Income-driven returns continuing

Custodian REIT 27 June 2018 Outlook
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Custodian REIT

Income-driven returns continuing

FY18 results and outlook

Real estate

27 June 2018

Price

122p

Market cap

£472m

Net debt (£m) as at 31 March 2018 (gross borrowings less unrestricted cash)

111.3

Net LTV as at 31 March 2018

21.0%

Shares in issue

386.9m

Free float

92%

Code

CREI

Primary exchange

LSE

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

2.4

8.2

5.2

Rel (local)

4.8

(0.9)

3.1

52-week high/low

122.0p

112.6p

Business description

Custodian REIT (CREI) is a London Main Market listed REIT focused on commercial property in the UK outside London. It is income-focused, with a commitment to pay a high but sustainable and covered dividend.

Next event

AGM

19 July 2018

Analysts

Martyn King

+44 (0)20 3077 5745

Andrew Mitchell

+44 (0)20 3681 2500

Custodian REIT is a research client of Edison Investment Research Limited

Custodian REIT (CREI) continued to deliver strong returns in FY18, with a NAV total return of 9.6% (FY17: 8.5%), 6.0% from dividends paid and the balance from NAV growth. Barring unforeseen circumstances, the board intends to again increase fully covered DPS in the current year. The manager’s ability to source accretive acquisitions, the opportunities to actively manage the existing portfolio, and the prospect of continuing rental growth, all suggest upside in income returns with further potential for capital growth.

Year end

Net rental income (£m)

EPRA EPS* (p)

EPRA
NAVPS (p)

DPS
(p)

P/NAV
(x)

Yield
(%)

03/17

25.7

6.59

104

6.35

1.18

5.2

03/18

33.2

6.94

107

6.45

1.14

5.3

03/19e

36.5

7.20

110

6.55

1.11

5.4

03/20e

37.0

7.29

112

6.62

1.09

5.4

Note: *EPRA EPS excludes revaluation gains/losses and other exceptional items.

Income-focused strategy

CREI has built a balanced portfolio of regional UK commercial real estate, diversified by sector, location, tenant and lease term. It is focused on institutional quality assets but with lot sizes of less than £10m, where the investment manager believes it has a competitive advantage. Rental growth is continuing across most of the portfolio, which has low exposure to offices and a relatively high exposure to industrial, retail warehouse and alternative sectors. Management focus is on maintaining high levels of occupancy and growing income through active asset management and accretive acquisitions. Fully covered dividends paid since the IPO in 2014 represent more than 70% of the NAV total return, a compound 7.3% pa.

9.6% NAV total return in FY18

Net rental income grew by 29% (to £33.2m) in FY18, and the investment portfolio by 26% to £529.0m, including £106.3m of acquisitions (before costs) and gross revaluation gains of £11.9m. Cost growth of 20% benefited from the revised management fee structure, effective 1 June 2017. EPRA earnings grew 28% and EPRA EPS by 5.3% to 6.94p after new share issuance to partly fund acquisitions, with the 6.45p DPS declared for the year again fully covered. With demand for the shares remaining high, 47.8m shares were issued under the tap facility at an average 11.1% premium to dividend adjusted NAV. EPRA NAV per share grew 3.4% to 107p and gearing remained conservative with a 21.0% loan to value (LTV).

Valuation: Yield premium supports P/NAV

With an income focus, CREI shares combine one of the highest yields in the sector (FY19e yield 5.4%) with a good level of dividend cover (FY19e 1.1x), and conservative gearing (FY18 LTV 21.0%). This provides support for the P/NAV ratio, which at 1.14x FY18 is above the peer average. The manager’s ability to source accretive acquisitions, the opportunities to actively manage the existing portfolio, and the prospect of continuing rental growth all suggest upside in income returns with further potential for capital growth.

Brief overview of FY18 results

CREI continued to deliver strong returns in FY18, with a NAV total return of 9.6% (FY17: 8.5%), 6.0% from dividends paid and the balance from NAV growth. Barring unforeseen circumstances, the board intends to again increase fully covered DPS in the current year. Portfolio growth continues through selective acquisitions, significantly funded during FY18 by new share issuance, for which investor demand remains high, while maintaining a conservative level of gearing.

Exhibit 1: Summary of results

(£000s)

2018

2017

% change

Net rental income

33,203

25,741

29.0%

Administrative expenses

(4,377)

(3,643)

20.1%

Operating profit before revaluations

28,826

22,098

30.4%

Net interest

(3,659)

(2,405)

52.1%

EPRA earnings

25,167

19,693

27.8%

Revaluation of investment properties

11,859

9,016

Costs of acquisitions

(6,212)

(6,103)

Profit on disposal

1,606

1,599

IFRS earnings

32,420

24,205

33.9%

EPRA EPS (p)

6.94

6.59

5.3%

IFRS EPS (p)

8.95

8.10

10.4%

DPS (declared) (p)

6.45

6.35

1.6%

Dividend cover (EPRA EPS/DPS declared)

1.08

1.04

3.7%

IFRS and EPRA NAV per share (p)

107

104

3.4%

NAV total return

9.6%

8.5%

Net LTV

21.0%

14.4%

Source: Custodian REIT

During FY18, £103.8m (before acquisition costs) was invested in 20 acquisitions, one ongoing pre-let development and one significant refurbishment. Five properties with an aggregate book value of £9.3m were disposed of, generating a £1.6m profit. Including a revaluation gain of £11.9m and other adjustments, the investment portfolio increased by 26.4% to £528.9m (FY17: £418.5m), reflecting a net initial yield (NIY) of 6.6% (FY17: 6.7%).

Net rental income increased by 29.0% to £33.2m.

The ongoing charge ratio (excluding direct property costs) reduced further, from 1.20% to 1.15%. Administrative expenses grew at a slower pace than income, by 20.1% to £4.4m, including a 17.0% increase in investment management fees, already benefiting from revised fee schedules from 1 June 2017.

The growth in net interest expense reflects the increase in borrowing during the year, although net LTV remained conservative at 21.0% (FY17: 14.5%). Drawn borrowings increased from £65m to £115m, all fixed rate. The weighted average cost of CREI’s agreed debt facilities, which also included the £35m floating rate revolving credit facility (RCF), undrawn at year-end, was 3.1% with a weighted average maturity of 9.1 years.

EPRA earnings grew by 27.8% to £25.2m and EPRA EPS by 5.3% to 6.94p. During the year, CREI issued 47.8m new shares, 14.1% of the opening number, at an average 11.1% (2017: 5.1%) premium to dividend adjusted NAV via an ongoing programme of tap issuance.

EPRA NAV per share increased by 3.4% to 107p per share.

In a confident outlook statement, CREI points to the continuing strength of the regional occupier market, giving confidence in its ability to maintain occupancy levels and achieve rental growth at lease renewals and through proactive asset management. Although the commercial property market is cyclical, the company believes that its strategy of securing sustainable income will support future dividends through any medium-term market volatility and deliver capital growth for shareholders over the long term, despite the potential for cyclical impacts on NAV along the way.

Barring unforeseen circumstances, the board anticipates an increase in quarterly dividends per share for the current year to an aggregate 6.55p (FY18: 6.45p), fully covered by earnings.

Income-oriented, targeting quality smaller lot sizes

CREI is a UK real estate investment trust (REIT) listed on the Main Market of the London Stock Exchange. Its diversified portfolio comprises regional commercial properties, predominantly let to institutional grade tenants throughout the UK, differentiated by a principal focus on properties with smaller individual values (‘lot sizes’) of less than £10m at acquisition. CREI is externally managed by Custodian Capital, a property management and investment business, regulated by the FCA. Custodian Capital is a subsidiary of Mattioli Woods, the specialist wealth management and employee benefits consultants, with £8.3bn of assets under management or advice.

Exhibit 2: Growth in investment property value and net rental income

Exhibit 3: Dividends per share declared fully covered by EPRA EPS

Source: Custodian REIT data

Source: Custodian REIT data

Exhibit 2: Growth in investment property value and net rental income

Source: Custodian REIT data

Exhibit 3: Dividends per share declared fully covered by EPRA EPS

Source: Custodian REIT data

The company seeks to provide investors with an attractive level of income as well as potential for capital growth. It aims to appeal to both retail and institutional investors in the UK REIT sector by providing high and stable dividends from a well-diversified portfolio of UK commercial real estate with conservative levels of gearing. At 31 March 2018, the portfolio, consisting of 147 assets spread across all of the main commercial real estate sectors as well as alternatives (eg car showrooms, trade counters and nurseries), was valued at £528.9m, reflecting a NIY of 6.6%. The net LTV was 21.0%, still below the medium-term target of c 25%.

CREI was listed in March 2014 with an initial portfolio of assets that had previously been held and managed on behalf of clients of Mattioli Woods, the specialist wealth management and employee benefits consultants, with £8.3bn of assets under management or advice. It is externally managed by Custodian Capital, a property management and investment business, wholly owned by Mattioli Woods and regulated by the FCA.

Investment objectives target sustainable income

CREI’s income-focused strategy targets good quality properties but with smaller lot sizes (less than £10m at the point of investment) and differentiates it from a number of peers that also focus on regional commercial property. Properties of this size may be too small for larger institutional buyers, yet too large for many private investors, and management believes that it can continue to benefit from less competitive pricing, sufficient to offset the additional administrative complexity of a broader portfolio. Other elements of CREI’s strategy for meeting its investment objective include:

A preference for single-let properties to high-quality tenants.

No tenant to represent more than 10% of the rent roll, unless it is a government body.

A maximum weighting to any one property sector, or any geographic region, of 50%.

Focus on areas with high residual values, strong local economies and favourable demand– supply characteristics.

No speculative development, except for refurbishing of existing assets or forward funding of pre-let schemes.

A conservative gearing ratio, limited to a maximum LTV of 35%, with an expected long-term average of 25%.

A high payout ratio and a fully covered dividend.

The investment objectives also currently state that CREI will seek to maintain a weighted average unexpired lease term (WAULT) of over five years across the portfolio but the AGM, to be held on 19 July 2018, will be asked to approve an amendment, giving the investment manager greater flexibility with acquisitions policy. The proposed new WAULT policy reads:

The company will seek to minimise rental voids and enhance the WAULT of the portfolio by managing lease expiries and targeting property acquisitions, which will in aggregate be accretive to WAULT at the point of acquisition, on a rolling 12-month basis.

Behind the proposal is the investment manager’s view that investor focus on WAULT as a proxy for income risk has actually contributed towards an inflation in prices for longer lease assets that in many cases under-prices risk. Given the strength of the occupational market, the investment manager believes that risk is better managed by acquiring shorter-lease, good-quality properties that are likely to be re-let, even if this reduces the overall WAULT of the portfolio.

The investment manager has a long-term approach to investment, with a focus on properties with low obsolescence and low capital expenditure requirements. It also prefers properties with high residual values, rather than just focusing on the terms of the lease contracts.

Gearing is deliberately kept at relatively low levels, such that management’s sensitivity analysis suggests it would not exceed a 40% LTV in a property sector downturn similar to that of 2008.

The portfolio is well diversified

Portfolio diversification, by property, sector, geography and tenant mix is a key element of managing the cyclicality inherent in the sector, but the investment objectives allow sufficient flexibility for CREI to be contra-cyclical where the investment manager believes this to be appropriate. The EPRA occupancy rate at end-FY18 was 96.5% (end-FY17: 98.6%), and as noted above, the investment manager is confident about maintaining a high level of occupancy in the current year. CREI’s nationwide portfolio of 147 properties covers the main commercial sectors: industrial, office and retail, but also a number of the alternative sectors as mentioned above, mainly restaurants, leisure, car showrooms and trade counters. The portfolio has a relatively low exposure to office property (11% as at 4 May 2018), which the investment manager regards as having more obsolescence risk and so requiring more capital expenditure, and has a relatively high exposure to industrial, retail warehouse and alternative sectors. Industrial property is a good fit with CREI’s strategy, with higher residual values (ie the vacant possession value is closer to the investment value than in other sectors) with less exposure to obsolescence. The portfolio is also well diversified geographically, with minimal exposure to London, but exposure to every other region.

Exhibit 4: Portfolio split by income

Exhibit 5: Regional Split by income

Source: Custodian REIT data as at 4 May 2018

Source: Custodian REIT data as at 4 May 2018

Exhibit 4: Portfolio split by income

Source: Custodian REIT data as at 4 May 2018

Exhibit 5: Regional Split by income

Source: Custodian REIT data as at 4 May 2018

The properties are let to more than 200 individual tenants, the largest of which represents just over 3% of total rental income, with the top 10 tenants accounting for less than 20% of the total.

As at end-FY18, the WAULT to first break was 5.9 years, unchanged on the previous year. Within this, the proportion of income due within the next 12 months has reduced.

Exhibit 6: Income profile

Source: Custodian REIT data

Exhibit 7 shows how the portfolio weightings by sector have shifted over the FY18 year (data to 31 March rather than 4 May as above), driven primarily by the acquisition of new assets (20 assets) rather than by sales (five assets). Each sector saw an increase in value.

Exhibit 7: Portfolio weightings, FY18 vs FY17

Valuation (£m)

Weighting by income

31 March

FY18

FY17

FY18

FY17

FY18 vs FY17

Industrial

209.8

188.4

39%

45%

(6%)

Retail warehouse

107.5

48.8

20%

11%

9%

Other

80.4

56.7

15%

13%

2%

Retail

75.3

72.2

14%

17%

(3%)

Office

55.9

52.4

12%

14%

(2%)

Total

528.9

418.5

100%

100%

0%

Source: Custodian REIT data

Although the share of the total portfolio has reduced, the strong existing exposure to industrial properties was very beneficial to performance during FY18. However, the retail warehouse sector saw the largest share of new investment, taking its weight in the overall portfolio from 11% to 20%. The investment manager notes that retail warehousing vacancy rates are close to historical lows, with development activity constrained by restricted planning policy among other factors, while retailers continue to target larger format stores, easy parking, and ‘click and collect’ capability.

CREI acquired 20 properties in FY18 with an aggregate agreed purchase price of £105.8m, before netting off rent-free top-ups (c £1.9m) and allowing for acquisition costs of £6.2m. The aggregate annual passing rent on these properties, disclosed at the time of acquisition, was c £7.6m and the blended NIY was c 6.7%. So far in FY19, two properties have been acquired for an aggregate £8.0m before costs, adding passing rent of c £625k with a blended NIY of 7.32%. Although investing for the long term, properties are disposed of when they no longer meet the long-term investment strategy, or when they can be disposed of significantly ahead of the expected valuation. Five properties were sold during FY18 for a total of £11.3m, realising a profit on disposal of £1.6m (net of costs of £0.1m), 20% ahead of the aggregate valuation. The NIY on disposals was a blended 5.7%. The sales included two industrial properties, with an aggregate disposal value of £5.2m, at £1.1m above valuation, benefiting from the current strong demand for regional industrial units. A further property has been sold in FY19, a five-unit retail development in Stourbridge, for £2.25m, in line with the end-FY18 valuation.

Market backdrop

Despite some slowing of UK economic growth, continuing Brexit uncertainty and a significant retracement of the boost to export competiveness that resulted from post EU-referendum sterling weakness, regional property markets have remained in good health over recent months. In general, across the regional markets, a positive occupational demand–supply balance continues, although some participants have indicated that in some instances letting decisions are taking longer to execute. Regional markets continue to benefit from structural factors such as business relocation away from London, office conversion to residential use and a relative lack of new development in the years following the financial crisis.

Regional industrial and office rents are growing, but from affordable levels following a number of years of decline in real terms, and in many cases remain below the threshold necessary to bring forward new development. Much of the retail sector, particularly secondary retail, remains a weak spot, but yields are above average and CREI has seen little impact from the aggressive use of company voluntary arrangements, which are being used to allow tenants to step away from their lease obligations or reduce rents.

From an investment point of view, CREI sees the market as characterised by a restricted supply of investment opportunities and a significant level of demand from a range of investors. Within this, investor demand has polarised, moving away from high-street retail and focusing on industrial/logistics assets and properties on long leases, especially when combined with inflation-indexed rents. CREI believes the market is over-pricing some of these assets and has taken a cautious approach to acquisitions. However, it does not believe that the sector is at risk from a significant cyclical correction, as witnessed in 2007/8, noting the relative lack of new regional supply, affordable rents, low interest rates and a stronger banking system that is less exposed to real estate lending.

The Investment Property Forum UK Consensus Forecasts survey gathers independent forecasts for UK commercial property, including London, from 26 leading consultants and fund/investment managers. We show a summary of the latest quarterly results, generated between the latter part of February and mid-May 2018, in Exhibit 8. For some time, the consensus has been for income to become the driver of continuing positive overall sector returns, with capital growth waning or even becoming mildly negative. Participants remain most positive about industrial and retail warehouse property. City of London and West End office rental growth is forecast to be negative over the next couple of years, which implies positive expectations for the regional contribution.

Exhibit 8: Consensus forecasts for UK commercial property

Rental value growth (%)

Capital value growth (%)

Total return (%)

2018

2019

2020

2018/22

2018

2019

2020

2018/22

2018

2019

2020

2018/22

West End office

(0.7)

(0.8)

0.8

1.0

(2.1)

(3.0)

(0.6)

(0.5)

1.3

0.6

3.1

3.2

City office

(1.3)

(1.6)

0.7

0.5

(2.5)

(3.4)

(0.6)

(0.8)

1.3

0.5

3.5

3.3

Office (all)

(0.1)

(0.5)

0.8

0.9

(0.8)

(2.7)

(0.9)

(0.6)

3.3

1.6

3.4

3.8

Industrial

3.6

2.4

2.0

2.4

5.4

1.0

(0.1)

1.3

10.2

5.8

4.8

6.3

Standard retail

0.6

0.5

0.8

1.0

(0.3)

1.2

(0.8)

(0.2)

4.2

3.2

3.7

4.3

Shopping centre

0.1

(0.1)

0.4

0.4

(3.0)

(2.9)

(1.6)

(1.5)

1.9

2.0

3.5

3.6

Retail warehouse

0.3

0.3

0.7

0.7

(1.0)

(1.7)

(0.8)

(0.6)

4.5

4.0

5.0

5.2

All property

1.0

0.6

1.0

1.2

0.4

(1.4)

(0.7)

(0.1)

5.2

3.4

4.2

4.8

Source: Investment Property Forum UK Consensus Forecasts, Spring 2018

Management and board

CREI’s board of directors comprises four members, all of whom are non-executive, responsible for the overall management of the company’s activities. The board has appointed Custodian Capital (www.custodiancapital.com), a wholly owned subsidiary of Mattioli Woods (www.mattioliwoods.com), as investment manager to provide investment and property management, and administrative services to the company.

Three of the board members are independent of the investment manager, including the non-executive chairman, David Hunter, a professional strategic adviser focused principally on UK and international real estate, who sits on the boards of a number of listed and unlisted companies, as well as holding corporate advisory roles. The independent non-executive directors are Matthew Thorne, an experienced former finance director in the UK quoted sector and non-executive director of Bankers Investment Trust, and Barry Gilbertson, an international consultant with a focus on real estate, strategy and risk, and with more than 40 years’ experience advising on property. Ian Mattioli, chief executive officer of Mattioli Woods, and a board member of the investment manager, is the fourth CREI non-executive director.

Custodian Capital was appointed investment manager at the IPO, with performance reviewed annually. It was reappointed for a further three years from 1 June 2017, with the board noting in particular the investment manager’s timely deployment of investment funds, the quality of its asset selection, and its success in generating earnings to fully cover the targeted dividend growth. At the same time, the property management and administrative fees payable to the investment manager were reduced such that further growth in CREI’s NAV will support further reduction in the ongoing charge ratio and increase the dividend paying capacity of the company. This is particularly the case when net assets increase above £500m (end-FY18: £415.2m) as shown in the fee schedule below, applied from 1 June 2017:

Property management fees: these continue to be charged at 0.90% pa on average net assets of up to £200m and at 0.75% pa on average net assets between £200m and £500m. However, on average net assets above £500m the fee was reduced from 0.75% to 0.65%.

Administrative fees: these continue to be charged at 0.125% pa on average net assets up to £200m but reduced to 0.08% on average net assets of £200–500m and to 0.05% on average net assets of above £500m.

Richard Shepherd-Cross is the managing director of Custodian Capital and the fund manager of CREI. He is a former director of Jones Lang LaSalle in London, where he led the portfolio investment team before joining Mattioli Woods in 2009, with responsibility for its syndicated property initiative, the precursor to Custodian. In total, the Custodian Capital team that is dedicated to the management of CREI’s assets consists of 16 members, including eight property professionals, supported by a compliance officer and an investment committee.

Financials

Compared with our forecasts published after the interim results, FY18 net rental income, EPRA earnings and EPRA NAV were all slightly ahead of our expectations (Exhibit 9), generating an EPRA NAV total return for the year of 9.6%.

In our forecasts, we have only included the two acquisitions (c £8m consideration) and one sale (c £2.25m proceeds) that have been announced in the period since end-FY18 but we have not assumed further portfolio additions, given the obvious forecasting uncertainty in doing so, even though these are highly likely. Our forecast end-FY19 LTV is 22.4%, below the 25% that CREI targets over time, and by way of illustration, we estimate that an additional c £20m of property acquisitions, fully funded by cash/debt, with no equity issuance, would take the LTV to 25%. Furthermore, if the NIY on such acquisitions were to be in line with the blended FY18 average of 6.7%, on an annualised basis, it would increase our forecast FY19 EPRA EPS by c 2.5%.

In addition to factoring in the known acquisition/disposals, we have assumed c 1.5% pa rental growth in FY19 and c 1.0% in FY20, with unchanged occupancy, both of which seem consistent with the management outlook statement.

We have assumed increases in property valuation, in line with rental growth, maintaining the implied NIY on the portfolio at around 6.5%. The assumed gains add 2.1p to NAV in FY19 and 1.4p in FY20.

Our forecasts assume £10m of additional debt drawn since end-FY18 as part-consideration for acquisitions, with finance costs based on the 3.1% average cost of CREI’s overall debt facilities. All £115m of CREI’s existing long-term, fixed-rate borrowing facilities were drawn at end-FY18, but there is also a £35m RCF, attracting variable interest at a rate of 2.45% above three-month LIBOR, none of which was drawn at year-end. The RCF, on which advances may be drawn from time to time, provides tactical flexibility over debt funding for acquisitions and helps to reduce the cash drag of forward funding with equity issuance.

The changes to our FY19 forecasts, shown in Exhibit 9, are modest. The small reduction in EPRA EPS shown in the table reflects a similar reduction in forecast EPA earnings driven by an upwards adjustment to our administrative expense assumption, in part related to the higher net asset value, that is only partly offset by the small increase in net rental income. We nevertheless forecast a further small reduction in the ongoing cost ratio. We have introduced an FY20 forecast for the first time. Our FY20 forecast looks for EPRA EPS and DPS to grow modestly, with full dividend cover maintained throughout the period.

Exhibit 9: Performance versus forecast, and forecast revisions

Net rental income (£m)

EPRA EPS (p)

DPS (p)

EPRA NAV/share (p)

Net LTV

F'cast

Actual

Diff (%)

F'cast

Actual

Diff (%)

F'cast

Actual

Diff (%)

F'cast

Actual

Diff (%)

F'cast

Actual

Diff (%)

03/18

32.7

33.2

1.6

6.90

6.94

0.6

6.45

6.45

0.0

106

107

0.9

22.1%

21.0%

N/A

Net rental income (£m)

EPRA EPS (p)

DPS (p)

EPRA NAV/share (p)

Net LTV

Old

New

Chg (%)

Old

New

Chg (%)

Old

New

Chg (%)

Old

New

Chg (%)

Old

New

Chg (%)

03/19e

36.5

36.5

0.0

7.29

7.20

(1.2)

6.55

6.55

0.0

110

110

0.0

20.8%

22.4%

N/A

03/20e

N/A

37.0

N/A

N/A

7.29

N/A

N/A

6.62

N/A

N/A

112

N/A

N/A

22.3%

N/A

Source: Edison Investment Research

Taking our forecasts for changes in EPRA NAV and DPS together, the implied EPRA NAV total return is 8.5% in FY19 and 7.9% in FY20, with dividends representing a return on NAV of 6.1% and 6.0%, respectively.

Valuation

CREI is an income-oriented REIT and management’s focus is on generating secure income over the long term. The shares combine one of the highest yields in the sector (FY19e yield 5.4%) with a good level of dividend cover (FY19e 1.1x), and conservative gearing (FY18 LTV 21.0%). Growth in EPRA NAV per share has also contributed to historical returns, contributing 2.2% pa to the compound annual EPRA NAV total return of 7.3% pa from the beginning of FY15 to the end of FY18.

Exhibit 10: EPRA NAV total return

Year ending 31 March

2015

2016

2017

2018

2015–18

Opening EPRA NAV per share (p)

98.2

101.3

101.5

103.8

98.2

Closing EPRA NAV per share (p)

101.3

101.5

103.8

107.3

107.3

Dividends paid per share (p)

3.750

6.350

6.350

6.425

22.875

EPRA NAV total return

7.0%

6.4%

8.5%

9.6%

32.6%

Compound annual total return

7.3%

Source: Custodian REIT data, Edison Investment Research

Exhibit 11 shows a prospective yield comparison of CREI with a broad range of listed property companies, and this combination of dividend cover and conservative gearing positions it well among those that offer the highest yields.

Exhibit 11: Sector prospective yield comparison

Source: Custodian REIT data, Edison Investment Research, Bloomberg data as at 26 June 2018.

Exhibit 12 shows a comparison of the same group, based on historical P/NAV per share, which shows that CREI’s above-average income profile has been rewarded with an above-average P/NAV.

Exhibit 12: Sector historical P/NAV comparison

Source: Custodian REIT data, Edison Investment Research, Bloomberg data as at 26 June 2018.

This broad peer group contains a wide variety of property companies, REITs and non-REITs, and specialist vehicles (healthcare property, student accommodation), and covers a wide range of strategies, from a pure focus on income and collecting rents to varying degrees of asset management and capital growth, extending to property development. In Exhibit 13 we show a summary valuation comparison of CREI with what we consider to be its closest peers.

Exhibit 13: Peer group comparison

Price
(p)

Market cap (£m)

P/NAV
(x)

Yield (%)

Share price performance

1 month

3 months

12 months

From 12M high

EPIC

113

239

1.12

5.1

4%

7%

1%

(2%)

F&C Commercial Property

154

1234

1.09

3.9

7%

12%

6%

0%

F&C UK Real Estate Investments

101

242

1.00

5.0

(3%)

2%

(4%)

(7%)

Picton Property Income

93

502

1.03

3.8

4%

12%

11%

0%

Regional REIT

95

354

0.90

8.5

(5%)

0%

(10%)

(11%)

Schroders REIT

63

325

0.92

4.0

3%

5%

(2%)

(4%)

Standard Life Investment Property

96

389

1.09

4.9

4%

9%

8%

0%

UK Commercial Property Trust

88

1143

0.95

4.2

1%

(1%)

(4%)

(5%)

Median

1.02

4.6

4%

6%

(1%)

(3%)

Custodian

122

446

1.14

5.4

2%

8%

5%

0%

UK Property Index

1,838

3.9

(1%)

5%

4%

(2%)

FTSE All-Share Index

4,146

4.0

(2%)

9%

2%

(4%)

Source: Custodian REIT data, Edison Investment Research, Bloomberg data as at 26 June 2018.

Custodian’s prospective yield of 5.4% is also above the median for the narrower peer group of 4.6%, and its P/NAV at a similar premium.

In terms of price performance, Custodian has slightly outperformed the broad property sector and has more clearly outperformed the FTSE All Share Index over the past 12 months, a stronger performance than the narrow peer group.

Sensitivities

The commercial property market is cyclical, historically exhibiting substantial swings in valuation through cycles. Income returns are significantly more stable, but fluctuating with tenant demand and rent terms. From a sector point of view, we would also highlight the increased risks and uncertainties that attach to development activity, including planning consents, timing, construction risks and the long lead times to completion and eventual occupation. With its income focus, CREI is not a developer and avoids such risks, but does actively invest in improvements to existing assets with the aim of enhancing long-term income growth and returns. During FY18, CREI also agreed to acquire development land and fund the pre-let development of a drive through coffee shop with parking space. We consider that the main sensitivities include:

Sector risk: some of the inherent cyclical risk to vacancy in commercial property can be mitigated by portfolio diversification. As noted above, CREI has a balanced portfolio of UK regional commercial property assets, diversified by property and by individual occupiers.

Macro risk:

Although expanding by c 1.8% in 2017, UK GDP growth was weak in Q4, and into early 2018; although poor weather is likely to have had a temporary impact. The Bank of England continues to forecast a similar rate of growth in 2018 compared with 2017, although Brexit uncertainty remains high.

Having risen, partly due to sterling depreciation after the EU referendum and rising oil prices, inflation has recently moderated again, relieving some of the pressure for higher interest rates. Other than the tactical RCF, all of CREI’s structural debt is fixed rate with an average duration of 9.1 years, mitigating the risk of any increase. An eventual increase in longer-term rates is likely to have a knock-on effect on NAV over time, through increased property yields.

Management risk: as CREI is externally managed, any management risk is indirect. The management agreement with Custodian Capital was renewed on 1 June 2017 and runs for three years. Custodian Capital operates with a relatively small team, and if a senior member of that team were to leave they would need to be replaced.

Stock issuance: the ability to regularly issue new equity on attractive terms has enabled CREI to grow its portfolio while maintaining a conservative level of gearing. The sustained P/NAV premium is evidence that issuance is in response to investor demand and rather than representing a share overhang is driven by the availability of attractive investment opportunities.

Exhibit 14: Financial summary

Year-end 31 March

£000s

2014

2015

2016

2017

2018

2019e

2020e

IFRS

IFRS

IFRS

IFRS

IFRS

IFRS

IFRS

PROFIT & LOSS

Gross rental income

11,228

18,561

26,980

34,055

37,798

38,326

Re-charge income

342

451

630

758

871

885

Total revenue

 

 

 

11,570

19,012

27,610

34,813

38,670

39,211

Gross property expenses

(715)

(1,023)

(1,869)

(1,610)

(2,194)

(2,227)

Net rental income

 

 

 

10,855

17,989

25,741

33,203

36,475

36,985

Administrative expenses

(2,327)

(2,828)

(3,643)

(4,377)

(4,714)

(4,886)

Operating Profit before revaluations

 

 

 

8,528

15,161

22,098

28,826

31,761

32,099

Revaluation of investment properties

6,083

3,031

9,016

11,859

8,095

5,548

Costs of acquisitions

(5,844)

(5,768)

(6,103)

(6,212)

(524)

0

Profit on disposal

269

56

1,599

1,606

0

0

Operating Profit

9,036

12,480

26,610

36,079

39,332

37,647

Net Interest

(289)

(1,273)

(2,405)

(3,659)

(3,900)

(3,900)

Profit Before Tax

 

 

 

8,747

11,207

24,205

32,420

35,432

33,747

Taxation

(2)

0

0

0

0

0

Profit After Tax

8,745

11,207

24,205

32,420

35,432

33,747

Net revaluation of investment property/costs of acquisition

(239)

2,737

(2,913)

(5,647)

(7,572)

(5,548)

Gains/(losses) on disposal

(269)

(56)

(1,599)

(1,606)

0

0

EPRA earnings

8,237

13,888

19,693

25,167

27,861

28,199

Average Number of Shares Outstanding (m)

146.1

204.2

298.7

362.4

386.9

386.9

IFRS EPS (p)

 

 

 

5.99

5.49

8.10

8.95

9.16

8.72

EPRA EPS (p)

 

 

 

5.64

6.80

6.59

6.94

7.20

7.29

Dividend per share (p)

 

 

 

5.25

6.25

6.35

6.45

6.55

6.62

Dividend cover (x)

1.07

1.09

1.04

1.08

1.10

1.10

Ongoing charges ratio (excluding property expenses)

0.00%

1.33%

1.20%

1.15%

1.12%

1.12%

BALANCE SHEET

Fixed Assets

 

 

 

207,287

318,966

418,548

528,943

551,650

561,540

Investment properties

207,287

318,966

418,548

528,943

551,650

561,540

Other non-current assets

0

0

0

0

0

0

Current Assets

 

 

 

1,921

9,973

10,260

12,942

12,509

11,036

Debtors

1,072

4,518

4,453

7,883

9,567

9,675

Cash

849

5,455

5,807

5,059

2,942

1,361

Current Liabilities

 

 

 

(5,411)

(8,165)

(12,572)

(12,755)

(14,539)

(14,625)

Creditors/Deferred income

(5,411)

(8,165)

(12,572)

(12,755)

(14,539)

(14,625)

Short term borrowings

0

0

0

0

0

0

Long Term Liabilities

 

 

 

(23,811)

(65,714)

(64,359)

(113,928)

(124,228)

(124,528)

Long term borrowings

(23,811)

(65,143)

(63,788)

(113,357)

(123,657)

(123,957)

Other long term liabilities

0

(571)

(571)

(571)

(571)

(571)

Net Assets

 

 

 

179,986

255,060

351,877

415,202

425,392

433,423

NAV/share (p)

101

102

104

107

110

112

EPRA NAV/share (p)

101

102

104

107

110

112

CASH FLOW

Operating Cash Flow

 

 

 

12,780

13,945

23,066

28,388

30,518

30,735

Net Interest

(204)

(1,285)

(2,200)

(3,521)

(3,600)

(3,600)

Tax

0

0

0

0

0

0

Net additions to investment property

(129,788)

(113,621)

(92,126)

(105,884)

(13,794)

(3,000)

Ordinary dividends paid

(5,546)

(12,220)

(18,493)

(23,007)

(25,242)

(25,716)

Debt drawn/(repaid)

23,811

41,700

(1,000)

49,364

10,000

0

Proceeds from shares issued (net of costs)

99,796

76,087

91,105

53,912

0

0

Other cash flow from financing activities

0

0

0

0

0

Net Cash Flow

849

4,606

352

(748)

(2,117)

(1,581)

Opening cash

0

849

5,455

5,807

5,059

2,942

Closing cash

 

 

 

849

5,455

5,807

5,059

2,942

1,361

Debt

(23,811)

(65,143)

(63,788)

(113,357)

(123,657)

(123,957)

Closing net debt

 

 

 

(22,962)

(59,688)

(57,981)

(108,298)

(120,715)

(122,596)

Net LTV

11.4%

19.1%

14.4%

21.0%

22.4%

22.3%

Source: Custodian REIT data, Edison Investment Research

Contact details

Revenue by geography

Penman Way
Grove Park
Enderby
Leicester LE19 1SY
0116 240 8740
www.custodianreit.com

100% UK

Contact details

Penman Way
Grove Park
Enderby
Leicester LE19 1SY
0116 240 8740
www.custodianreit.com

Revenue by geography

100% UK

Leadership team

Chairman of Custodian REIT: David Hunter

Managing director of Custodian Capital: Richard Shepherd-Cross

David Hunter is an international property consultant, specialising in supporting the creation, operation and liquidation of property funds and companies. He is chairman of a UK-based real estate debt fund manager and also has corporate advisory roles in the UK and France. He was managing director of Aberdeen Asset Management’s £6.5bn UK and international property fund business from 2001–04. He was president of the British Property Federation in 2004

Richard Shepherd-Cross is the managing director of Custodian Capital and the fund manager of Custodian REIT. He is a chartered surveyor, and a former director of Jones Lang LaSalle in London, where he led the portfolio investment team before joining Mattioli Woods in 2009, where he was responsible for the syndicated property initiative, which was the precursor to CREI. He was instrumental in establishing CREI and raising £55m at IPO.

Non-executive director: Ian Mattioli

Company secretary: Nathan Imlach

Ian Mattioli is the founder director of Custodian REIT and, together with Bob Woods, founded Mattioli Woods, the AIM-listed wealth management and employee benefits business, which is the parent company of Custodian Capital, external fund manager of Custodian REIT. He has more than 30 years’ experience in the financial services industry. Ian is responsible for the vision and operational management of Mattioli Woods and instigated the development of its investment proposition. This included the syndicated property initiative that developed into the seed portfolio for the launch of Custodian REIT.

Nathan Imlach qualified as a chartered accountant with Ernst & Young, specialising in providing mergers and acquisitions advice to a broad range of quoted and unquoted clients in the UK and abroad, latterly as a director and associate of Johnston Carmichael. He is a fellow of the Chartered Institute for Securities & Investment and a member of the Institute of Chartered Accountants in Scotland.

Principal shareholders*

(%)

Mattioli Woods

7.3

BlackRock

3.4

*As disclosed in the 2018 Annual Report. Shareholdings of more than 3%. Ownership incorporates the control of voting rights through acting as a discretionary investment manager on behalf of retail investors holding the beneficial interest.

Companies named in this report

Ediston Real Estate (EPIC), F&C Commercial Property Trust (FCPT), F&C UK Real Estate Investments (FCRE), Picton Property Income (PCTN), Regional REIT (RGL), Schroder REIT (SREI), Standard Life Investment Property Trust (SLI), UK Commercial Property Trust (UKCM)

Edison is an investment research and advisory company, with offices in North America, Europe, the Middle East and AsiaPac. The heart of Edison is our world-renowned equity research platform and deep multi-sector expertise. At Edison Investment Research, our research is widely read by international investors, advisers and stakeholders. Edison Advisors leverages our core research platform to provide differentiated services including investor relations and strategic consulting. Edison is authorised and regulated by the Financial Conduct Authority. Edison Investment Research (NZ) Limited (Edison NZ) is the New Zealand subsidiary of Edison. Edison NZ is registered on the New Zealand Financial Service Providers Register (FSP number 247505) and is registered to provide wholesale and/or generic financial adviser services only. Edison Investment Research Inc (Edison US) is the US subsidiary of Edison and is regulated by the Securities and Exchange Commission. Edison Investment Research Pty Limited (Edison Aus) [46085869] is the Australian subsidiary of Edison. Edison Germany is a branch entity of Edison Investment Research Limited [4794244]. www.edisongroup.com

DISCLAIMER
Copyright 2018 Edison Investment Research Limited. All rights reserved. This report has been commissioned by Custodian REIT and prepared and issued by Edison for publication globally. 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. Opinions contained in this report represent those of the research department of Edison at the time of publication. The securities described in the Investment Research may not be eligible for sale in all jurisdictions or to certain categories of investors. This research is issued in Australia by Edison Investment Research Pty Ltd (Corporate Authorised Representative (1252501) of Myonlineadvisers Pty Ltd (AFSL: 427484)) and any access to it, is intended only for "wholesale clients" within the meaning of the Corporations Act 2001 of Australia. The Investment Research is distributed in the United States by Edison US to major US institutional investors only. Edison US is registered as an investment adviser with the Securities and Exchange Commission. Edison US 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. As such, Edison does not offer or provide personalised advice. We publish information about companies in which we believe our readers may be interested and this information reflects our sincere opinions. The information that we provide or that is derived from our website is not intended to be, and should not be construed in any manner whatsoever as, personalised advice. Also, our website and 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 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. This document is provided 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.
Edison has a restrictive policy relating to personal dealing. 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. Edison or its affiliates may perform services or solicit business from any of the companies mentioned in this report. The value of securities mentioned in this report can fall as well as rise and are subject to large and sudden swings. In addition it may be difficult or not possible to buy, sell or obtain accurate information about the value of securities mentioned in this report. Past performance is not necessarily a guide to future performance. 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. 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 (ie 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. To the maximum extent permitted by law, Edison, its affiliates and contractors, and their respective directors, officers and employees will not be liable for any loss or damage arising as a result of reliance being placed on any of the information contained in this report and do not guarantee the returns on investments in the products discussed in this publication. FTSE International Limited (“FTSE”) © FTSE 2018. “FTSE®” is a trade mark of the London Stock Exchange Group companies and is used by FTSE International Limited under license. All rights in the FTSE indices and/or FTSE ratings vest in FTSE and/or its licensors. Neither FTSE nor its licensors accept any liability for any errors or omissions in the FTSE indices and/or FTSE ratings or underlying data. No further distribution of FTSE Data is permitted without FTSE’s express written consent.

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

295 Madison Avenue, 18th Floor

10017, New York

US

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

295 Madison Avenue, 18th Floor

10017, New York

US

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

Edison is an investment research and advisory company, with offices in North America, Europe, the Middle East and AsiaPac. The heart of Edison is our world-renowned equity research platform and deep multi-sector expertise. At Edison Investment Research, our research is widely read by international investors, advisers and stakeholders. Edison Advisors leverages our core research platform to provide differentiated services including investor relations and strategic consulting. Edison is authorised and regulated by the Financial Conduct Authority. Edison Investment Research (NZ) Limited (Edison NZ) is the New Zealand subsidiary of Edison. Edison NZ is registered on the New Zealand Financial Service Providers Register (FSP number 247505) and is registered to provide wholesale and/or generic financial adviser services only. Edison Investment Research Inc (Edison US) is the US subsidiary of Edison and is regulated by the Securities and Exchange Commission. Edison Investment Research Pty Limited (Edison Aus) [46085869] is the Australian subsidiary of Edison. Edison Germany is a branch entity of Edison Investment Research Limited [4794244]. www.edisongroup.com

DISCLAIMER
Copyright 2018 Edison Investment Research Limited. All rights reserved. This report has been commissioned by Custodian REIT and prepared and issued by Edison for publication globally. 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. Opinions contained in this report represent those of the research department of Edison at the time of publication. The securities described in the Investment Research may not be eligible for sale in all jurisdictions or to certain categories of investors. This research is issued in Australia by Edison Investment Research Pty Ltd (Corporate Authorised Representative (1252501) of Myonlineadvisers Pty Ltd (AFSL: 427484)) and any access to it, is intended only for "wholesale clients" within the meaning of the Corporations Act 2001 of Australia. The Investment Research is distributed in the United States by Edison US to major US institutional investors only. Edison US is registered as an investment adviser with the Securities and Exchange Commission. Edison US 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. As such, Edison does not offer or provide personalised advice. We publish information about companies in which we believe our readers may be interested and this information reflects our sincere opinions. The information that we provide or that is derived from our website is not intended to be, and should not be construed in any manner whatsoever as, personalised advice. Also, our website and 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 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. This document is provided 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.
Edison has a restrictive policy relating to personal dealing. 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. Edison or its affiliates may perform services or solicit business from any of the companies mentioned in this report. The value of securities mentioned in this report can fall as well as rise and are subject to large and sudden swings. In addition it may be difficult or not possible to buy, sell or obtain accurate information about the value of securities mentioned in this report. Past performance is not necessarily a guide to future performance. 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. 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 (ie 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. To the maximum extent permitted by law, Edison, its affiliates and contractors, and their respective directors, officers and employees will not be liable for any loss or damage arising as a result of reliance being placed on any of the information contained in this report and do not guarantee the returns on investments in the products discussed in this publication. FTSE International Limited (“FTSE”) © FTSE 2018. “FTSE®” is a trade mark of the London Stock Exchange Group companies and is used by FTSE International Limited under license. All rights in the FTSE indices and/or FTSE ratings vest in FTSE and/or its licensors. Neither FTSE nor its licensors accept any liability for any errors or omissions in the FTSE indices and/or FTSE ratings or underlying data. No further distribution of FTSE Data is permitted without FTSE’s express written consent.

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

295 Madison Avenue, 18th Floor

10017, New York

US

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

295 Madison Avenue, 18th Floor

10017, New York

US

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

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