Builder ready to exploit an upturn

THEY ARE not yet cracking open bottles of champagne at retirement homes specialist, McCarthy & Stone, but the group looks well placed if conditions in the housing market improve.

Finance director Matthew Thorne, admits there are still no great signs of recovery but, with costs at the group still falling, useful profit progress over the next couple of years is virtually assured. Beyond that, as the only volume supplier of warden-managed housing left in the market, the group has an opportunity for something of a re-run of the remarkable growth it enjoyed in the 1980s.

It is no mean achievement that McCarthy & Stone is still in business. Rivals, like Anglia Secured Homes, collapsed almost overnight when the housing market turned down. McCarthy itself racked up losses of nearly pounds 60m between 1990 and 1993. These took a fierce toll of the share price, which fell from nearly 800p at its peak to 79p currently, having been as low as 22p at the end of 1992.

The firm survived because even in the darkest days it managed to generate plenty of cash - nearly pounds 29m from 1992-93 alone. In effect, a great bubble of overpriced land and homes, bought and built in the late 1980s and early 1990s, has been steadily moving through the profit and loss account. As the group has sold the high-priced stock at the lower prices now achievable, it has crystallised huge losses but also restored liquidity to its balance sheet.

Two developments have helped the group to return to profit in the last two years. First, the cost of land per home has dropped from pounds 16,200 in 1992 to pounds 14,100 last year. Secondly, the group has cut building costs per unit - from pounds 32,200 in 1992 to pounds 27,900 in 1995.

The bottom-line effects have been considerable: the group returned to profitability in 1993- 94 and then almost doubled profits to pounds 9.2m for the year to end August, 1995. It was aided by a 25 per cent rise in gross margins to a handsome 33 per cent. With the cash position better, a sharp fall in interest charges from pounds 3.6m to pounds 1.3m also helped.

Further increases in profits should be underpinned by a continuing decline in land costs. The group's recent cost of land has been as low as pounds 9,800 per unit. As this flows through the system it should help profits top pounds 11m for 1995-96 and pounds 13m the following year. This would take the price/earnings multiple down into high single figures, even on a full tax charge, for 1997. That, in turn, suggests the stock is not expensive even if the housing market remains subdued.

Over the medium term, the outlook should be for stronger growth. McCarthy & Stone points out that there are already 9 million people in the UK over 65, so the number of those who could benefit from living in warden-managed housing is poised to grow dramatically. Demand is constrained by the difficulties people are having selling their existing homes. So any pick-up in transactions as mortgage rates fall might translate quickly into more buyers of retirement homes.

The second constraint is the difficulty of getting planning permission for new developments convenient for town centres. As a result, McCarthy & Stone cautions that it is unlikely to meet its medium-term target of doubling sales to 1,500 units over the next two years.

But, as conditions improve, the group is well placed to build strongly on sales and profits. Retirement housing is a capital-hungry exercise because sales are usually made only after the units are completed. This makes it unlikely that big housebuilders, who suffered from entering the market at the peak, will come back in a hurry. If there is a demand for warden-managed housing with guest rooms and other common facilities located in pleasant town-centre positions, the group can expect a relatively free hand in capitalising on it.

There is, however, one small quoted rival, Secure Retirement. The group is tiny, with a market capitalisation of around pounds 6m to McCarthy & Stone's pounds 78m. Its principal attraction is net assets of 61p a share, of which 35p is cash, against a current 63p share price.

It could make an attractive vehicle for a reverse takeover by a private business looking for a quote, though nothing seems in the pipeline.

The company's chairman, Rupert Lowe, together with a colleague, Andrew Cowen, who own around 10 per cent of the shares between them, are currently considering two opportunities in health and retirement-related services. The shares trade in an extremely thin market but, again, do not look dear at current levels.