黑洞社区

For the past year, it is fair to say that partnerships housebuilder Vistry has been the toast of the housebuilding sector. While others have been reducing their output, Vistry has grown rapidly, saying in September that it had become the UK鈥檚 biggest residential developer 鈥� with its eyes on delivering 30,000 to 40,000 homes a year in the long term.

Its focus on the vital affordable housing space means that it has also made itself a key part of the government鈥檚 1.5 million homes ambition. No surprise then that its stock market value outperformed other housebuilders this year 鈥� by an average of 43% to October 鈥� hitting over 拢4.5bn at peak.

But, on 8 October, events took a turn for the worse. More than 拢1bn was wiped off the value of the company in a single day following a profit warning related to what it initially said were 拢115m of 鈥渦nderstated鈥� cost projections on its projects. And last Friday, things got even worse, as the business revealed a further 拢50m profit warning and said it was reviewing growth prospects for the years ahead. The firm鈥檚 chief executive Greg Fitzgerald admitted the news was 鈥渧ery unfortunate [and] upsetting鈥�, and the market seemed to agree 鈥� Vistry ended the day with shares down nearly 20%, and the company overall worth less than half what it was just two months ago.

However, the firm, which sells most of the homes it builds to housing association, local authority and build to rent clients under 鈥減artnership鈥� deals, said on Friday that it continued to believe that the problem is largely related to just one part of the business.

It said an in-depth review of the issue, commissioned in October, had confirmed its expectation that the cost projecting issue was not systemic across the rest of the business. 鈥淐ritically, we found no systemic issues outside of the South Division,鈥� Fitzgerald said on the analyst call on Friday. 鈥淭hat鈥檚 the big takeaway.鈥�

The continuing roster of major project wins announced since the initial October profit warning 鈥� such as Bromford, for 700 homes; Hinckley, Leicestershire for 475; and Solihull Council for around 200 鈥� certainly indicates business as usual. However, the Friday update did also point to other issues which could affect future performance, such as newly rising build costs overall, the impact of Labour鈥檚 national insurance changes, escalating building safety costs, and a weaker than expected market. Certainly, the scale of the drop in the firm鈥檚 value suggests there are many who have their doubts. The profit warning seems to be a vector which has allowed questions about the business鈥檚 rapid transformation, its business model and its charismatic CEO and chair to resurface.

A problem in the southern division

Vistry said on 8 October that the 鈥渢otal full-life cost projections鈥� to complete some projects had been understated by around 10% of 鈥渢otal build costs鈥�. It said the 拢115m problem was limited to just nine schemes 鈥� out of more than 300 across the business 鈥� and to just its southern division (one of six).

It immediately commissioned an independent review into the issue, conducted by Vistry鈥檚 independent non-executive director, and former Laing O鈥橰ourke finance director, Rowan Baker, which reported at the scheduled trading update last Friday.

In broad terms, while this review uncovered an extra 拢50m of costs, it ultimately endorsed Vistry鈥檚 belief that the problem regarding cost projections has not been systemic across the business (see 鈥橶hat Vistry has said鈥�, below). Speaking to analysts, Fitzgerald, who, according to the Times last Friday, had gone to the board to offer his resignation in the light of the profit warning, said the issues had been confined to jobs in the former housebuilding parts of the business 鈥� not jobs running the new 鈥減artnerships鈥� model 鈥� and all in the southern division, where management was being taken in hand. 鈥淢anagement capability in certain areas has been an issue,鈥� he admitted, 鈥渁nd non-compliance with our processes and a poor divisional culture. [But] That all relates to the South division.

鈥淲e are extremely confident that we have now uncovered, in the last five weeks, the full extent of the issues, and there will be no more adjustments.鈥�

They鈥檝e had an issue and they鈥檙e dealing with it. There鈥檚 a lot of talk out in the market, but how much is just stirred up by competitors with their noses out of joint?

Greg Campbell, partner Campbell Tickell

 

There is also, to date, no evidence that Vistry has financial problems on further jobs, and there are plenty in the sector happy to accept this account of events. Terry Fuller, former Taylor Wimpey executive and Homes England regional director, says the negative reaction has been overdone. 鈥淭here has been an increase in overall build costs across the industry. Vistry is not alone here. There might have been some very poor decision-making in a division, but all firms go through this.

鈥淚f I鈥檓 an investor, I鈥檓 asking if the cash flow is still good 鈥� and the answer鈥檚 鈥榶es鈥�. You could actually argue the timing of Vistry鈥檚 expansion in terms of the wider market now picking up is great.鈥�

Moreover, while the warning will impact profitability by 拢105m this year, Vistry has made clear that it is sticking to a series of previously announced financial goals, including a 拢130m share buyback scheme, 拢1bn of capital back to shareholders and 拢800m adjusted profit.

Displaying his confidence in the business, Fitzgerald immediately bought 拢200,000 of stock after 8 October 鈥� presumably in the expectation of a price recovery.

Greg Campbell, partner at consultant Campbell Tickell, which advises housing associations on development deals, speaking after the first profit warning, said he had confidence that the business will stay on track. 鈥淭he response suggests they鈥檝e had an issue and they鈥檙e dealing with it,鈥� he said.

鈥淭here鈥檚 a lot of talk out in the market, but how much is just stirred up by competitors with their noses put out of joint?鈥�

Another industry figure close to the firm, who declined to be named, agreed. 鈥淰istry is a disruptor. You shouldn鈥檛 be surprised if those that are happy with the orthodoxy are lining up to criticise it.鈥�

So, given all this, why the extreme reaction by the City? Initially, after 8 October, investors will have been worried that the profit warning was the beginning, not the end of problems. While the reaction to the review will have offered some reassurance that problems are not systemic, it also flagged a lowering of expectations in the medium term.

Managing transition

Beyond generalised uncertainty, there remain specific questions about all the recent change in the business. The former Bovis Homes business that executive chair Greg Fitzgerald joined in 2017 is still in the process of absorbing two transformative acquisitions 鈥� of Galliford Try鈥檚 housebuilding and partnership housing businesses, Linden, in 2020, and of partnerships firm Countryside in September 2022.

Fitzgerald just over a year ago switched Vistry to a radical 鈥減artnerships-only鈥� business model and has embarked on a pell-mell quest for turnover growth. The firm will this year build more than four times as many homes as it did when Fitzgerald was brought in just seven years ago and if the firm hits its longer term 24,000 homes-per-year target it will be not just the biggest UK housebuilder, it will be the biggest housebuilder in UK history.

>> See also: 鈥業鈥檓 extremely demanding鈥� Greg Fitzgerald on delivering the Vistry growth plan

Hence, Charlie Campbell, analyst at investment bank Stifel, said in the wake of 8 October the firm faced a challenge of 鈥渞esetting credibility鈥� after 鈥渉aving persuaded a sceptical audience that it was managing the transition from mainstream to partnerships housebuilder鈥�.

UBS鈥檚 Kuglitsch, meanwhile, said it will 鈥渓ikely question the credibility of the business plan and put into question the ability to execute鈥�.

Discounts

This is particularly the case as the pace of the growth strategy, propelled by the US investors who own 60% of Vistry, might be expected to make some nervous at the best of times. But the past few years have not been the best of times in the UK market.

Following the spike in lending rates that came after the Liz Truss mini-Budget, both the mainstream housing market and the build-to-rent (BTR) market, important to the partnerships model, have been weak, with house sales and investment in BTR both falling last year. More significantly, a cash crunch for housing associations, Vistry鈥檚 main customers, caused by rent caps and the need to invest in their existing stock, has seen many rein in development activity.

The concern is around how easy it will have been to manage rapid growth into this kind of market, given how price conscious customers will have been. Vistry has undoubtedly been winning a large volume of work, but Fitzgerald this year admitted to giving 鈥渕assive discounts鈥� to tempt big customers, albeit he maintained that the business had not altered its margins or hurdle rates for taking on work.

Growing at a very accelerated rate while integrating very sizable businesses 鈥� in a market with construction inflation, but that is weak 鈥� is a risky thing to do

Anonymous consultant

 

The big advantage of the 鈥減artnerships鈥� model over traditional housebuilding is that firms are not required to tie up lots of capital in land to undertake development, and are not beholden to private sale market absorption rates. However, City analysts say the disadvantages are lower margins and a greater exposure to the risk of construction price inflation.

One consultant working closely within the housebuilding sector says: 鈥淭he issue is that, if you are doing big deals on a fixed price, you don鈥檛 have the release valve to cope with increasing construction costs that you do with private housing.

鈥淲ith private housing, so often price rises in the sales market are effectively a get out of jail on the construction increases you鈥檙e having to absorb. But, with this model, you have all the risk. And, at this point in the cycle, work would have been on relatively thin margins anyway.鈥�

They add that these risks would have been exacerbated by how hard the business was being driven to grow. 鈥淕rowing at a very accelerated rate while integrating very sizeable businesses 鈥� in a market with construction inflation, but that is weak 鈥� is a risky thing to do. I certainly didn鈥檛 fall off my chair when I heard the news [of profit warnings].鈥�

Unsurprisingly, Fitzgerald doesn鈥檛 paint quite the same picture. He told analysts on Friday that fixed price contracts all had a 鈥渧ery healthy contingency鈥�. In addition, he said that while the 鈥減ace and purpose鈥� of the business鈥� growth had clearly affected the management of the southern division, growth itself wasn鈥檛 at fault because other divisions hadn鈥檛 been affected in the same way. 鈥淭he other five divisions are dealing with that pace and pressure exceptionally well, and are a little bit dumbfounded as to what鈥檚 happened in the South division,鈥� he said.

Chief financial officer Tim Lawlor added that the feedback gained during the review suggested it was the pace of structural and system changes, rather than growth, that staff felt had been putting pressure on.

Any concerns are not helped by the fact that Fitzgerald, in breach of usual City governance standards, is both chair and chief executive of the company 鈥� leading one observer to point out that it is not clear who shareholders should turn to for independent scrutiny of the company鈥檚 executive. However, four in every five Vistry shareholders voted in favour of Fitzgerald becoming chair when the role was added to his chief executive brief this year, and it will be reviewed next year.

Analysts have also flagged concerns about the way that it reports profit. UBS鈥檚 Kuglitsch said in October that Vistry鈥檚 accounting methods rely on 鈥渆stimating costs鈥� and 鈥渃an lead to uneven profit performance if early estimates on costs are over-optimistic鈥�.

Barclays鈥� Biddulph said in October the size of that warning relative to the small number of contracts was 鈥渁 function of the way profits are accounted for鈥�, and is a 鈥渇undamental ongoing risk to the Vistry investment case, due to its long-term contract accounting鈥�.

No money tree

Following Friday鈥檚 statement, Vistry appears to be putting its underestimate of costs down to the poor judgment of southern division managers under pressure following the post-merger restructure. But there are some who have drawn the link instead with the very public decision to force down supply chain prices just over a year ago. While Fitzgerald on Friday again said subcontractors 鈥渙verwhelmingly support鈥� its partnerships strategy, some specialist contractors, still upset about Fitzgerald鈥檚 decision to impose a unilateral 10% pay cut on subbies, think it is no coincidence that 10% is exactly the margin by which, according to Vistry, costs have been understated on the problem jobs.

Vistry has said the cut in rates was justified by a guaranteed flow of work to its suppliers, with Fitzgerald telling 黑洞社区 earlier this year that 鈥渁nger had completely gone鈥�.

The supply chain is not a money tree that you can just shake. We said from day one that the 10% wasn鈥檛 there

Iain McIlwee, chief executive, Finishes and Interiors Sector

 

Iain McIlwee, chief executive of trade body the Finishes and Interiors Sector, says they made the point a year ago that the supposed savings Vistry was expecting were just not available. 鈥淭he supply chain is not a money tree that you can just shake,鈥� he says, adding that with some contractors walking away and others negotiating, the 10% cut will not have been achieved. 鈥淲e said from day one that the 10% wasn鈥檛 there.鈥�

Mike Wharton, a former City analyst who is now chief executive of roofing contractor CRS, publicly walked away from Vistry when it imposed the 10% cut last autumn, telling the firm then that its 鈥渟hort termism may well get your CEO a great bonus approved by happy shareholders, but it does nothing for the future of construction in the UK, and especially nothing for affordable housing鈥�.

Vistry said in January that its strategy had been successful, adding that 鈥渨orking with our key supply chain partners, it agreed cost reductions for all existing and future contracts鈥�.

Coalface

黑洞社区 asked to speak to Vistry, but the firm did not respond by the time of publication. However, it is clear from its statement that it believes it is now tackling the 鈥減oor divisional culture鈥� which has led to the profit warning, with a review of Vistry鈥檚 structure designed to remove layers of management and, in Fitzgerald鈥檚 words, 鈥済et me closer to the coalface鈥�. It is also working harder to mandate group commercial practices, roll out training and support, and change the culture around whistle-blowing 鈥� presumably to ensure employees feel safe passing bad news upwards. It feels the problem is on its way to being dealt with.

Given the UK government鈥檚 reliance on Vistry to hit its housebuilding numbers, it is not only investors and industry executives who will be watching closely to see if this is really the case.