The most attractive aspects of the far sighted 'Capital Return Plan' IMHO are the recognition that operating with debt, except to fund seasonal peaks,is unwise in the construction industry and secondly that there is an optimal size for the business,now that the UK house building sector has become fairly consolidated. The top 10 players account for over 50% of the output, whilst Persimmon's (PSN) share is 8.5%.The plan maybe a close copy of Berkeley Group's blueprint, but imitation of the share owner friendly ways of the financially most successful house builder of the past quarter of a century by the second most is the sincerest form of flattery.I have argued before taken across the economic cycle, a house builder that consistently demonstrates cash generating characteristics - most don't - is a competitive proposition, particularly if purchased when out of favour at or below net asset value (NAV) and so long as the consumer element of the economy is not over heating. In reality that is as often as not. Paradoxically, over the cycle returns are relatively predictable, because latent demand is always there, there is no threat of technological challenge, barriers to entry are high as it takes new competitors decades to acquire the necessary land banks in this cash intensive industry and the supply side situation is almost invariably in favour of the producer over the consumer.As an example,I purchased my holding in PSN in the Summer of 2000 at 190p a share. At the time it was yielding 6% and had a balance sheet NAV of 200.6p a share. You could describe the contemporary economic scene then as benignly comfortable, yet you could still purchase the shares on a high yield and at a discount to NAV. By Summer 2012, I will have enjoyed a capital return in the form of dividends of 225.7p i.e. 118.7% of the original investment. My investment in rival Bellway at the same time has netted a dividend return of 90% of my starting capital. By comparison Reckitt Benkiser (RB), which I also purchased in 2000 has delivered a dividend return of 139.6% of my starting investment and RB has been a top decile performer in the FTSE100 since the turn of the century with a near quintupling of the dividend from 25.5p to 125p on an elevated staring yield of 5.1%. So my contention is that PSN's record is very good considering the worst housing downturn since the 1920s and is backed up by the fact that NAV has tripled since 2000 to 608p a share without recourse to a rights issue and with net debt extinguished.So how credible is the 'Capital Return Plan'? It is certainly challenging, but achievable, and would have to be abandoned in the unlikely event of another deep recession as opposed to typical recession. 620p over 9 years equates to 94.6% of the current 655p share price, over 10%pa, but strongly back end loaded. Over half in the last 3 years. At 37p for 2011 EPS are cyclically depressed and house volumes, too. Only 110,000 homes have been completed in each of the past two years and PSON's volumes have fallen from 16,000pa before the recession to less than 10,000 currently. Output peaked in the last cycle in 2006 at 186,000 homes, which was way below previous cyclical peaks.Over the past decade the UK population, fueled by inward migration and high fertility rates among the new settlers, has increased by 350,000pa, which would suggest after also taking into account replacement of exhausted housing stock and smaller households among the increasing elderly, that at least 200,000 new builds are required each year to stop the housing shortage worsening from already crisis levels. The average age of first time buyers has increased from 25 to 37 over a generation, whilst the private rental sector has ballooned from 10% to 17% of housing tenure in a decade. I suspect that if and when the government gets its revenue deficit under control, there is likely to be state sponsored initiatives to stimulate house building later in the decade, which would also have a beneficial impact on high unemployment levels, as was achieved in the 1930s.When the economy is growing sedately house builders usually achieve margins of 15%, which is a 50% uplift from current levels and there is scope to double volume output eventually if annual volumes reach the 200,000 minimum everyone agrees is required. There will also be significant savings on the £700million former debt pile which will flow through to the bottom line. Thus EPS should triple and may even quadruple without a booming consumer economy; sufficient I would say to execute the 'Capital Return Plan'successfully.As the absolute most profitable house builder in the top 20, the second in terms of return on capital after the more regionally focused Berkeley Group, I suspect a purchase at or around current NAV of 608p will turn out to be excellent value in a decade's time for those investors running a HYP of 25 or more stocks.The only negative thing I can see about bundling two years dividends together, is that it may, in a small number of cases, affect the marginal tax rate of the investor or impact undesirably on means tested age related personal allowances. It is not as though PSN are skipping a year in moving from ordinary to capital return dividends, although missing out on the normal interim in autumn 2012 may be a slight irritation to some.Valuemargin
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