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HQ completion opens strong growth opportunity

Palace Capital 17 June 2021 Update
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Palace Capital

HQ completion opens strong growth opportunity

FY21 results update

Real estate

17 June 2021

Price

261p

Market cap

£120m

Net debt (£m) as at 31 March 2021

118.9

Net LTV as at 31 March 2021

42.0%

Shares in issue

46.1m

Free float

95%

Code

PCA

Primary exchange

LSE

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

6.3

13.7

50.0

Rel (local)

4.3

7.9

26.8

52-week high/low

268p

171p

Business description

Palace Capital is a UK property investment company listed on the Main Market of the LSE. It is not sector-specific and looks for opportunities where it can enhance the long-term income and capital value through asset management and strategic capital development in locations outside London.

Next events

Q421 DPS paid

5 August 2021

Analyst

Martyn King

+44 (0)20 3077 5745

Palace Capital is a research client of Edison Investment Research Limited

Palace Capital’s (PCA) FY21 results were robust, with a clear improvement in the second half. With a good level of rent collection continuing, Q421 DPS was increased by 20%, to a level that management hopes to at least maintain through FY22. Importantly, the flagship Hudson Quarter (HQ) development in York completed in April, on budget. We expect HQ to be a significant driver of forecast increasing returns and deleveraging.

Year end

Net rental income (£m)

Adj PBT*
(£m)

Adj EPS*
(p)

EPRA NTA/
share (p)**

DPS
(p)

P/NTA
(x)

Yield
(%)

03/21

14.9

7.5

16.4

350

10.5

0.74

4.0

03/22e

14.2

6.6

14.3

366

12.0

0.71

4.6

03/23e

15.2

7.5

16.4

385

14.0

0.68

5.4

03/24e

17.6

9.8

21.3

401

18.0

0.65

6.9

Note: *Adjusted for revaluation gains and non-recurring items. **EPRA NTA is fully diluted.

Robust earnings and DPS recovering

FY21 adjusted PBT of £7.5m, including a £0.9m receivables provision, exceeded our forecast, with H221 improving to £4.5m vs £3.1m in H121. With strong and consistent rent collection continuing, the Q421 DPS was increased to 3.0p, the minimum pay-out that management expects through FY22. End-FY21 EPRA NTA per share was 350p (end-FY20: 364p) but also improved in H221 (from 347p at end-H121) as the net like-for-like decrease in property valuations slowed from 3.5% to 0.5%. With HQ residential sales beginning to complete, and the £30m non-core asset disposal programme proceeding well, we expect the end-FY21 gearing (LTV of 42.0%) to represent the peak level; despite forecasting £40m of reinvestment, we forecast a prospective LTV of little more than 30%. Our FY22 adjusted PBT forecast is unchanged but increases for FY23 with further growth reflected in our tentative FY24 forecast. We expect DPS growth to follow earnings. Forecast EPRA NTA per share increases in each year, in part reflecting FY21 performance.

HQ completion to unlock embedded value

PCA has a range of opportunities to optimise both income and capital values in various market conditions over the medium term. The £20.6m end-FY21 estimated rental value (ERV) of the portfolio was £4.1m (25%) ahead of passing rent including £0.9m of high-quality HQ commercial space. The key opportunities are reversionary rent uplifts for the fully let industrial assets and void reduction in the office portfolio. We expect HQ to add c 19p to EPRA NTA through FY22–23 as the residential apartments are sold and the commercial space let. With management remaining very positive about the prospects for regional commercial property in its core office and industrial sectors, there is significant scope to reinvest the proceeds of the £30m non-core and residential asset sales in higher-return acquisitions and in a range of identified refurbishment and development initiatives.

Valuation: Not reflecting company growth targets

A 4.6% prospective yield and FY21 P/NTA of 0.74x is undemanding relative to peers and is yet to reflect the potential growth that management seeks from crystallisation of the HQ value and accretive reinvestment of sales proceeds.

Summary of FY21 results

The FY21 financial performance was robust with a clear improvement in the second half of the year (H221 adjusted PBT of £4.5m vs £3.1m in H121), and ahead of our forecast. For the year as a whole, COVID-19 had a negative impact on valuations and slowed leasing activity, but rent collection remained robust with 95% collection during the year. Quarterly DPS was reinstated at the beginning of the year and increased by 20% in Q421. Since end-FY21, HQ has been completed, to budget, and sales of residential apartments have accelerated as the lockdown has been eased.

Exhibit 1: Summary of FY21 financial performance

£m unless stated otherwise

FY21

FY20

FY21/FY20

H121

H221

Edison FY21e

Actual vs Forecast

Adjusted earnings

Rental & other income

17.3

18.3

8.3

9.1

16.7

Movement in credit loss

(0.9)

0.0

(0.3)

(0.6)

0.0

Non-recoverable property costs

(1.5)

(2.4)

(1.0)

(0.5)

(2.2)

Net rental income

14.9

15.9

-6.5%

7.0

7.9

14.5

2.6%

Dividend on listed equity investment

0.1

0.1

0.0

0.1

0.0

Administrative expenses

(4.0)

(4.2)

-2.6%

(2.1)

(1.9)

(4.2)

-3.9%

Net finance expense

(3.3)

(3.8)

-12.6%

(1.8)

(1.6)

(3.6)

-7.4%

Adjusted profit before tax

7.5

8.0

-6.0%

3.1

4.5

6.7

13.2%

Surrender premium

0.0

2.9

0.0

0.0

0.0

Share based payments expense

(0.3)

(0.1)

(0.2)

(0.2)

(0.3)

EPRA earnings

7.2

10.8

-32.9%

2.9

4.3

6.4

13.8%

Unrealised gains/(loss) on revaluation

(14.0)

(17.9)

(10.0)

(3.9)

(14.5)

Profit/(loss) on disposal of investment properties

0.9

(0.1)

0.3

0.6

0.9

Unrealised gain/(loss) on listed investments

0.7

(0.4)

(0.2)

0.9

(0.2)

Fair value loss on derivatives

(0.3)

(0.8)

(0.4)

0.1

(0.4)

Debt termination costs

(0.1)

(0.5)

0.0

(0.1)

0.0

IFRS profit before tax

(5.5)

(9.1)

(7.5)

1.9

(7.8)

Tax

(0.0)

3.6

0.0

0.0

0.0

IFRS net profit

(5.5)

(5.4)

1.7%

(7.5)

1.9

(7.8)

Basic EPS (p)

(12.0)

(11.8)

(16.2)

4.2

(16.9)

Fully diluted EPRA EPS

15.7

23.4

6.3

9.4

13.8

Fully diluted adjusted EPS (p)

16.4

17.5

-6.5%

6.6

9.7

14.5

13.2%

DPS declared (p)

10.5

12.0

-12.5%

5.0

5.5

10.0

5.0%

EPRA NTA per share (p)

350

364

-3.9%

347

350

341.1

2.7%

EPRA NTA total return

-1.8%

-5.8%

-4.1%

2.3%

-4.4%

Investment properties (inc. trading assets)

278.6

276.3

279.8

278.6

279.2

Gross debt

(128.3)

(120.8)

(132.7)

(128.3)

(127.3)

Cash

9.4

14.9

14.0

9.4

9.4

Net LTV

42.0%

38.1%

42.1%

42.0%

41.9%

Source: Palace Capital data, Edison Investment Research FY21 forecast

The key financial highlights include:

Net rental income was £14.9m (FY20: £15.9m), primarily reflecting lower occupancy and disposals, partly offset by end-year rates relief that reduced direct property costs. Provisions against rent receivables were separately disclosed at £0.9m.

Administrative expenses were well controlled and net finance expense charged to the income statement reduced due to a lower average cost of debt and lower average structural debt. Interest costs of c £0.9m (FY20: c £0.5m) in respect of the HQ development were capitalised.

Adjusted PBT was £7.5m (FY20: £8.0m) or 16.4p per share. The greater decline in EPRA earnings (£7.2m vs £10.8m in FY20) reflects the inclusion in FY20 of £2.9m of non-recurring surrender premium, excluded from adjusted PBT.

Including realised gains on disposal of investment property and unrealised valuation losses (4.0% like for like) the IFRS loss was £5.5m, while EPRA net tangible assets (NTA) per share was 350p (FY20: 364p).

A DPS of 2.5p was declared in each of the first three quarters of the year and was increased by 20% to 3.0p in Q4. The aggregate 10.5p for the year was 1.56x covered by adjusted EPS and fully covered on a cash basis.

Reflecting continuing development expenditure, net loan to value increased to 42.0%, which we expect to be the peak on an annual basis as HQ residential sales are completed and development borrowing is repaid.

The FY21 operational highlights include:

31 completed events providing additional income of £0.9m pa and reducing void costs by £0.1m, comprising:

14 new leases at an average 16% uplift to ERV, providing £0.7m pa of additional income;

11 lease renewals at an average 12% uplift to ERV, providing additional income of £0.1m pa;

and six rent reviews at an average 13% uplift to ERV, providing additional income of £0.1m pa.

On an EPRA basis, end-FY21 occupancy was 86.4% (FY20: 87.3%).

PCA completed the sale of five non-core assets for an aggregate £5.4m at a blended 23% premium to book value.

The property portfolio value increased by £5.0m to £282.8m (FY20: £277.8m) as a result of capital expenditure, primarily relating to the HQ development. On a like-for-like basis, valuations were 4.0% lower in the year but with a noticeable improvement in the second half of the year (-0.5% compared with -3.5% in H1). By sector, the annual movements broadly reflected market-wide trends with industrial assets showing the strongest gains and retail & leisure related assets, most affected by the pandemic, showing the weakest performance.

Exhibit 2: Like-for-like portfolio valuation movement – stronger H2

Market value (£m)

H121 gain/(loss)
%

Market value (£m)

H221 gain/(loss)
%

Market value (£m)

31-Mar-20

30-Sep-20

31-Mar-21

FY20

H121

FY21

Offices*

124.4

(4.2)

119.2

(2.5)

116.3

Development

37.8

39.4

52.7

13.1

59.6

Industrial

38.8

2.1

39.6

2.8

40.7

Leisure

37.9

(7.4)

35.0

1.2

35.4

Retail*

23.6

(6.5)

22.1

(2.7)

21.5

Retail warehouse

10.5

(10.5)

9.4

(2.5)

9.2

Total market value

273.1

1.9

278.2

1.7

282.8

Capital expenditure**

(14.5)

(20.7)

Total like for like

273.1

1.9

263.7

(0.5)

262.2

Source: Palace Capital data. Note: *Excludes properties disposed in FY20. **Includes capital expenditure on developments and capitalised legal and letting fees incurred in FY21.

On an ungeared basis the property portfolio total return, combining capital returns and income returns, was 1.0%, slightly behind the MSCI UK Quarterly Index benchmark. On a three-year basis PCA’s total return remains 4% ahead of the benchmark.

95% of rents collected in FY21

FY21 rent collection was strong and PCA attributes its 95% collection rate (98% from the top-20 tenants that account for more than 40% of contracted rents) in part to its early and active outreach to its 182 tenants. This collection performance has continued into the current year, with 95% (including agreed monthly collections) collected to date1 for the March 2021 rent quarter. Significant support was provided to tenants, amounting to £1.1m via rent concessions and rent deferrals, regearing leases to provide rent-free periods, and payment plans to help tenants manage their cash flow.

  At 8 June 2021.

Exhibit 3: Rent collection data

FY21 rent demanded

FY21 rent concessions/deferrals

FY21 cash collected

FY21 collection rate

March 2021 collection rate*

Office

£8.6m

£0.1m

£8.0m

95%

96%

Industrial

£2.4m

£2.4m

98%

97%

Leisure

£3.3m

£0.9m

£2.2m

91%

91%

Retail warehouse

£0.8m

£0.8m

100%

100%

Retail

£2.0m

£0.1m

£1.8m

94%

89%

Portfolio total

£17.1m

£1.1m

£15.2m

95%

95%

Source: Palace Capital data. Note: *Data as at 8 June 2021. Rent collection is defined as cash rent collected in full and rent being collected monthly as per agreed payment plans.

Provisions against rent receivables held on the balance sheet were c £1.3m at end-FY21, of which 63% relates to the retail and leisure sectors, increasing by £0.9m during the year. PCA expects to recover some of the rents provided for as the lockdown restrictions eases.

Update on portfolio development and asset management

The portfolio was externally valued at £282.8m at end-FY21, comprising 48 assets let to 182 individual tenants. PCA’s current and future focus is on the office (c 41%) and industrial (c 14%) sectors and management estimates that the combined total of these two sectors will increase from c 56% to more than 70% once the HQ residential apartments have been sold and the commercial space let. The contractual rent income of £16.4m pa at end-FY21 is reflected in a portfolio net initial yield of 5.6% and with an externally assessed estimated market rental value at full occupancy (ERV) of £20.6m the reversionary yield was 7.3%. The FY21 ERV includes £0.9m in respect of the HQ commercial space. The gap between ERV and contractual rent provides a significant opportunity for income and value generation, discussed below.

Exhibit 4: Portfolio summary

FY21

FY20

31-Mar-21

31-Mar-20

External portfolio valuation

£282.8m

£277.8m

Net initial yield

5.6%

6.0%

Reversionary yield

7.3%

6.6%

Contractual rental income

£16.4m

£17.6m

Estimated rental value (ERV)

£20.6m

£20.6m

Properties

48

53

Tenants

182

204

WAULT to first break

4.8 years

4.8 years

Void rate

13.6%

12.7%

Source: Palace Capital data

Hudson Quarter completion

The flagship HQ development in York2 (HQ) was completed on budget on 20 April and the first occupiers, both residential and commercial, have already moved in. HQ is a large project for PCA (the gross development value represents c two-thirds of market capitalisation) and completion provides the potential to crystalise sales profits on the residential apartments, recognise development gains on the commercial space, and earn recurring income as it is let. Completion on budget also represents a significant de-risking, while the proceeds of residential sales can be used to de-gear and/or can be recycled, depending on market conditions and opportunities. Our forecasts include c £10m (gross) of development/disposal gains from HQ (c £8.8m net of residential disposal costs) over FY22 and FY23, c 20p per share, and for the commercial space to add c £0.9m to rental income on an annualised basis, in line with ERV, once fully let.

  HQ occupies a two-acre site in York, within the city walls and just a minute’s walk from York railway station, which is 105 minutes (non-stop) by rail from London. The scheme comprises three residential buildings and a commercial building. The 127 flats (c 95,000 sq ft of living space) are being sold and the commercial element, comprising 39,500 sq ft of grade A offices will be retained for income.

Although the pandemic slowed completion slightly (by about three months compared with the original schedule), forced the closure of the residential marketing suite for much of the past year, and slowed activity in the commercial letting market, underlying market conditions in York remain favourable for both the residential and commercial assets and the high quality and strong location of the scheme should appeal.

The pace of residential sales has accelerated as lockdown restrictions have eased. Sales have now been completed or contracts exchanged on 46 of the 127 residential apartments3 with a sales value of £12.5m, with an additional four apartments under offer, with a sales value of £3.4m. At c £550 per sq ft, PCA expects the gross sales value of the residential assets to be c £52m and although most of the apartments sold to date have been lower-value studios and smaller one-bedroom apartments, the most recent sales show a noticeable increase in average sales value. Palace expects at least two-thirds of all apartments to be sold by the end of FY22, taking total sales proceeds (including the existing apartments where contracts have been exchanged) to at least £30m. Including existing financial resources, PCA expects to repay the Barclays development facility, utilised to part-fund the entire project, in full by the end of calendar 2021.

  At 16 June 2021.

While the pandemic has also slowed pre-letting activity, 4,500 sq ft of office space, on the ground floor of one of the residential buildings, has been pre-let to Knights, a quoted law firm, at a record rent for York of £25 per sq ft, and PCA has seen strong interest in the 35,000 sq ft of self-contained commercial space, which it expects to be let or under offer by the end of FY22.

Disposal programme and capital recycling

Having grown the portfolio primarily through portfolio acquisition, non-core disposals have been a regular feature, enabling capital deployment to be optimised and supporting operational efficiency. Disposals are typically driven by the completion of the business plan for the asset or where the risk-return balance favours disposal, in some cases generating an immediate saving on property operating costs. PCA has identified and targets the disposal of at least 15 properties with an aggregate value of more than £30m in the current year and has already made good progress, with £9.4m of sales completed or exchanged at a premium to book value.

With up to £30m of net proceeds (net of repayment of the development loan) over the next two years and the £30m proceeds from the non-core disposal programme, PCA will have considerable capital to recycle into income generating investments and new asset management opportunities. Although we expect HQ to generate significant profits for PCA this is in the form of capital growth (at least until the commercial assets are let) rather than immediate income. We anticipate that the net income forgone on the non-core disposals will be below that achievable from reinvestment and in some cases will yield savings on vacant property costs.

Regional offices and industrials, particularly logistics, remain the core focus for reinvestment, while in time we expect PCA to divest of its two large leisure assets, valued at more than £35m, particularly if valuations improve as a result of recent asset management activity (including three new lettings in the past year) and a sector recovery, which would provide additional capital recycling opportunities.

The majority of PCA’s portfolio has been assembled through cost-effective corporate acquisitions, which generate a considerable savings on stamp duty, and this continues to be its preferred method of acquisition. It expects corporate acquisition opportunities may emerge later this year or early next year as government support for companies is withdrawn.

Other asset management opportunities

In addition to capital recycling and HQ there is a broad range of additional asset management opportunities embedded within the PCA portfolio, including lease renewals, new lettings and regears, as well as refurbishment, and further development projects.

The most immediate opportunity is the reversionary potential within the existing portfolio. Exhibit 5 shows the ERV and vacant/void ERV by sector. Of the £4.2m difference to current contractual income, c £2.8m is accounted for by voids (including the opportunity to let the recently completed HQ commercial space) and the balance by lease incentive run-off and reversion to market rent levels.

Exhibit 5: Reversionary upside by sector

Market value
(£m)

Contractual rental income (£m)

ERV
(£m)

ERV of void
(£m)

WAULT to first break (years)

Offices

116.3

8.0

10.8

2.3

2.8

Industrial

40.7

2.5

2.9

0.1

3.5

Development

59.6

-

0.9

-

-

Leisure

35.5

3.4

3.2

0.2

10.8

Retail

21.5

1.9

2.1

0.2

8

Retail warehouses

9.2

0.8

0.6

-

5.7

Total portfolio

282.8

16.4

20.6

2.8

4.8

Source: Palace Capital data

Void reduction within the office assets, including several properties that have recently been refurbished or are currently being refurbished, and reversion to market rent in the effectively fully occupied industrial assets are the largest opportunities. During the past year, in response to the pandemic, PCA has prioritised those capital expenditure projects that are expected to have the most immediate impact on value or tenant use. This included the ongoing refurbishment of the c 99,000 sq ft office property at St James Gate in Newcastle, which is expected to complete in August 2021, and PCA says that it is confident that the c 20,000 sq ft of vacant space will be let before end-FY22.

There are several medium-term refurbishment and development opportunities for which detailed asset management plans have been identified, potentially providing further opportunities to add value to the portfolio, including:

The office properties at Holly Walk in Leamington Spa, with potential to create a 70,000 sq ft mixed-use development, subject to planning consent, which is currently anticipated to commence around 2024.

The office property Bank House in Leeds, which is currently c 85% occupied under short-term leases, pending a planned accretive refurbishment in 2025.

Forecast update

For FY22 a slight reduction in forecast net rental income is offset by slightly lower administrative expenses. In FY23 a combination of slightly higher forecast net rental income, lower administrative, and lower financing costs drives a c 6% increase in adjusted PBT and adjusted EPS. Our new FY24 forecast requires caution given the continuing economic uncertainty, but indicates further strong growth driven by net rental income. The growth in net rental income includes reversionary capture and a full period contribution from assumed FY23 acquisitions as detailed below. FY21 EPRA NTA was above our expectation and this feeds through into our forecasts, which also benefit from like-for-like growth including realised gains on sales of HQ residential assets, development gains on the HQ commercial space and reversionary capture/reduced voids.

Exhibit 6: Forecast revisions

Net rental income (£m)

Adjusted PBT (3m)

Adjusted EPS (p)

EPRA NTA (p)

DPS (p)

Old

New

Change (%)

Old

New

Change (%)

Old

New

Change (%)

Old

New

Change (%)

Old

New

Change (%)

03/22e

14.3

14.2

(0.9)

6.6

6.6

0.0

14.3

14.3

0.0

360

366

1.8

12.0

12.0

0.0

03/23e

15.0

15.2

0.9

7.1

7.5

6.0

15.5

16.4

5.9

369

385

4.5

14.0

14.0

0.0

03/24e

N/A

17.6

N/A

N/A

9.8

N/A

N/A

21.3

N/A

N/A

401

N/A

N/A

18.0

N/A

Source: Edison Investment Research

The key component of our adjusted PBT forecast is net rental income for which we assume:

Completion of the £30m non-core asset sale programme in FY22, with £40m of reinvestment during FY23, less than the c £50m that management indicates.

We forecast contracted rents of £16.4m pa at end FY21 to:

Reduce to £15.3m at end-FY22 due to the disposals (although we expect the net income effect to be offset by property cost and interest expense savings).

Increase to £18.7m at end-FY23, including £2.4m (6% net initial yield) from the acquisitions and c £1.0m from reversionary rent capture/void reduction (effectively equal to fully letting the HQ commercial space).

Increase to £19.7m at end-FY24 including a further £1.0m of reversionary capture/void reduction.

Net rental income reflects:

the weighted impact of annual contracted rents.

Other income of c £0.5m pa.

An increase in direct property costs from c £1.5m in FY21 to c £2.5m in FY22, falling to c £2.2m thereafter. The rise in FY22 costs is driven by the non-repeat of FY21 rates relief (c £0.4m) and costs related to HQ (rates etc) in the period between practical completion and letting/disposal, partly offset by savings generated by the disposal programme.

We do not forecast continuing charges in respect of concessions/rent receivables on a net basis.

Our IFRS earnings and the change in NTA include the following capital valuation assumptions:

A c £2.0m unrealised development gain/revaluation uplift on the HQ commercial space upon letting (end-FY22).

Aggregate gross disposal gains on the HQ residential assets of c £7.9m (£6.8m net of transaction costs at 2% on the gross sales value of c £52m), spread over FY22 and FY23.

Like-for-like revaluation gains of c 2% pa in FY23 and FY24 (nil in FY22) reflecting progress with void reduction. We believe these assumptions are consistent with a c 0.3% increase in net initial yield (as contracted income increases) and a very slight reduction in the reversionary yield. We estimate that a 1% increase/decline in the FY22 property valuation compared with our forecasts would increase/reduce FY22e EPRA NTA by c 5p.

Our forecast for DPS increases in FY22 and FY23 are unchanged, and we expect continuing growth in FY24, with dividend cover consistently 1.5–1.2x. With the forecast proceeds of residential sales and non-core disposals exceeding our assumed reinvestment, our forecast net loan to value ratio (LTV) for end-FY24 is 32%.

Funding

End-FY21 debt facilities of £141.7m were diversified across several lenders. £128.3m had been drawn and adjusting for £9.4m of cash, net borrowing was £118.9m with an LTV of 42.0%. The average cost of debt was 3.0% (FY20: 3.1%) with costs fixed by hedging on 49% of debt. Immediately available debt and cash resources amounted to £14.4m at end-FY21.

At end-FY21 the average debt maturity was 2.6 years, but since then the maturity date of the Barclays development facility has been extended and repayments from the proceeds of completed residential asset sales have reduced the drawn balance to £11.6m. On an FY21 pro-forma basis, including the development loan part-repayment the group LTV has reduced from 42% to 40.4 PCA expects continuing residential sales to enable a full repayment of the development facility before the end of 2021 and for LTV to reduce further.

  As at 8 June 2021.

Exhibit 7: Summary of debt portfolio as at 31 March 2021 (end-FY21)*

Lender

Facility (£m)

Drawn (£m)

Maturity

Hedging

Barclays

38.0

38.0

Jun-24

£34.3m fixed

NatWest (RCF)

40.0

28.6

Aug-24

100% floating*

Santander

25.3

25.3

Aug-22

£19.0m fixed

Lloyds

6.8

6.8

Mar-23

100% floating

Scottish Widows

9.3

9.3

Jul-26

100% floating

Barclays (development facility)

22.3

20.3

Jul-22*

100% floating

Total

141.7

128.3

2.6 years

49% fixed/51% floating

Source: Palace Capital data. Note: *Maturity extended from January 2022 since 31 March 201.

At the group level, interest cover was 2.7x at end-FY21 (end-FY20: 3.5%). Each debt facility is secured at a special purpose vehicle (SPV) level, each with its own interest cover and LTV covenants. In the past year the pandemic lockdowns have put pressure on facilities charged to the two leisure assets, requiring covenant waivers from the respective lenders during periods where concessions and rent deferrals have been agreed with tenants. Additionally, PCA reduced its loan balance with Scottish Widows by £4.1m to ‘cure’ the LTV covenant with an ongoing waiver of the interest cover covenant.

Valuation

Unlike many REITs, PCA operates a total return model, aiming to provide attractive income returns, as well as exposure to capital growth from the repositioning of value-add properties. Since its first major post-IPO transaction in H214, it has built a proven track record of acquiring properties where it can extract value by enhancing sustainable recurring income and generating capital growth through refurbishment and development opportunities. During this period, it has generated cumulative EPRA NTA total returns of 110.1% or a compound annual average return of 10.4%. This is a good level of return despite the negative impacts of COVID-19 on late FY20 and FY21. Our forecasts for FY22–24 indicate total returns of c 8% pa in each of the three years, driven by development gains/residential disposal profits on the completion of HQ and increased rental income through reversionary capture.

Exhibit 8: NAV total return history

H214

FY15

FY16

FY17

FY18

FY19

FY20

FY21

Cumulative*

Opening EPRA NTA per share (p)**

218

341

388

414

443

414

407

364

218

Closing EPRA NTA per share (p)**

341

388

414

443

414

407

364

350

350

Dividend per share paid (p)

2.5

8.50

14.00

18.00

19.00

19.00

19.00

7.50

108

Income return (%)

1.1%

2.5%

3.6%

4.3%

4.3%

4.6%

4.7%

2.1%

49.3%

Capital return (%)

56.6%

13.5%

6.9%

6.9%

-6.4%

-1.8%

-10.4%

-3.9%

60.8%

EPRA NTA total return (%)

57.8%

16.0%

10.5%

11.2%

-2.1%

2.8%

-5.8%

-1.8%

110.1%

Average annual return

10.4%

Source: Palace Capital data, Edison Investment Research. *Cumulative returns from end-H114 to end-FY21. **FY20 and H121 are EPRA net tangible assets per share and previous years reflect the broadly equivalent EPRA net asset value per share.

Based on the minimum 3p quarterly DPS that PCA targets during FY22, the prospective yield is 4.6%. We forecast the annualised 12p DPS to be well covered (1.2x) by adjusted earnings. Meanwhile, the shares trade at a significant discount of c 26% to end-FY21 diluted EPRA NTA per share of 360p.

In Exhibit 9 we show a summary performance and valuation comparison of PCA and a peer group of UK commercial real estate investment companies with a strong regional focus. For comparative purposes, the valuation data is based on last reported EPRA NTA/NAV and trailing 12-month DPS declared. On this basis, PCA trades at a lower P/NTA than the group average and although its trailing dividend is lower, this is yet to reflect the recent 20% DPS increase.

Exhibit 9: Peer group performance and valuation comparison

Price
(p)

Market cap (£m)

P/NTA/NAV*
(x)

Trailing yield (%)**

Share price performance

1 month

3 months

12 months

From 12M high

Circle Property

197

56

0.70

2.3

0%

9%

16%

-9%

Custodian

98

414

1.00

4.6

0%

5%

5%

-6%

Picton

88

482

0.91

3.3

2%

0%

33%

-4%

Real Estate Investors

40

71

0.72

7.6

5%

16%

20%

-6%

Regional REIT

86

373

0.84

7.1

4%

11%

10%

-7%

Schroder REIT

47

231

0.78

4.8

0%

15%

41%

-3%

UK Commercial Property REIT

79

1027

0.90

3.2

4%

9%

21%

-5%

BMO Commercial Property Trust

90

719

0.75

3.2

8%

20%

22%

-4%

BMO Real Estate Investments

72

174

0.73

4.4

-5%

1%

35%

-11%

Average

0.81

4.5

2%

10%

23%

-6%

Palace Capital

261

120

0.75

3.8

6%

13%

49%

-3%

UK property sector index

1,780

3%

9%

16%

-2%

UK equity market index

4,088

2%

6%

18%

0%

Source: Company data, Refinitiv. Note: Prices at 16 June 2021. *Based on last reported EPRA NAV per share. **Based on trailing 12-month DPS declared.

Exhibit 10: Financial summary

Year end 31 March (£m)

2018

2019

2020

2021

2022e

2023e

2024e

PROFIT & LOSS

Rental & other income

16.7

18.8

21.1

17.3

16.7

17.4

19.7

Movement in credit loss

0.0

0.0

(0.9)

0.0

0.0

0.0

Non-recoverable property costs

(1.8)

(2.3)

(2.4)

(1.5)

(2.5)

(2.2)

(2.1)

Net rental income

14.9

16.4

18.8

14.9

14.2

15.2

17.6

Dividend income from listed equity investments

0.0

0.1

0.1

0.0

0.0

0.0

Administrative expenses including share based payments

(4.2)

(4.1)

(4.3)

(4.3)

(4.4)

(4.6)

(4.7)

Operating Profit (before capital items)

10.7

12.4

14.6

10.6

9.8

10.6

12.8

Unrealised gains/(losses) on properties

5.7

(0.7)

(17.9)

(14.0)

2.0

4.2

5.0

Realised gains/(losses) on properties

0.3

(0.4)

(0.1)

0.9

3.9

2.9

0.0

Loss on revaluation of listed equity investments

(0.2)

(0.4)

0.7

0.0

0.0

0.0

Operating Profit

16.7

11.1

(3.9)

(1.8)

15.7

17.7

17.9

Net finance expense

(3.4)

(4.7)

(5.2)

(3.8)

(3.5)

(3.3)

(3.3)

Profit Before Tax

13.3

6.4

(9.1)

(5.5)

12.2

14.4

14.5

Taxation

(0.8)

(1.3)

3.6

(0.0)

0.0

0.0

0.0

Profit After Tax (FRS 3)

12.5

5.2

(5.4)

(5.5)

12.2

14.4

14.5

EPRA adjustments:

Unrealised gains/(losses) on properties

(5.7)

0.7

17.9

14.0

(2.0)

(4.2)

(5.0)

Realised gains/(losses) on properties

(0.3)

0.4

0.1

(0.9)

(3.9)

(2.9)

0.0

Deferred tax charge

(0.3)

0.2

0.0

0.0

0.0

0.0

0.0

Other adjustments

0.3

1.1

(1.8)

(0.3)

0.0

0.0

0.0

EPRA earnings

6.5

7.6

10.8

7.2

6.3

7.2

9.5

Non-recurring items

0.7

0.0

(2.9)

0.0

0.0

0.0

0.0

Share-based payments

0.2

0.3

0.1

0.3

0.3

0.3

0.3

Adjusted earnings

7.4

7.9

8.1

7.5

6.6

7.5

9.8

Tax adjustments

1.1

1.0

(0.0)

(0.0)

0.0

0.0

0.0

Company adjusted PBT

8.5

8.9

8.0

7.5

6.6

7.5

9.8

Average fully diluted number of shares outstanding (m)

35.0

45.9

46.0

46.1

46.1

46.1

46.1

Basic EPS - FRS 3 (p)

35.8

11.3

(11.8)

(12.0)

26.5

31.2

31.5

Fully diluted EPRA EPS (p)

18.7

16.5

23.4

15.7

13.7

15.7

20.6

Fully diluted adjusted EPS (p)

21.2

17.3

17.5

16.4

14.3

16.4

21.3

Dividend per share declared (p)

19.0

19.0

12.0

10.5

12.0

14.0

18.0

Dividend cover by adjusted earnings (x)

1.11

0.91

1.46

1.56

1.20

1.17

1.18

NTA total return

-2.1%

2.8%

-5.8%

-1.8%

7.8%

8.7%

8.4%

BALANCE SHEET

Fixed Assets

254.0

261.1

251.7

239.3

217.5

266.7

276.7

Investment properties

253.9

258.3

248.7

235.9

214.0

263.2

273.2

Other non-current assets

0.1

2.7

3.0

3.5

3.5

3.5

3.5

Current Assets

46.3

55.3

51.8

61.9

64.6

23.5

22.0

Trading properties

0.0

14.4

27.6

42.7

18.9

0.0

0.0

Assets held for sale

21.7

11.8

0.0

0.0

0.0

0.0

0.0

Cash

19.0

22.9

14.9

9.4

35.9

13.7

12.2

Other current assets

5.6

6.2

9.3

9.8

9.8

9.8

9.8

Current Liabilities

(11.5)

(16.0)

(16.1)

(34.9)

(33.5)

(33.2)

(34.5)

Creditors

(8.8)

(10.0)

(14.1)

(12.9)

(11.5)

(11.2)

(12.5)

Short term borrowings

(2.7)

(6.0)

(1.8)

(21.9)

(21.9)

(21.9)

(21.9)

Long Term Liabilities

(105.5)

(120.0)

(121.1)

(108.5)

(83.4)

(83.2)

(83.0)

Long term borrowings

(97.2)

(112.0)

(117.5)

(105.4)

(80.4)

(80.2)

(80.0)

Deferred tax & other long-term liabilities

(8.3)

(8.0)

(3.5)

(3.1)

(3.1)

(3.1)

(3.1)

Net Assets

183.3

180.3

166.3

157.8

165.1

173.7

181.2

EPRA net assets

0.0

0.0

167.9

161.3

168.6

177.2

184.7

Basic NAV/share (p)

400

393

361

343

359

377

394

Diluted EPRA NAV/share (p)

0

0

364

350

366

385

401

CASH FLOW

Operating Cash Flow

9.9

11.9

15.7

11.3

8.7

10.6

14.4

Net Interest

(2.7)

(3.4)

(3.7)

(3.6)

(3.2)

(3.0)

(3.0)

Tax

(0.4)

(1.6)

(2.2)

(1.2)

0.0

0.0

0.0

Net cash from investing activities

(67.7)

(11.5)

(10.1)

(14.8)

51.6

(23.2)

(5.0)

Ordinary dividends paid

(6.7)

(8.7)

(8.7)

(3.5)

(5.3)

(6.0)

(7.4)

Debt drawn/(repaid)

8.2

18.0

1.4

7.6

(25.4)

(0.5)

(0.5)

Proceeds from shares issued (net)

67.7

(0.0)

0.0

0.0

0.0

0.0

0.0

Other cash flow from financing activities

(1.1)

(0.1)

(1.0)

(0.3)

0.0

0.0

0.0

Net Cash Flow

7.0

4.4

(8.5)

(4.5)

26.5

(22.2)

(1.5)

Opening cash

10.9

18.0

22.4

13.9

9.4

35.9

13.7

Closing cash

18.0

22.4

13.9

9.4

35.9

13.7

12.2

Restricted cash

1.0

0.5

1.0

0.0

0.0

0.0

0.0

Closing balance sheet cash

19.0

22.9

14.9

9.4

35.9

13.7

12.2

Closing balance sheet debt

(99.8)

(118.0)

(119.4)

(127.3)

(102.2)

(102.0)

(101.8)

Unamortised debt costs

(1.6)

(1.3)

(1.4)

(1.0)

(0.7)

(0.4)

(0.1)

Closing net (debt)/cash

(82.4)

(96.5)

(105.8)

(118.9)

(67.1)

(88.7)

(89.7)

Net LTV (exc restricted cash & adjusted for unamortised debt costs)

29.8%

33.7%

38.1%

42.0%

28.3%

33.2%

32.3%

Source: Palace Capital historical data, Edison Investment Research forecasts

General disclaimer and copyright

This report has been commissioned by Palace Capital and prepared and issued by Edison, in consideration of a fee payable by Palace Capital. Edison Investment Research standard fees are £49,500 pa for the production and broad dissemination of a detailed note (Outlook) following by regular (typically quarterly) update notes. Fees are paid upfront in cash without recourse. Edison may seek additional fees for the provision of roadshows and related IR services for the client but does not get remunerated for any investment banking services. We never take payment in stock, options or warrants for any of our services.

Accuracy of content: All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report and have not sought for this information to be independently verified. Opinions contained in this report represent those of the research department of Edison at the time of publication. Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations.

Exclusion of Liability: To the fullest extent allowed by law, Edison shall not be liable for any direct, indirect or consequential losses, loss of profits, damages, costs or expenses incurred or suffered by you arising out or in connection with the access to, use of or reliance on any information contained on this note.

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Investment in securities mentioned: Edison has a restrictive policy relating to personal dealing and conflicts of interest. Edison Group does not conduct any investment business and, accordingly, does not itself hold any positions in the securities mentioned in this report. However, the respective directors, officers, employees and contractors of Edison may have a position in any or related securities mentioned in this report, subject to Edison's policies on personal dealing and conflicts of interest.

Copyright: Copyright 2021 Edison Investment Research Limited (Edison).

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New Zealand

The research in this document is intended for New Zealand resident professional financial advisers or brokers (for use in their roles as financial advisers or brokers) and habitual investors who are “wholesale clients” for the purpose of the Financial Advisers Act 2008 (FAA) (as described in sections 5(c) (1)(a), (b) and (c) of the FAA). This is not a solicitation or inducement to buy, sell, subscribe, or underwrite any securities mentioned or in the topic of this document. For the purpose of the FAA, the content of this report is of a general nature, is intended as a source of general information only and is not intended to constitute a recommendation or opinion in relation to acquiring or disposing (including refraining from acquiring or disposing) of securities. The distribution of this document is not a “personalised service” and, to the extent that it contains any financial advice, is intended only as a “class service” provided by Edison within the meaning of the FAA (i.e. without taking into account the particular financial situation or goals of any person). As such, it should not be relied upon in making an investment decision.

United Kingdom

This document is prepared and provided by Edison for information purposes only and should not be construed as an offer or solicitation for investment in any securities mentioned or in the topic of this document. A marketing communication under FCA Rules, this document has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research.

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Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

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London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

1185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

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Level 4, Office 1205

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Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

1185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

General disclaimer and copyright

This report has been commissioned by Palace Capital and prepared and issued by Edison, in consideration of a fee payable by Palace Capital. Edison Investment Research standard fees are £49,500 pa for the production and broad dissemination of a detailed note (Outlook) following by regular (typically quarterly) update notes. Fees are paid upfront in cash without recourse. Edison may seek additional fees for the provision of roadshows and related IR services for the client but does not get remunerated for any investment banking services. We never take payment in stock, options or warrants for any of our services.

Accuracy of content: All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report and have not sought for this information to be independently verified. Opinions contained in this report represent those of the research department of Edison at the time of publication. Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations.

Exclusion of Liability: To the fullest extent allowed by law, Edison shall not be liable for any direct, indirect or consequential losses, loss of profits, damages, costs or expenses incurred or suffered by you arising out or in connection with the access to, use of or reliance on any information contained on this note.

No personalised advice: The information that we provide should not be construed in any manner whatsoever as, personalised advice. Also, the information provided by us should not be construed by any subscriber or prospective subscriber as Edison’s solicitation to effect, or attempt to effect, any transaction in a security. The securities described in the report may not be eligible for sale in all jurisdictions or to certain categories of investors.

Investment in securities mentioned: Edison has a restrictive policy relating to personal dealing and conflicts of interest. Edison Group does not conduct any investment business and, accordingly, does not itself hold any positions in the securities mentioned in this report. However, the respective directors, officers, employees and contractors of Edison may have a position in any or related securities mentioned in this report, subject to Edison's policies on personal dealing and conflicts of interest.

Copyright: Copyright 2021 Edison Investment Research Limited (Edison).

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Edison Investment Research Pty Ltd (Edison AU) is the Australian subsidiary of Edison. Edison AU is a Corporate Authorised Representative (1252501) of Crown Wealth Group Pty Ltd who holds an Australian Financial Services Licence (Number: 494274). This research is issued in Australia by Edison AU and any access to it, is intended only for "wholesale clients" within the meaning of the Corporations Act 2001 of Australia. Any advice given by Edison AU is general advice only and does not take into account your personal circumstances, needs or objectives. You should, before acting on this advice, consider the appropriateness of the advice, having regard to your objectives, financial situation and needs. If our advice relates to the acquisition, or possible acquisition, of a particular financial product you should read any relevant Product Disclosure Statement or like instrument.

New Zealand

The research in this document is intended for New Zealand resident professional financial advisers or brokers (for use in their roles as financial advisers or brokers) and habitual investors who are “wholesale clients” for the purpose of the Financial Advisers Act 2008 (FAA) (as described in sections 5(c) (1)(a), (b) and (c) of the FAA). This is not a solicitation or inducement to buy, sell, subscribe, or underwrite any securities mentioned or in the topic of this document. For the purpose of the FAA, the content of this report is of a general nature, is intended as a source of general information only and is not intended to constitute a recommendation or opinion in relation to acquiring or disposing (including refraining from acquiring or disposing) of securities. The distribution of this document is not a “personalised service” and, to the extent that it contains any financial advice, is intended only as a “class service” provided by Edison within the meaning of the FAA (i.e. without taking into account the particular financial situation or goals of any person). As such, it should not be relied upon in making an investment decision.

United Kingdom

This document is prepared and provided by Edison for information purposes only and should not be construed as an offer or solicitation for investment in any securities mentioned or in the topic of this document. A marketing communication under FCA Rules, this document has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research.

This Communication is being distributed in the United Kingdom and is directed only at (i) persons having professional experience in matters relating to investments, i.e. investment professionals within the meaning of Article 19(5) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005, as amended (the "FPO") (ii) high net-worth companies, unincorporated associations or other bodies within the meaning of Article 49 of the FPO and (iii) persons to whom it is otherwise lawful to distribute it. The investment or investment activity to which this document relates is available only to such persons. It is not intended that this document be distributed or passed on, directly or indirectly, to any other class of persons and in any event and under no circumstances should persons of any other description rely on or act upon the contents of this document.

This Communication is being supplied to you solely for your information and may not be reproduced by, further distributed to or published in whole or in part by, any other person.

United States

Edison relies upon the "publishers' exclusion" from the definition of investment adviser under Section 202(a)(11) of the Investment Advisers Act of 1940 and corresponding state securities laws. This report is a bona fide publication of general and regular circulation offering impersonal investment-related advice, not tailored to a specific investment portfolio or the needs of current and/or prospective subscribers. As such, Edison does not offer or provide personal advice and the research provided is for informational purposes only. No mention of a particular security in this report constitutes a recommendation to buy, sell or hold that or any security, or that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person.

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

1185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

1185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

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