Investing for growth

Palace Capital 2 December 2019 Update
Download PDF

Palace Capital

Investing for growth

Interim results

Real estate

2 December 2019

Price

284p

Market cap

£130m

Net debt (£m) at 30 September 2019

94.1

Net LTV at 30 September 2019

34.1%

Shares in issue

46.0m

Free float

95%

Code

PCA

Primary exchange

LSE

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

(0.5)

2.9

(3.6)

Rel (local)

(1.6)

(0.3)

(8.6)

52-week high/low

328p

265p

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

Q2 DPS paid

December 2019

Analyst

Martyn King

+44 (0)20 3077 5745

Palace Capital is a research client of Edison Investment Research Limited

During H120, Palace stepped up its refurbishment and development activity aimed at improving the quality of the portfolio and enhancing its income and valuation potential over the longer term. The flagship Hudson Quarter development is making good progress and the initial tranche of the apartments offered for sale in June has been well received. Although refurbishment and redevelopment activity is dampening current income, DPS is being maintained in anticipation of future income growth and represents an attractive yield.

Year end

Net rental income (£m)

Adj. PBT*
(£m)

Adj. EPS*
(p)

EPRA NAV/
share (p)**

P/NAV
(x)

DPS
(p)

Yield
(%)

03/19

16.4

8.9

17.3

407

0.70

19.0

6.7

03/20e

18.3

8.0

16.7

391

0.73

19.0

6.7

03/21e

15.7

8.1

17.6

412

0.69

19.0

6.7

03/22e

16.8

9.0

19.5

416

0.68

19.0

6.7

Note: *Adjusted earnings – in addition to EPRA adjustments for revaluation gains, profits or losses on disposals of investment properties and surrender gains on early lease terminations, this adjusts for share-based payments and Main Market listing costs. **EPRA NAV is fully diluted.

Robust H120

The property portfolio produced an ungeared total return of 1.5% in H120 compared with 0.8% for the MSCI Quarterly Benchmark Index, benefiting from a focus on regional office and industrial assets. The Hudson Quarter (HQ) development remains on track and on budget and, after initial marketing of 20 apartments in June, 21 apartments have been sold with another seven under offer. Refurbishment and redevelopment are dampening current income and recurring earnings, but adjusted net earnings increased to £3.9m (H119: £3.6m) due to post-REIT conversion tax benefits. With capex yet to be reflected in property valuation EPRA NAV fell 3.9% to 391p. Gearing remained moderate at 34%. Mainly reflecting refurbishment plans our forecasts are reduced slightly (see page 7).

Significant income and value potential

End-H120 estimated rental value (ERV) of £21.2m pa, before the c £0.9m rent potential expected from the HQ commercial assets, is 30% ahead of passing rent of £16.3m pa. This represents a significant opportunity to increase recurring income and underpins the continuation of attractive dividend distributions. Relatively little of this income and value opportunity is reflected in our forecasts although we do include c £10m in development gains in respect of HQ. Similarly not factored into our forecasts, management continues to seek accretive acquisitions for which borrowing headroom exists.

Valuation: Attractive yield and discount to NAV

The dividend yield is attractive, more than 6%, and management has committed to the current level of DPS despite a near-term earnings cover shortfall. The discount to EPRA NAV is c 27%. Asset management initiatives to capture reversionary potential and progress with Hudson Quarter are potential triggers for a re-rating.

Investing for future growth

During H120, Palace stepped up its refurbishment and development activity aimed at improving the quality of the portfolio, and enhancing its income and valuation potential over the longer term. The flagship Hudson Quarter development is making good progress and the initial tranche of the apartments offered for sale in June has been well received. The necessary increase in vacancy has dampened recurring income in the period, while capex is yet to be fully reflected in property revaluation. However, DPS has been maintained in anticipation of the future income growth that management expects and the solid financial position. Reported earnings included significant lease surrender income as well as positive current and deferred tax effects resulting from REIT conversion.

Exhibit 1: Summary of H120 financials

H120

H119

H120/ H119

FY19

£m unless stated otherwise

IFRS

Adj.

Adj. earnings

IFRS

Adj.

Adj. earnings

Adj. earnings

IFRS

Adj.

Adj. earnings

Rental & other income

11.9

(2.9)

9.1

9.2

0.0

9.2

18.8

18.8

Non-recoverable property costs

(1.2)

(1.2)

(1.1)

(1.1)

(2.3)

(2.3)

Net rental income

10.7

(2.9)

7.9

8.1

0.0

8.1

-3.2%

16.4

0.0

16.4

Dividend on listed equity investment

0.1

0.1

0.0

0.0

0.0

0.0

Share based payments

(0.1)

0.1

0.0

(0.1)

0.1

0.0

(0.3)

0.3

0.0

Other administrative expenses

(2.1)

(2.1)

(1.9)

(1.9)

10.9%

(3.8)

(3.8)

Operating profit before gains/(losses) on property assets

8.6

(2.8)

5.8

6.1

0.1

6.2

-6.6%

12.4

0.3

12.7

Unrealised gains/(loss) on revaluation of investment properties

(6.2)

6.2

0.0

3.9

(3.9)

0.0

(0.4)

0.4

0.0

Profit/(loss) on disposal of investment properties

(0.3)

0.3

0.0

0.2

(0.2)

0.0

(0.7)

0.7

0.0

Impairment of trading properties

(0.3)

0.3

0.0

0.0

0.0

Unrealised gain/(loss) on listed investments

0.1

(0.1)

0.0

0.0

0.0

0.0

(0.2)

0.2

0.0

Operating profit

1.9

3.9

5.8

10.2

(4.0)

6.2

-6.6%

11.1

1.6

12.7

Net finance costs

(2.4)

0.5

(1.9)

(1.9)

0.0

(1.9)

-2.1%

(3.7)

(3.7)

Change in value of interest rate derivatives

(0.7)

0.7

0.0

0.1

(0.1)

0.0

(0.9)

0.9

0.0

Profit before tax

(1.2)

5.1

3.9

8.3

(4.1)

4.3

-8.6%

6.4

2.5

8.9

Taxation

3.7

(3.7)

0.0

(1.1)

0.4

(0.6)

(1.3)

0.2

(1.0)

Profit after tax

2.6

1.4

3.9

7.3

(3.6)

3.6

7.4%

5.2

2.8

7.9

OTHER DATA

Basic EPS (p)

5.6

15.9

11.3

Fully diluted EPRA EPS (p)*

14.5

7.7

87.7%

16.5

Fully diluted adjusted EPS (p)

8.5

8.0

6.8%

17.3

DPS (p)

9.5

9.5

0.0%

19.0

EPRA NAV per share (p)

391

421

-7.2%

407

EPRA NAV total return

-1.4%

4.0%

2.8%

Fair value of investment properties

275.8

261.6

286.3

Net debt

94.1

85.4

96.5

Net LTV

34.1%

30.3%

33.7%

Source: Palace Capital data, Edison Investment Research

The key highlights of the H120 results were:

The property portfolio produced an ungeared total return of 1.5% compared with 0.8% for the MSCI Quarterly Benchmark Index, benefiting from a focus on regional office and industrial assets.

On an IFRS basis, net rental income included £2.9m of previously disclosed non-recurring lease surrender income. Excluding this, rental income was marginally lower, reflecting the current focus on strategic refurbishment and development. On an EPRA basis, occupancy was 84% at the end of the period compared with 87% at end-FY19.

Adjusted profit before tax (excluding realised and unrealised valuation movements, share-based payments and non-recurring items, including the lease surrender premium) was £3.9m (H119: £4.3m). As a result of REIT conversion, the tax charge has fallen away, and post-tax adjusted earnings were also £3.9m but ahead of H119 (£3.6m). Adjusted EPS was 8.5p and covered DPS (unchanged at 9.5p) by c 90%.

Negative property revaluation was driven by the impact of the lease surrender on the carried value of the short leasehold asset value and the lack of recognition of refurbishment and redevelopment capex in the property valuation. This typically comes through with a lag as the projects complete and refurbished and developed space is re-let or sold. As a result, EPRA NAV per share reduced 3.9% to 391p compared with 407p at end-FY19.

IFRS earnings and IFRS NAV benefited from the post-REIT conversion elimination of £3.7m of deferred tax liabilities in respect of unrealised property revaluation gains (EPRA NAV had previously adjusted for this).

Gearing remained moderate, with a c 34% net LTV. The company had c £46m of undrawn debt facilities comprising the £26.5m development loan that will be used to fund continuing building costs at Hudson Quarter, and a £20m flexible revolving credit facility.

In a confident outlook statement management reiterates its confidence that the core income-producing properties, together with the development and refurbishment pipeline, including the ongoing progress at Hudson Quarter, will generate increasing income and significant value for shareholders over the long term.

Portfolio update

Palace’s property portfolio performance continues to benefit from its sector positioning. The 1.5% property total return in H120 was ahead of the MSCI Quarterly Benchmark Index return of 0.8% and the Palace portfolio has now outperformed the index over three successive years. The portfolio also contains significant opportunities to enhance income and capital values, in many cases supported by identified asset management initiatives.

The Palace property portfolio was externally valued at £275.8m at 30 September 2019. This included an income-generating investment portfolio of 55 commercial assets (plus two car park assets) and the Hudson Quarter development asset, split on the balance sheet between investment properties under development (the office and other commercial) and trading properties (the residential space that will be sold). The balance sheet value differs slightly from the external valuation, primarily due to lease incentive and other adjustments. The standing commercial assets had a gross annualised contracted rental income of £16.3m with a weighted average unexpired lease term (WAULT) of 5.2 years to first break. On an EPRA basis, occupancy was 84%. The ERV of the portfolio of £21.2m represents a significant income opportunity, discussed below, and is expected to increase to c £22.2m on completion of the Hudson Quarter commercial space.

Exhibit 2: Portfolio summary

£m unless otherwise stated

30 September 2019

31 March 2019

H120

FY19

Property valuation

275.8

286.3

Number of commercial properties*

55

59

Commercial GLA** (million square feet)

1.7

1.7

Contractual rental income

16.3

17.7

Net rental income

14.8

15.8

ERV (excluding Hudson Quarter)

21.2

22.4

WAULT (to first break)

5.2 years

4.5 years

EPRA occupancy rate

84%

87%

Source: Palace Capital. Note: *In addition there are two car parks. **GLA is gross lettable area.

Overweight in industrial and office assets

Although Palace is sector-agnostic in terms of its approach to asset selection, it nevertheless maintains a diversified portfolio by both sector and location. The portfolio is regional (ie not central London) and 62% (by value) is invested in offices and industrial assets, which continue to drive overall returns. The tenant base is also diversified in number and industry exposure, providing income security. The largest tenant (Vue) accounts for c £0.9m of contracted rents and the top 20 tenants account for c 45%.

The largest sector exposure is to regional offices (48% by value) where growing tenant demand, including relocations away from London and limited new supply including conversion of office space to residential have all contributed to a generally positive demand-supply balance and continuing rental growth. Industrial property (14% by value) has similarly benefited from firm occupier demand, limited new supply and rental growth. The leisure portfolio comprises two large leisure assets, in Halifax and Northampton, accounting for 15% of the portfolio by value. The leisure sector has faced similar challenges to the retail sector, although recent letting success at Northampton has taken occupancy to 89% and management says interest in the remaining space is strong. The retail portfolio includes a number of strong tenants (eg Aldi on a secure and recently extended long lease) and has no exposure to problem areas like mid-market fashion or department stores.

Exhibit 3: Sector split by value

Exhibit 4: Geographic split by value

Source: Palace Capital, 30 September 2019

Source: Palace Capital, 30 September 2019

Exhibit 3: Sector split by value

Source: Palace Capital, 30 September 2019

Exhibit 4: Geographic split by value

Source: Palace Capital, 30 September 2019

Portfolio activity

Palace invested £9.7m in H120 in refurbishment capex (£3.5m) and development spending (£6.2m). Acquisitions were sought, but none that met the group’s strict acquisition criteria was identified. Disposals amounted to £13.2m, including the £11.5m sales of the remaining non-core residential units acquired with RT Warren and a small non-core commercial asset (Rathbone House, Weybridge). Palace continues to look for suitable, accretive acquisition opportunities and also plans further non-core disposals in H220. The company has identified four non-core assets and management estimates that disposal will increase the remaining portfolio occupancy by 3pp to 87%, reduce non-recoverable property costs by c £0.5m pa, and generate c £2.75m of equity for reinvestment.

During H120, 12 lease renewals and five rent reviews were completed at an average of 3% above ERV, with a 25% uplift on previous rents, and creating c £0.4m of additional annual rental income. Nine lease reviews provided an additional £0.5m of annual income.

The reduction in H120 occupancy (EPRA basis) from 87% at end-FY19 to 84% additionally reflects the previously announced lease surrender at Priory House Birmingham (c £0.3m of annual rent) and other lease expiries. Palace says it has tactically reserved some of this freed space for refurbishment or redevelopment and in some instances the space has been let on a short-term basis.

Significant asset management opportunities

Significant opportunities exist in the current portfolio. The ERV of £21.2m is c 30% or £4.9m ahead of the end-H120 passing rent of £16.3m. Around £4.5m of the reversionary potential is within the regional office portfolio and £2.8m of this represents the upside from reducing voids.

Exhibit 5: Portfolio income opportunity to full occupancy estimated rental value (ERV)

Source: Palace Capital

The company continues to target void reduction alongside the programme of refurbishment and development opportunities that have been identified in the asset management plans of each individual property. These will be phased in over a number of years providing counter-cyclical opportunities to add value to the portfolio. Exhibit 6 provides a summary of the main upside opportunities. It is not possible to model all of these on an individual basis although, given its significance, we include detailed forecasts for Hudson Quarter within our overall group estimates.

Exhibit 6: Future upside within the portfolio

Source: Palace Capital

Hudson House progressing and well received

We expect the Hudson Quarter development to be a key driver of income growth and value creation during the forecast period. We expect the fully let income benefit from the retained commercial assets (c £0.9m pa) at completion to make an important contribution to rental income, and our forecast development gain of c £10m adds more than 20p per share to NAV. For details of our Hudson Quarter forecast, please see our outlook note published on 15 July.

Hudson Quarter occupies a two-acre site in York, within the city walls and just a minute’s walk from the York railway station. The scheme comprises three residential buildings and a commercial building. The 127 flats will be sold and the commercial development, comprising 35,000 sq ft of grade A offices and 5,000 sq ft of other commercial space and car parking, will be retained for income. Building work commenced in February 2019 and is expected to take around two years, with completion scheduled for January 2021. Management says that it is well ahead of the business plan and that marketing of the residential assets has been well received. An initial tranche of 20 apartments was offered for sale in June and demand has been such that pre-sales have been contracted on 21 apartments with another seven under offer. The York office market is strong and with the Hudson Quarter office development being the first within the city walls for more than a decade, the company anticipates strong interest from potential tenants with a view to pre-letting ahead of completion.

The commercial property market remains polarised

Amid some slowing of UK economic growth and continuing Brexit-related uncertainty, the UK commercial property market as a whole has entered a period of increased uncertainty, with sector performance remaining highly polarised. The industrial, warehouse and logistics sectors in particular, and also the office sector, are continuing to deliver positive returns, while the retail sector continues to suffer from weak occupational demand and the impact of CVAs and defaults, reflected in softer rental and capital values. Regional office returns continue to outperform central London office returns as they have done in every year since 2016. Research by Avison Young indicates that take-up of office space across the big nine regional office markets continued to be above the long-term average through Q219 and that against a backdrop of limited supply this has continued to put upward pressure on rents.

Looking forward, the most recent quarterly market forecasts by the Investment Property Forum (IPF, canvassing a group of fund managers and surveyors under the IPF Research Programme) were published in September and point to a deterioration in expectations for capital growth over the past quarter. This is focused on the retail sector, where the expectation of capital value decline has increased but also includes industrial, where expectations of capital value growth have been tempered. The consensus expectation for overall total property return remains positive despite weakness in retail.

Exhibit 7: Summary of IPF market consensus

Rental growth value (%)

Capital value growth (%)

Total return (%)

2019

2020

2021

2019/23

2019

2020

2021

2019/23

2019

2020

2021

2019/23

Office

0.8

0.6

1.3

1.3

(1.1)

(1.1)

0.5

0.2

2.9

3.1

4.9

4.6

Industrial

3.0

2.0

1.7

2.0

2.1

1.1

1.5

1.5

6.6

5.7

6.1

6.1

Standard retail

(3.1)

(2.1)

(0.9)

(1.2)

(8.1)

(4.4)

(1.4)

(2.7)

(3.9)

0.1

3.3

1.9

Shopping centre

(4.7)

(3.3)

(1.8)

(2.3)

(13.8)

(7.2)

(3.7)

(5.7)

(8.8)

(1.5)

2.3

0.0

Retail warehouse

(3.8)

(2.5)

(1.0)

(1.5)

(10.8)

(5.7)

(1.9)

(3.9)

(5.2)

0.5

4.6

2.4

All property

(0.2)

0.1

0.6

0.5

(3.6)

(1.8)

(0.2)

(0.8)

0.9

2.9

4.7

4.0

Change since spring forecast

Rental growth value (%)

Capital value growth (%)

Total return (%)

2019

2020

2021

2019/23

2019

2020

2021

2019/23

2019

2020

2021

2019/23

Office

0.4

0.3

0.2

0.2

0.6

0.2

0.6

0.5

0.5

0.0

0.6

0.5

Industrial

0.0

(0.2)

(0.1)

(0.1)

(0.5)

0.1

1.0

0.5

(0.6)

0.0

0.9

0.4

Standard retail

(0.3)

(0.4)

(0.3)

(0.4)

(0.7)

0.1

(0.1)

(0.2)

(0.7)

0.1

(0.1)

(0.2)

Shopping centre

(0.8)

(0.7)

(0.5)

(0.6)

(3.1)

(1.0)

(0.6)

(1.1)

(3.0)

(0.8)

(0.4)

(1.0)

Retail warehouse

(0.7)

(0.4)

(0.1)

(0.5)

(1.9)

(0.8)

0.1

(0.7)

(2.0)

(0.7)

0.2

(0.6)

All property

0.0

0.0

0.0

(0.1)

(0.8)

(0.1)

0.3

0.0

(0.9)

(0.2)

0.3

0.0

Source: Investment Property Forum (IPF) UK consensus forecasts

We present the market consensus data as a guide to expected overall market direction and returns but would caution against a direct read across to Palace’s, or any other, portfolio. The market consensus is formed of a wide range of differing expectations and, at the individual portfolio level, much depends on the performance of individual assets as well as the timing and effectiveness of asset management initiatives. For Palace, we expect the Hudson Quarter development to be a significant driver of return over the next two years.

Financials

Our forecasts are based on an unchanged portfolio, although management continues to seek accretive acquisitions and, as discussed above, has also highlighted non-core asset disposals that it expects will generate gross proceeds of c £2.75m in H220. Forecast rental income is slightly reduced, reflecting the ongoing refurbishment plans and additional deferment of income/higher void rate at H120. We have also increased our forecast for administrative costs, partly offset by lower net finance costs (lower debt).

Exhibit 8: Estimate revisions

Net rental income (£m)

Adjusted PBT (£m)

Adjusted EPS* (p)

EPRA NAV* (p)

DPS (p)

Old

New

Chg (%)

Old

New

Chg (%)

Old

New

Chg (%)

Old

New

Chg (%)

Old

New

Chg (%)

03/20e

18.6

18.3

(2.0)

8.2

8.0

(2.5)

17.1

16.7

(2.4)

411

391

(4.8)

19.0

19.0

0.0

03/21e

16.1

15.7

(2.1)

8.4

8.1

(2.7)

18.2

17.6

(3.1)

432

412

(4.4)

19.0

19.0

0.0

03/22e

17.0

16.8

(1.4)

9.0

9.0

(0.7)

19.7

19.5

(1.0)

435

416

(4.6)

19.0

19.0

0.0

Source: Edison Investment Research. Note: *Adjusted EPS and EPRA NAV are both fully diluted.

Key forecasting assumptions

Our forecasts are based on an unchanged portfolio, although management continues to seek accretive acquisitions and, as discussed above, has also highlighted non-core asset disposals that it expects will generate gross proceeds of c £2.75m in H220.

The increase in recurring earnings that we forecast is driven by our expectation of growth in passing rent from £16.3m at end-H120 (£17.7m at end-FY19) to £18.6m by end-FY22. We had previously forecast end-FY22 passing rent of £19.2m and the reduction reflects lower assumed occupancy. We had previously assumed that like-for-like occupancy would rise from 87% at end-FY19 to 91.5% at end-FY22 but, with H120 occupancy lower at 84%, we now assume an increase to 90% by FY22. We continue to assume reversionary rental growth of c 0.5% pa and a contribution of c £0.9m pa from FY22 in respect of the Hudson Quarter commercial assets. Given management’s focus on void reduction and continuing rental growth in regional offices, our assumptions may prove conservative. Non-recoverable property costs are assumed to increase slightly in FY20 and then drop modestly with void reduction.

We have increased our forecasts for administrative expenses in line with H120. H120 included some undisclosed REIT conversion costs and we also note that Palace has recently strengthened its property management team. We now look for £3.9m (before share-based payment costs) in FY20 (previously £3.4m), falling to £3.7m in FY21 (£3.5m previously) as FY20 one-off costs fall away.

Our forecast for underlying net finance costs is reduced, although FY20 IFRS costs include the H120 c £0.7m of negative derivative fair value movements and c £0.5m of debt termination costs. These non-recurring costs are excluded from adjusted earnings. The reduction in underlying net interest cost is driven by lower average debt.

We expect accounting earnings and NAV to benefit from modest underlying revaluation gains, in line with achieved rental growth, adding an aggregate c £3.2m from the beginning of H220 through to end-FY22 (c 7p per share), with a more significant impact from the development profits that we forecast in respect of Hudson Quarter (c £10.2m or 22p per share) in FY22.

Funding and debt

End-H120 gross outstanding debt was £108.1m (including unamortised debt facility fees) and the cash balance was £14.0m. Net debt of £94.1m represented a net loan to value ratio (LTV) of 34.1%, within the company’s target range of 30–40%.

The debt was well spread across lenders with an average cost of 3.2% and an average maturity of 4.5 years. 63% of the debt was either fixed rate or hedged to mitigate interest rate risk. Undrawn facilities amounted to £46.5m comprising the £26.5m Barclays Bank development facility arranged to substantially fund the Hudson Quarter construction costs and a £20.0m revolving credit facility.

In our forecasts we do anticipate the need for further debt facilities but expect the development facility to be fully drawn during FY21, ahead of completion. We forecast the net LTV to peak at around 40% (net debt to peak at c £134m and gross debt at c £140m) as the Hudson Quarter nears completion and to then decline to c 30% as the residential asset sales complete.

This analysis suggests there is scope for Palace to bring forward acquisitions and/or other asset management and development projects during the period (not in our forecasts), especially as Hudson Quarter construction progresses and the residential pre-sales and commercial pre-letting position becomes clearer.

Valuation

Palace’s total return strategy has generated cumulative EPRA NAV total returns of 123.8% measured since the end of H114, or a compound annual average return of 15.8%.

Exhibit 9: NAV total return track record

H214

FY15

FY16

FY17

FY18

FY19

Cumulative return H214–FY19

Opening EPRA NAVPS

218

341

388

414

443

414

218

Closing NAVPS

341

388

414

443

414

407

407

Dividend per share paid

2.5

8.50

14.00

18.00

19.00

19.00

81

Income return (%)

1.1%

2.5%

3.6%

4.3%

4.3%

4.6%

37.2%

Capital return (%)

56.6%

13.5%

6.9%

6.9%

-6.4%

-1.8%

86.7%

NAV total return (%)

57.8%

16.0%

10.5%

11.2%

-2.1%

2.8%

123.8%

Average annual compound return

15.8%

Source: Palace Capital data, Edison Investment Research

As discussed above, we believe that our forward-looking estimates have been struck cautiously, reflecting a less benign external market environment than has been experienced over the past five years, while assuming a relatively modest capture of the upside potential within the portfolio. Total return was a negative 1.4% in H120, reflecting the reduction in EPRA NAV per share during the period, primarily as a result of capital expenditure not being fully reflected in valuation. As refurbished space is leased at completion, we would expect some catch-up and, over the forecast period as a whole (FY20–22), our estimates imply a cumulative total return of 16.1% or an annual average compound return of 5.1%. There remains considerable scope for Palace to do better than this if market conditions remain favourable, and it is successful in continuing to let remaining vacant refurbished space and capturing reversionary potential through lease renewals. Management also continues to seek accretive acquisitions, which are similarly not reflected in our forecasts. Almost 90% of our forecast return comes from DPS payments and we expect these to be fully covered by earnings in FY22 following a full year, post-completion contribution from the Hudson Quarter development. Even on what we believe to be a cautious basis of forecasting, there remains a material uplift compared with risk-free returns (the 10-year UK gilt yield is c 0.7%).

Exhibit 10: Peer comparison

Price
(p)

Market cap (£m)

P/NAV*
(x)

Yield**
(%)

Share price performance

1 month

3 months

12 months

From 12M high

Circle Property

205

58

0.74

3.1

2%

8%

3%

0%

Custodian

114

471

1.10

5.8

-1%

-2%

-1%

-5%

Picton

93

507

0.98

3.8

3%

7%

11%

-8%

Real Estate Investors

53

99

0.77

7.0

-2%

0%

-4%

-9%

Regional REIT

108

466

0.94

7.5

2%

3%

9%

-2%

Schroder REIT

54

280

0.79

4.8

-3%

2%

-2%

-9%

UK Commercial Property Trust

88

1140

0.97

4.2

1%

7%

7%

-6%

BMO Commercial Property Trust

119

948

0.89

5.1

1%

8%

-12%

-13%

BMO Real Estate Investments

86

206

0.82

5.8

0%

1%

-3%

-14%

Average

0.89

5.2

1%

4%

1%

-7%

Palace Capital

284

131

0.73

6.7

-6%

3%

-4%

-14%

UK property index

1,872

3.6

3%

14%

16%

-1%

FTSE All-Share Index

4,067

4.7

1%

2%

6%

-3%

Source: Company data, Refinitiv. Note: Prices at 29 November 2019. *Based on last reported EPRA NAV per share. **Based on trailing 12-month DPS declared.

In Exhibit 10, we show a summary performance and valuation comparison of Palace and a peer group of UK commercial real estate investment companies with a strong regional focus. Reflecting the balance sheet liquidity and a comfortable level of gearing, and the expectation of future recurring income growth, Palace has maintained its attractive dividend payout, which represents a yield of 6.7%, above the average for the peer group. The discount to NAV at which Palace shares trade (27%) is also noticeably larger than for the peer group average (c 11%). Within the peer group, the companies with the higher P/NAVs tend to be REITs with a strong focus on income returns (in contrast to Palace’s total return strategy) and we believe that this higher rating results from investors’ continuing search for sustainable income, and perhaps due to concerns about the maturity of the economic and commercial property cycle. REIT conversion may well underline Palace’s strong commitment to attractive dividends, while investing to grow the portfolio and enhance capital values. Given the strong track record of total return generation and the potential to drive further returns from the existing portfolio, the Palace valuation continues to appear undemanding.

Exhibit 11: Financial summary

Year end 31 March (£000s)

2017

2018

2019

2020e

2021e

2022e

PROFIT & LOSS

Rental & other income

14,266

16,733

18,750

20,722

18,074

19,056

Non-recoverable property costs

(2,055)

(1,824)

(2,318)

(2,464)

(2,350)

(2,250)

Net rental income

12,211

14,909

16,432

18,258

15,724

16,806

Dividend income from listed equity investments

43

53

0

0

Administrative expenses before share-based payments

(2,678)

(4,011)

(3,790)

(3,943)

(3,700)

(3,820)

Share-based payments

(237)

(174)

(332)

(250)

(300)

(300)

Operating Profit (before capital items)

9,296

10,724

12,353

14,118

11,724

12,686

Revaluation of investment properties

3,101

5,738

(382)

(5,552)

11,532

1,317

Gains/(losses) on disposals

3,191

274

(652)

(24)

0

0

Loss on revaluation of listed equity investments

(214)

101

0

0

Operating Profit

15,588

16,736

11,105

8,643

23,256

14,003

Net finance expense

(3,011)

(3,432)

(4,672)

(4,996)

(3,899)

(4,019)

Profit Before Tax

12,577

13,304

6,433

3,648

19,357

9,984

Taxation

(3,191)

(773)

(1,263)

3,729

0

0

Profit After Tax (FRS 3)

9,386

12,531

5,170

7,377

19,357

9,984

EPRA adjustments:

Revaluation of investment properties

(3,101)

(5,738)

382

5,857

(11,532)

(1,317)

Gains/(losses) on disposals

(3,191)

(274)

652

24

0

0

Deferred tax charge

2,200

(299)

243

0

0

0

Other adjustments

155

308

1,143

1,063

0

0

EPRA earnings

5,449

6,528

7,590

14,320

7,825

8,667

Adjusted for:

Non-recurring items

0

698

0

(2,850)

0

0

Share-based payments

237

174

332

250

300

300

Adjusted earnings

5,686

7,400

7,922

11,720

8,125

8,967

Company adjusted PBT

6,677

8,472

8,942

7,991

8,125

8,967

Average fully diluted number of shares outstanding (000s)

25,738

34,980

45,898

46,020

46,069

46,069

Basic EPS - FRS 3 (p)

36.5

35.8

11.3

14.8

42.0

21.7

Fully diluted EPRA EPS (p)

21.2

18.7

16.5

22.4

17.0

18.8

Fully diluted adjusted EPS (p)

22.2

21.2

17.3

16.7

17.6

19.5

Dividend per share declared (p)

18.5

19.0

19.0

19.0

19.0

19.0

EPRA dividend cover (x)

1.14

0.98

0.87

1.18

0.89

0.99

BALANCE SHEET

Fixed Assets

183,959

253,984

261,064

266,691

279,194

284,511

Investment properties

183,916

253,863

258,331

263,139

275,642

280,959

Goodwill

0

0

0

0

0

0

Other non-current assets

43

121

2,733

3,552

3,552

3,552

Current Assets

13,692

46,292

55,256

40,136

63,354

29,781

Trading properties

0

0

14,367

27,137

52,250

0

Assets held for sale

0

21,708

11,756

0

0

0

Cash

11,181

19,033

22,890

7,710

5,540

23,761

Other current assets

2,511

5,551

6,243

5,288

5,564

6,021

Current Liabilities

(8,197)

(11,520)

(16,000)

(9,158)

(13,169)

(9,577)

Creditors

(6,161)

(8,834)

(10,001)

(7,322)

(11,333)

(7,741)

Short term borrowings

(2,036)

(2,686)

(5,999)

(1,836)

(1,836)

(1,836)

Long Term Liabilities

(79,895)

(105,457)

(119,997)

(119,005)

(139,905)

(113,805)

Long term borrowings

(75,758)

(97,157)

(112,017)

(115,226)

(137,126)

(111,026)

Deferred tax

(2,187)

(6,531)

(5,580)

(204)

796

796

Other long-term liabilities

(1,950)

(1,769)

(2,400)

(3,575)

(3,575)

(3,575)

Net Assets

109,559

183,299

180,323

178,664

189,474

190,911

EPRA net assets

111,759

190,011

186,968

180,203

190,013

191,450

Basic NAV/share (p)

436

400

393

388

412

415

Diluted EPRA NAV/share (p)

443

414

407

391

412

416

CASH FLOW

Operating Cash Flow

10,294

9,899

11,920

12,551

15,661

8,836

Net Interest

(2,516)

(2,704)

(3,385)

(3,946)

(4,379)

(3,619)

Tax

(1,047)

(395)

(1,639)

(1,554)

(1,000)

0

Net cash from investing activities

(3,352)

(67,725)

(11,560)

(12,241)

(25,204)

48,250

Ordinary dividends paid

(4,617)

(6,744)

(8,718)

(8,737)

(8,747)

(8,747)

Debt drawn/(repaid)

6,467

8,151

17,954

(1,246)

21,500

(26,500)

Proceeds from shares issued

29

70,000

0

0

0

0

Other cash flow from financing activities

(2,897)

(3,434)

(162)

(627)

0

0

Net Cash Flow

2,361

7,048

4,410

(15,800)

(2,170)

18,220

Opening balance sheet cash

8,576

10,937

17,985

22,395

6,595

4,426

Restricted cash

244

1,048

495

1,115

1,115

1,115

Other items (including cash assumed on acquisition)

0

0

0

0

0

0

Closing balance sheet cash

11,181

19,033

22,890

7,710

5,541

23,761

Closing balance sheet debt

77,794

99,843

118,016

117,062

138,962

112,862

Unamortised debt costs

936

1,552

1,334

1,041

641

241

Closing net debt/(cash)

67,549

82,362

96,460

110,393

134,062

89,342

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

36.9%

29.8%

33.7%

37.8%

40.7%

31.6%

Source: Palace Capital 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.

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 2019 Edison Investment Research Limited (Edison). All rights reserved FTSE International Limited (“FTSE”) © FTSE 2019. “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.

Australia

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

1,185 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

1,185 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 2019 Edison Investment Research Limited (Edison). All rights reserved FTSE International Limited (“FTSE”) © FTSE 2019. “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.

Australia

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

1,185 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

1,185 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

Share this with friends and colleagues