NAV-accretive disposals

Palace Capital 28 February 2017 Update

Palace Capital

NAV-accretive disposals

Disposals of assets

Real estate

28 February 2017

Price

352p

Market cap

£90m

Net debt (£m) at 30 September 2016

73.5

Shares in issue

25.7m

Free float

94%

Code

PCA

Primary exchange

AIM

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

(1.4)

(0.7)

6.0

Rel (local)

(2.6)

(6.4)

(10.2)

52-week high/low

375.0p

307.5p

Business description

Palace Capital is an AIM-quoted property investment company focused on commercial real estate in the UK outside London. The portfolio is diverse, with the largest weighting in offices. Management aims to increase capital value and provide a sustainable and growing income stream.

Next events

Financial year end

31 March 2017

FY17 results

June 2017

Analysts

Julian Roberts

+44 (0)20 3077 5748

Andrew Mitchell

+44 (0)20 3681 2500

Mark Cartlich

+44 (0)20 3077 5700

Palace Capital is a research client of Edison Investment Research Limited

Palace Capital (Palace) has announced the disposals of two properties: one in Leeds and one in Stockport. The rationale for each is clear and in line with the company’s strategy to deliver shareholder value through capital and income growth. The disposals, totalling £3.7m, will crystallise value from active asset management, free capital to be recycled, increase the portfolio’s average unexpired lease term to first break and reduce void costs. We have adjusted our forecasts accordingly and expect Palace will reinvest the proceeds in other regional property assets in due course.

Year end

Revenue
(£m)

Adjusted EPRA earnings* (£m)

Adjusted EPRA EPS (p)

EPRA NAV/share (x)

DPS
(p)

Yield
(%)

03/15

8.6

4.8

28.3

396

13.0

3.7

03/16

14.6

4.6

18.9

414

16.0

4.5

03/17e

14.0

5.5

21.8

424

18.0

5.1

03/18e

13.7

5.7

22.2

428

18.0

5.1

03/19e

13.4

6.1

23.6

433

18.0

5.1

Note: *Adjusted EPRA earnings exclude revaluation gains, profits or losses on disposals of investment properties and surrender on early lease terminations.

One disposal increases value…

The sale of the long leasehold at Warwick House in Leeds for £2.15m is well above the carrying value of £1.4m, representing a 54% gain before expenses. The tenant, Interserve, pays rent of £196.3k a year, or £172.5k after ground rent due to the freeholder, Leeds City Council, and has an option to break the lease in August 2017. Palace has been able to reduce the risk of vacancy and make a disposal well above the price paid when the property was bought from Quintain in 2013 as part of the Sequel portfolio. The uplift to the carrying value is significant and shows Palace’s ability to generate capital value growth through active asset management.

…the other reduces costs

Allen House in Stockport was also bought as part of the Sequel portfolio and has been vacant since the occupier surrendered the lease in September 2015. The price of the sale (£1.55m) is slightly above the most recent valuation, but perhaps more significantly, it removes the c £185k of annual vacancy costs associated with the building. Palace has previously stated it intended to sell the property and the effect of the sale was included in our earlier forecast assumptions. The disposal frees capital for reinvestment, as does Warwick House, and is another example of the effective implementation of Palace’s strategy.

Valuation: Still at a discount to peers

Palace’s c 18% discount to our FY17 EPRA NAV forecast seems high compared with a basket of regional property investor peers, which trade at c 98% of EPRA NAV on average. As the announcements demonstrate, Palace can deliver capital value growth as well as pay a dividend yield of c 5%, comparable to REIT peers, underpinned by stable income from its portfolio. As Palace extends its track record, its investor audience is likely to broaden and the discount may narrow.

Details of the disposals and their effect on forecasts

The announced disposals of assets in Stockport and Leeds, acquired from Quintain in 2013 as part of the Sequel portfolio, are in line with Palace’s active approach to asset management and we expect them to be NAV accretive. Exhibit 1 shows details of each disposal.

Exhibit 1: Disposals

Property name

Location

Sector

Size (sqft)

Book value (£m)

Sale price (£m)

Net rent (£000s)

Buyer

Warwick House

Leeds

Office

14,818

1.40

2.15

172.5

Private group

Allen House

Stockport

Industrial

68,000

1.55

1.55

(185.0)

Not disclosed

Source: Palace Capital

Warwick House in Leeds has been sold at a premium of 54% to its book value, or £0.75m, equivalent to c 2.9p per share before tax. This gain was not included in our forecasts for FY17 and is equal to half of our estimated valuation uplift in FY18, which we still expect to be generated by gains at Boulton House in Manchester and Solaris House in Milton Keynes (see our initiation note). the attractive price, the lease break coming up in August 2017 and the secondary location of the property motivated the sale. It will allow Palace to crystallise a gain on the property and recycle capital, in line with its investment strategy. The reduction in annual rent is offset by the reduction in void costs from selling Allen House in Stockport. This vacant asset, which the company had previously announced its intention to sell, had annual void costs of c £185k,. This cost reduction was already included in our forecasts, and we have now allowed for the reduction in rent from the disposal of Warwick House. This reduction in rental income reduces forecast EPRA EPS slightly and we have not allowed for any new investment. The changes to our forecasts are set out in Exhibit 2.

Exhibit 2: Estimate changes

Year end

Rental income (£m)

EPRA EPS (p)

EPRA NAV per share (p)

Dividend per share (p)

Old

New

Change
(%)

Old

New

Change
(%)

Old

New

Change
(%)

Old

New

Change
(%)

03/17e

14.0

14.0

0.0

21.2

21.2

0.0

422

424

0.6

18.0

18.0

0

03/18e

13.9

13.7

-0.9

21.8

21.5

-1.5

426

428

0.4

18.0

18.0

0

03/19e

13.6

13.4

-1.2

23.3

22.9

-1.9

431

433

0.5

18.0

18.0

0

Source: Edison Investment Research

We note that management’s strategy is to recycle capital, so we expect the proceeds of the disposals to be reinvested in income-producing assets. If all £3.7m of sale proceeds were reinvested at a yield of 7% and assuming purchaser’s costs of 6%, they would generate a rental income of c £240k. If the funds were invested in the middle of FY18, our model indicates they would feed through to EPRA EPS of 21.6p per share in FY18 and 23.5p in FY19.

Valuation: NAV accretive and EPS neutral

The disposals are NAV accretive, and we continue to view Palace’s discount to NAV (currently c 18% vs our new FY17 forecast) as high compared with regional peers, which trade at around a 2% discount to stated EPRA NAV on average. This may be because of Palace’s relatively short time as a listed company, and we would expect it to move closer to the peer average as it establishes a longer track record of delivering value and income growth.

Exhibit 3: Financial summary

Year end 31 March

£'000s

2014

2015

2016

2017e

2018e

2019e

IFRS

IFRS

IFRS

IFRS

IFRS

IFRS

PROFIT & LOSS

Revenue

 

 

3,252

8,637

14,593

13,969

13,748

13,436

Cost of Sales

(648)

(1,200)

(1,624)

(2,322)

(1,862)

(1,396)

Gross Profit

2,604

7,437

12,969

11,647

11,887

12,040

Administrative expenses

(649)

(1,439)

(2,048)

(2,511)

(2,615)

(2,079)

Operating Profit before revaluation

1,955

5,998

10,921

9,136

9,272

9,331

Revaluation of investment properties

19,501

9,769

3,620

32

1,500

0

Costs of acquisitions/profits on disposals

270

(461)

(525)

1,623

0

0

Operating Profit

21,725

15,306

14,016

10,791

10,772

9,331

Net Interest

(573)

(1,398)

(2,264)

(2,822)

(2,427)

(2,328)

Profit Before Tax (norm)

1,652

4,139

8,132

7,936

6,845

7,003

Profit Before Tax (FRS 3)

21,153

13,908

11,752

7,968

8,345

7,003

Taxation

81

107

(953)

(951)

(1,252)

(1,050)

Profit After Tax (norm)

1,733

4,246

7,179

6,985

5,593

5,952

Profit After Tax (FRS 3)

21,234

14,015

10,799

7,017

7,093

5,952

EPRA earnings

1,463

4,707

7,704

5,362

5,593

5,952

Adjusted for:

Surrender premium

0

0

(3,172)

0

0

0

Share-based payments

0

114

110

145

100

100

Adjusted EPRA earnings

1,463

4,821

4,642

5,507

5,693

6,052

Average Number of Shares Outstanding (m)

5.3

17.1

24.6

25.7

26.0

26.0

EPS - normalised (p)

 

32.9

24.8

29.2

27.2

21.5

22.9

EPS - FRS 3 (p)

 

403.4

82.0

43.9

27.3

27.2

22.9

Adjusted EPRA EPS (p)

 

29.7

28.3

18.9

21.8

22.2

23.6

EPRA EPS (p)

 

27.8

27.5

31.3

21.2

21.5

22..9

Dividend per share (p)

0.0

13.0

16.0

18.0

18.0

18.0

Dividend cover (x)

N/A

2.12

1.96

1.18

1.19

1.27

BALANCE SHEET

Fixed Assets

 

60,086

104,470

175,738

182,597

184,097

186,097

Investment properties

59,440

102,988

174,542

181,587

183,087

185,087

Goodwill

6

6

0

0

0

0

Other non-current assets

640

1,475

1,196

1,010

1,010

1,010

Current Assets

 

7,060

15,653

11,903

16,220

14,060

11,459

Debtors

1,937

3,375

3,327

3,170

3,170

3,170

Cash

5,123

12,279

8,576

13,050

10,890

8,289

Current Liabilities

 

(4,171)

(3,487)

(9,048)

(11,193)

(11,193)

(11,193)

Creditors

(2,971)

(3,087)

(6,815)

(7,952)

(7,952)

(7952)

Short term borrowings

(1,200)

(400)

(2,233)

(3,241)

(3,241)

(3,241)

Long Term Liabilities

 

(18,599)

(36,620)

(71,778)

(78,774)

(75,538)

(73,502)

Long term borrowings

(17,384)

(35,407)

(69,711)

(76,709)

(73,473)

(71,437)

Other long term liabilities

(1,215)

(1,214)

(2,067)

(2,065)

(2,065)

(2,065)

Net Assets

 

44,376

80,016

106,815

108,850

111,426

112,861

Net Assets excluding goodwill and deferred tax

44,370

80,010

106,815

108,850

111,426

112,861

Basic NAV/share (p)

219

395

414

424

428

433

EPRA NAV/share (p)

219

396

414

424

428

433

CASH FLOW

Operating Cash Flow

 

1,297

4,388

12,287

9,777

9,392

9,451

Net Interest

(390)

(1,593)

(3,421)

(2,529)

(2,427)

(2,328)

Tax

(13)

(15)

(158)

(477)

(1,252)

(1,050)

Preference share dividends paid

(18)

0

0

0

0

0

Net cash from investing activities

2,532

(2,922)

(50,012)

(5,408)

(20)

(2,020)

Ordinary dividends paid

0

(1,766)

(3,221)

(4,617)

(4,617)

(4,617)

Debt drawn/(repaid)

(21,266)

(10,600)

21,272

8,241

(3,236)

(2,036)

Proceeds from shares issued

23,009

19,664

19,114

38

0

0

Other cash flow from financing activities

(66)

(2)

(2)

(551)

0

0

Net Cash Flow

5,085

7,155

(4,141)

4,474

(2,160)

(2,601)

Opening cash

 

39

5,123

12,278

8,576

13,050

10,890

Other items (including cash assumed on acquisition)

0

0

439

0

0

0

Closing cash

 

5,123

12,278

8,576

13,050

10,890

8,289

Opening net debt/(cash)

1,724

13,476

24,742

65,435

68,965

67,887

Closing net debt/(cash)

13,476

24,742

65,435

68,965

67,889

68,454

Source: Palace Capital, Edison Investment Research

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 Limited (Edison Aus) [46085869] is the Australian subsidiary of Edison and is not regulated by the Australian Securities and Investment Commission. Edison Germany is a branch entity of Edison Investment Research Limited [4794244]. www.edisongroup.com

DISCLAIMER
Copyright 2017 Edison Investment Research Limited. All rights reserved. This report has been commissioned by Palace Capital 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 Aus and any access to it, is intended only for "wholesale clients" within the meaning of the Australian Corporations Act. 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 2017. “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

245 Park Avenue, 39th Floor

10167, New York

US

Sydney +61 (0)2 8249 8342

Level 12, 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

245 Park Avenue, 39th Floor

10167, New York

US

Sydney +61 (0)2 8249 8342

Level 12, 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 Limited (Edison Aus) [46085869] is the Australian subsidiary of Edison and is not regulated by the Australian Securities and Investment Commission. Edison Germany is a branch entity of Edison Investment Research Limited [4794244]. www.edisongroup.com

DISCLAIMER
Copyright 2017 Edison Investment Research Limited. All rights reserved. This report has been commissioned by Palace Capital 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 Aus and any access to it, is intended only for "wholesale clients" within the meaning of the Australian Corporations Act. 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 2017. “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

245 Park Avenue, 39th Floor

10167, New York

US

Sydney +61 (0)2 8249 8342

Level 12, 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

245 Park Avenue, 39th Floor

10167, New York

US

Sydney +61 (0)2 8249 8342

Level 12, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

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