Why Bovis Homes Group plc is on my watch list

Updated: 
Bovis Homes

Shares of Bovis Homes Group (LSE: BVS) rose by nearly 5% this morning following news that the company has appointed a new chief executive, former Galliford Try boss Greg Fitzgerald.

Bovis also said that it had rejected the terms of a merger proposal from Galliford and would remain independent.

Time to buy Bovis?

Bovis shares have now risen by 17% from February's lows. It's easy to forget that it issued a profit warning in January and has been forced to set aside £7m to correct problems with poorly-built houses.

However, the appointment of Mr Fitzgerald is definitely good news. He worked at Galliford Try for 30 years until 2014, and is rated by City analysts as one of the best chief executives in the housebuilding sector. What's not yet certain is how easy he will find it to correct Bovis's problems.

Today's update refers to customer service problems, inadequate build processes and discusses "balance sheet optimisation". In my opinion, Mr Fitzgerald should be able to deliver fairly fast progress on customer service and build quality. Cost savings should also be possible.

But if it turns out that Bovis's land bank isn't as profitable as those of its peers, returns could take longer to improve. Bovis reported an operating margin of 15.2% last year, down 2.1% from 2015. Most of the big housebuilders have operating margins of more than 20%.

The appointment of Mr Fitzgerald probably makes Bovis a speculative buy. But it's possible that further problems will emerge. With profits uncertain and the stock trading at a 15% premium to book value, I'm going to wait for the outcome of the ongoing strategic review before considering a buy.

The UK's most profitable housebuilder?

When Bovis's problems became public at the start of this year, institutional shareholder Schroders reportedly suggested that the company should merge with London-focused luxury housebuilder Berkeley Group Holdings (LSE: BKG).

The deal might have worked for Bovis, but I could never see Berkeley chairman Tony Pidgley going for it. Mr Pidgley founded Berkeley and has made it one of the most profitable and well-run companies in this sector.

Over the last 12 months, Berkeley has generated an operating margin of 25.9% and a return on capital employed of 28.5%. These figures put it right at the top of the housebuilding sector in terms of profitability.

Although the group has seen a 16% drop in reservations since the Brexit referendum, Berkeley says that the last two months have been "ahead of last year". Pricing is said to be "above business plan levels" and the firm has a strong order book.

At the start of December, Berkeley reported cash due on forward sales of £2.9bn, net cash of £208m and an estimated gross profit on its future land bank of £5.9bn. The group expects to deliver pre-tax profit of £2bn over the next three years, and plans to return a further £10 per share to shareholders by 30 September 2021.

Problems may still emerge. But the firm's stock is available for a P/E of 7.6, with a dividend yield of 6%.

Bovis may be of interest to turnaround investors. But if you're looking for income and growth, I believe Berkeley is a better buy.

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Roland Head has no position in any shares mentioned. The Motley Fool UK has recommended Berkeley Group Holdings. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.