Real Estate

Chris Bryant is a Bloomberg Gadfly columnist covering industrial companies. He previously worked for the Financial Times.

Buying back shares when your stock price is already overvalued is daft because it rewards shareholders who sell at the expense of those who don't.

Regardless, plenty of U.S and U.K. companies have done exactly that lately. But it might be a little unfair to lump Berkeley Group, the London-focused home-builder, in with that group. Its stock has fallen about 20 percent since Britain's vote to quit the EU, and its bosses think that no longer reflects its true potential.

Despite almost daily headlines about London's housing market hitting the skids, they have a point.

Instead of just paying a cash dividend, Berkeley said on Friday that it would also consider buying back stock "to the extent the board believes the prevailing share price materially undervalues the company." Total shareholder returns will remain the same.

Though some investors would doubtless prefer to take the cash in an uncertain environment, buying back stock doesn't seem so foolish.

Berkeley trades on a pretty miserable 7 times estimated earnings, a discount to the less London-centric Persimmon. So it's hard to argue that the company's horrendously overvalued. Only long-suffering carmakers, airlines and banks fetch similar.

London Penalty
Berkeley Group's shares have suffered more than Persimmon, which doesn't build in the capital
Source: Bloomberg

The shares yield 7.5 percent (based on its target to return 2 pounds a year to shareholders), which would usually suggest a dividend cut is on the way. But there's little reason to think that's the case here. True, reservations have fallen 20 percent, a function of Brexit and taxation changes that discourage home purchases. Yet earnings per share jumped 35 percent in the six months to October 31, thanks in part to higher selling prices -- the average price was 650,000 pounds.

Indeed, Berkeley felt cheerful enough to make a new forecast of at least 3 billion pounds ($3.8 billion) of pretax profit over the next five years, about 50 percent more than it's achieved since 2012.

Safe as Houses?
Berkeley's new guidance implies a decent level of future profits
Source: Gadfly interpretation of company guidance
Methodology: Berkeley expects £2 billion of pre-tax profit in three years starting fiscal 2015/2016, and at least £3 billion in the five years starting in fiscal 2016/2017. We've averaged these amounts.

It's unwise to set too much store by such long-term projections. But Berkeley's already exchanged contracts on about 2.9 billion pounds of sales (or more than a year's worth of revenue) due over the next three years, so it can be fairly confident about cash flow for now.

That means it shouldn't have to borrow money to buy back stock or fund dividends. It's sitting on 200 million pounds of net cash.

Of course, the London market has seen better days. But, as with share buybacks, timing's everything. Berkeley bought many of its sites several years ago when prices were lower, analysts at JP Morgan note. So it's not as exposed to peak property values as someone who took out a big mortgage in May.

While much has changed since the Brexit vote, London's perennial shortage of homes hasn't. Even if some air's released from the housing bubble, Berkeley won't be feeling too deflated.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Chris Bryant in Frankfurt at cbryant32@bloomberg.net

To contact the editor responsible for this story:
James Boxell at jboxell@bloomberg.net