring years of above-average building rates to eliminate it. At present, the UK is only creating ~220K new homes per annum, ~60K of which are affordable. An estimated ~150K affordable homes per annum would start to address the housing issue over the next decade. While this subsection of the UK housing market is being hit hardest by undersupply, solving the problem is expected to take at least a decade.  However, an accelerated closing of this supply gap would necessitate lower levels of housing development in the future. This is a “known unknown” risk, as the time of supply-demand reversal and the level of housing construction thereafter are both unclear.

Competition/Replication Risk. The company’s Partnerships business generates impressive cash flow, which in theory could attract new entrants. However, as noted above, Vistry’s network of local authorities is unmatched, and the company produces twice as many affordable houses as the rest of the next three largest UK partnership businesses combined. Additionally, for traditional homebuilders, building lower-margin homes may also be a deterrent to entry. Therefore, at present, Vistry’s replication and competition risks are minimal.

Government Regulation/Funding Risk. The affordable housing sector in the UK is subject to government regulation. Regulatory initiatives to streamline permitting and cut through other red tape could narrow Vistry’s competitive advantage by making it easier for rivals to close deals with local housing authorities.

Vistry also could be exposed to expensive building code changes. For example, the Fire Safety Regulations of 2022 resulted in Vistry taking a £300M+ provision (now behind it) to remediate a portion of its homes by removing dangerously combustible aluminum cladding, which was the culprit in the Grenfell Tower fire of 2018.

Additionally, the UK government has elevated debt/GDP ratios, and substantive government funding for housing may get crowded out of a fiscal budget, given higher interest costs on debt. Notably, local authorities, which are Vistry’s direct customers, are better capitalized, with multiple forms of funding available.

Capital Allocation Risk. Vistry can generate substantial cash, and this thesis rests in part on the assumption that a large portion of this cash will be delivered to shareholders. There is a risk that Vistry might decide to put its cash to other uses, or to save it, depending on opportunities in both the equity and housing markets. However, we think management’s track record and the activist nature of Vistry’s shareholder base reduce that risk.

Additionally, management might be tempted to selfishly grab more of the company’s returns by issuing excessive stock options to itself. Indeed, Norbert Lou’s only lament concerning NVR’s stellar stock price performance was management’s excessive stock option grants: 1.9M issued against 7.5M shares outstanding, or more than 25% dilution. (Comment #42 on his 2001 VIC post, dated 5/27/02, has some choice turns of phrase.) However, we trust Vistry’s management and activist shareholders not to sabotage the company’s success for short-term personal gain.

6) Valuation

Vistry is turning into a capital-light housebuilder that stands apart from its traditional peers with a highly defensible business model, consistent 5%-8% revenue growth, ROIC trending upwards from 20%-25% to more than 40%, and capital returns of up to 50% of operating profit.

The following are our Base Case assumptions for the company:

1. Short-term guidance:
   1. Orders: £4.3B (£3B Partnerships)
   2. 2023 operating income: £425M
2. Long-term guidance:
   1. ~22K Partnerships homes per annum
   2. Revenue growth: 5%-8%
   3. Operating margins: 12%
   4. Operating income: £800M
   5. Capital returns: £1.3B
      1. £300M debt paydown
      2. £1B share buybacks (£55M in 4Q 2023)
3. Revenue should grow from ~£4B to ~£6.5B in 2025 as the weak Housebuilding division transitions to the partnerships model, producing 20K-22K houses per annum. From there, revenue should grow more than 7% per annum with annual home completions increasing modestly towards ~25K by 2029.
4. Operating margins should trend upwards from ~10% in 2023 to ~12% in 2024; operating income grows from £400M+ in 2023 to ~£800M by 2025 and ~£1B by 2029.
5. Roughly 50% of operating income is returned to shareholders (est. 75% via buybacks, 25% via dividends).
6. Capex: ~0.25% of revenue.
7. No net debt after 1H 2024.
8. ~12.5x normalized EV/EBIT (or ~15x EV/FCF) multiple. Our reasoning behind these multiples is in the Peer Analysis section below.
9. Discount rate of ~12.5% (mid-cap).

Five-Year Operating Model

We use a simple five-year operating model to determine value:

Base Case: Our Base Case assumes the company grows 7.5% per annum to £8B+ in revenue by 2028-29, with operating margins of ~12%, on a 12.5x EV/EBIT valuation (~15x EV/FCF). These assumptions yield a ~44% IRR over five years.

• Base Case Valuation: £4,850p/share.

Upside Case: Our Upside Case assumes the company grows 10% per annum to £10B+ in revenue by 2028-29, with operating margins of ~15%, on 20x EV/FCF ala NVR over a 10-year time horizon given the visibility of the model and market opportunity. This gives yields a ~33% IRR over 10 years.

• Upside Case Valuation: £133,000p/share.

Downside Case: The Downside Case assumes the company neither grows past its £800M operating income guidance nor returns capital to shareholders, and is valued at ~5x EV/EBIT (~6.5x EV/FCF). The result is a ~24% IRR over five years.

• Downside Case Valuation: £2,300p/share.

A summary of the three valuation scenarios is below:

Peer Analysis
Vistry has few direct public comparables, as most UK homebuilders only have a small number of annual completions of affordable homes via a partnership model. Moreover, these businesses trade on tangible book value, and are not a fair benchmark for a business with drastically different characteristics. Additionally, while US homebuilders have increasingly adopted a capital-light model, only NVR operates a fully capital-light business. Therefore, to triangulate a fair valuation, we used an EV/EBIT framework based on NVR and a few precedent transactions.

Trading Comparables

EV/EBIT

1. NVR (NVR): ~12.5x normalized EV/EBIT; currently at ~10.5x FTM.

NVR builds almost entirely prefabricated (and pre-sold) homes on land acquired via options, a capital-light model with less cyclical growth and lower operating margins. The company is on pace to build ~22K homes this year. Revenue growth should be flat over the next five years.

The normalized EV/EBIT multiple comes in at ~12.5x and has ranged from 7.5x to 15x over the period from 2010 to 2022. Vistry currently trades at ~6.5x FTM and ~3.25x EV/EBIT on its £800M operating income near-term guidance. We expect it to show growth of ~7.5% per annum for the next five years.

EBIT Margins

1. NVR (NVR): ~15% normalized EBIT margin; currently at ~20% FTM.

NVR’s margins are expected to decline to its normalized 15% level as the company comes down from an over-earning period following the COVID-19 pandemic. Its capital expenditures should average zero to 0.5% of revenue.

NVR generates ~15% normalized EBIT margins through a cycle. Vistry should generate 12% EBIT margins by 2024-25, with possible expansion to ~15% over time, given scale and other efficiency initiatives.

Precedent Transaction Analysis

Vistry’s management has acquired two of the below peers, primarily for their partnerships businesses:

1. Galliford Try Partnerships (to Vistry, 2020): £1,075M less Linden Homes £730M TBV - ~£350M, ~10x EV/EBIT (~£35M EBIT for Partnerships).
2. Keepmoat (to Aermont Capital, 2021): £700M, ~13.25x EV/EBIT (~£52.5M EBIT for Partnerships).
3. Countryside Partnerships (to Vistry, 2022): £1,270M, ~12.5x EV/EBIT (~£110M EBIT for Partnerships, no housebuilding division adjustment like Linden).

In using Vistry’s own acquisitions to reach our own valuation estimate, we note that the company is trading at ~6.5x EV/2023 EBIT on depressed housebuilding earnings, while its purchases were between 10x-12.5x. An average of the three transactions gives us a ~12x EV/EBIT multiple. 

Valuation Multiple Conclusion

For Vistry, a ~12.5x EV/EBIT normalized valuation appears reasonable, based on capital-light homebuilding peer NVR and several partnerships acquisitions.

Additionally, NVR’s normalized EV/FCF multiple is ~20x, a 33% premium to our inferred 15x EV/FCF multiple for Vistry. This implies some level of conservativeness in our valuation, should the company be valued on cash flow and compared (accurately) to NVR.

7) Market Expectations/Perceptions

Vistry is covered by 16 analysts, most with a “Hold” rating, and with an average price target of ~£870p/share. Most appear to be highly focused on the downward trajectory of near-term gross margins as the company transitions to a partnerships model. Additionally, many of these analysts apparently don’t understand or appreciate the working capital/cash flow dynamics Vistry will enjoy after its business model transition. On valuation, they appear to value the company based on TBV, not earnings or cash flow.

Despite Vistry already building homes at a run-rate of 16K-17K per annum (~11K partnership homes), the analysts appear to be highly skeptical of its ability to reach ~22K partnership homes per annum construction rate in a few years.

Consensus forecasts vary widely, especially on cash flow expectations, but analysts generally believe Vistry will take at least 3-4 years to hit management’s operating income target. The largest underlying disconnects are the cycle dynamics of partnerships-model housing versus the rest of the UK housing sector, and the company’s operating cadence over the course of the partnerships model transition.

8) Downside Protection – Where’s the Margin of Safety?

The company’s downside is well-protected, as Vistry is shifting to a more consistent and defensible subsection of the UK housing market. Transitioning the traditional housebuilding segment to a partnerships model will free up ~£1B of capital, which can then be returned to shareholders over the next 2-3 years. With the enterprise value of the business sitting below £3B, that means the returned capital would equal almost 40% of Vistry’s current market cap. Vistry is free cash flow-positive, with FCF margins in the 10%+ range. It has no net debt and is aiming to return capital representing 50% of operating earnings via share buybacks.

The company currently trades around 6.5x its depressed 2023 EBIT, below normalized peers. Assuming its £800M operating income guidance holds up, it trades at ~3.25x EV/EBIT, almost one-third the multiples of those peers.

Adjusting growth and margins to consensus estimates implies a negative EV/EBIT valuation for the business, based on the current market price of ~777p/share. This is because the business should produce more in discounted free cash flow over the next 5 years than its current market cap.

Vistry appears to already amply discount many investors’ (misplaced) fears about the housing cycle, its ability to scale up its partnerships operations, and its belief in delivering returns to shareholders.

9) Conclusion

Vistry is a unique business with the ability to compound shareholder wealth over a durable time horizon. It’s currently mispriced as indicators of its normalized returns and operating tempo are obscured. In fact, the company at this point in time could be considered a “special situation,” given the inflection in the business this year, and its expected large-scale return of capital.

The partnerships model transition should occur over the next 2-3 years. Once it’s complete, Vistry’s exceptional business characteristics and returns should be visible to investors. If not, consistent buybacks should ensure a solid return.

As of December 7, 2023, Vistry is trading at 777p/share. With a Base Case valuation of 4,850p/share, we believe there is ~525% upside, equating to a ~44% IRR over five years.

In time, should the company remain disciplined and live up to our “NVR-but-better” thesis and operating strategy, we would anticipate even higher returns.

Catalyst

• Ramp in Partnerships completions/large scale deals
• Successful operational shift from traditional Housebuilding
• Margins stabilize at 12%, inflect upward once transitioned to 100% Partnerships
• Return of capital to shareholders – Predominately buybacks