October 25, 2011

Reality Bites Realty Markets – Time to move out of Berkeley Group (BKG LN)?

by Alpha Now Research Team

The global real estate markets have seen turbulent times in the last 2 years. The UK was no exception. Berkeley Group (BKG LN) is the 8th largest group in the real estate space in the UK, when measured by total volume. It engages in urban regeneration projects, with a heavy focus on London.

Has BKG LN weathered the storm, or is there more pain on the horizon? There seem to be two conflicting forces driving the stock prices: momentum and valuation, making the sustainability of earnings a key issue. Unfortunately, BKG LN has a weak Earnings Quality (EQ) score of 3, which may lead one to question the sustainability of earnings into the future.

However, BKG LN has a strong StarMine PriceMo score of 100, placing it in the top decile. Analysts too have been raising estimates, and are expected to continue to raise estimates, as suggested by the StarMine Analyst Revision Model (ARM). These are shorter term momentum indicators.

The longer term indicators are not as favorable. In fact, the StarMine Relative Value (RV) model ranks BKG LN in the bottom decile of companies in the region with a score of 6. Let’s look deeper into the earnings of BKG LN to see if there are any red flags.

Cash flow from operations (CFFO) shows a worrying trend. In the chart below, red indicates when cash flow from operations (CFFO) lags net income; green when cash flow exceeds net income. Cash flow from operations lagged net income by £260M during the last semiannual period. Noteworthy is that throughout most of 2008 and 2009, CFFO was positive. Since then however, the company has been increasingly bleeding cash. Earnings backed by cash are typically more sustainable than earnings from non-cash sources.

Cash Flow from Operations vs. Net Income
Source: Thomson ONE / StarMine

As you can see in the chart below, BKG LN has been experiencing an inventory buildup over the last 5 years. In general, high and rising inventory levels are a negative factor, often representing declining demand for a company’s properties and an increasing risk of downward price pressures on its land acquisitions. In addition, inventory represents an important accrual item, and StarMine’s research has found that companies with high accruals tend to underperform in the future.

Inventory Days
Source: Thomson ONE / StarMine

In addition, BKG LN saw an increase in accounts receivable days, which may indicate that the company is having an increasingly difficult time collecting payments from its customers.

These factors explain why the stock has a low score on 3 in the StarMine Earnings Quality (EQ) model. In conclusion, this may only be a stock worth looking into once the current momentum trend runs its course.

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