Portfolio growth

Palace Capital 7 August 2017 Update
Download PDF

Palace Capital

Portfolio growth

Acquisition

Real estate

7 August 2017

Price

370p

Market cap

£93m

Net debt (£m) at 31 March 2017

68.6

Shares in issue

25.2m

Free float

94%

Code

PCA

Primary exchange

AIM

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

(0.7)

3.5

12.1

Rel (local)

(3.0)

0.2

(0.3)

52-week high/low

390p

320p

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

Half year end

30 September 2017

Half year results

November 2017

Analysts

Julian Roberts

+44 (0)20 3077 5748

Martyn King

+44 (0)20 3077 5745

Palace Capital is a research client of Edison Investment Research Limited

Palace Capital has completed the previously announced £20m acquisition via a corporate deal, more than replacing rental income from disposals made in FY17. The new assets are fully let at a higher yield than our previous estimates. This leads us to raise our forecasts slightly and provides scope for rental and valuation uplifts in future, in line with Palace’s strategy of providing capital growth as well as stable income.

Year end

Revenue (£m)

Adj. EPRA earnings* (£m)

Adj. EPRA EPS* (p)

EPRA NAV/
share (p)

P/EPRA NAV/
share (x)

DPS
(p)

Yield
(%)

03/16

14.6

4.6

18.9

414

0.89

16.0

4.3

03/17

14.3

5.7

22.2

443

0.84

18.5

5.0

03/18e

14.1

5.5

21.7

449

0.82

19.0

5.1

03/19e

14.8

6.3

24.9

455

0.81

19.5

5.3

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

High-quality assets at an attractive price

The company Palace has acquired owns a mixed-use, modern, office, residential, hotel and retail development in central Newcastle, with two floors of a multi-storey car park as well. The new assets’ annual rental income of £1.765m represents a net initial yield of 8.6% on the £20m acquisition price after costs, which compares well with the rest of the portfolio at c 7.5% on average. It is expected that the next speculative office development in Newcastle will not be ready for two years, and occupier demand has been strong in recent months – favourable dynamics for rental markets in the area.

Executing the investment strategy

The acquisition aims to fulfil both Palace’s aims of providing capital value increases and a rising dividend supported by a stable rental portfolio. There is potential for increased rents, with current rates c 15% below prime rates for Newcastle offices according to local property consultants, which, if achieved, could lead to higher valuations too. The 8.6% yield may also come down if investor demand in the regions rises; London offices are widely expected to lose value over the next two to three years and investors may seek income-producing assets in areas where higher yields provide attractive returns, protection from cyclical changes in the property market and less exposure to Brexit-related risks. Finally, following the disposal of £12.6m of assets in FY17 (including a £3.4m valuation gain), the new investment also shows Palace’s ability to recycle capital efficiently, with the new income more than offsetting rent on the properties sold.

Valuation: Unrecognised value

Palace’s 17% discount to 31 March 2017 EPRA NAV of 443p is well above the peer average (4% discount) and seems high even allowing for development risk on some of its assets. High yields and the regional focus provide some risk protection and the 19p FY18e dividend (5.1% yield) may add to the shares’ attraction. Our forecasts indicate 1.28x cover in FY19, or possible scope for a higher distribution.

Acquisition summary

Palace had already announced in its update on 2 May 2017 that it was negotiating a £20m acquisition and the news released today adds further detail. Palace has bought the entire share capital of SM Newcastle OB, a company that owns the freeholds of 1, 2 and 3 St James’s Gate, the adjacent Jury’s Inn (and a 125-year lease from October 2002 on the fourth and fifth floors of the Times Square Car Park), all near Newcastle Railway Station. The acquisition has been funded by a new loan from Santander of £11.5m and from the company’s existing cash resources.

The properties were developed by McAleer & Rushe from 2003 to 2006, which owns the company being acquired. They comprise a 274-bed hotel (the Jury’s Inn); 143,000 sqft of modern office space (1 and 2 St James’s Gate) and 145 apartments (3 St James’s Gate) above 16,500 sqft of commercial retail space, as well as a 635-space multi-storey car park on the other side of Railway Street, of which Palace has acquired the top two floors.

The hotel, the 61,000 sqft of offices in 1 St James’s Place and the residential element of 3 St James’s Place were already sold on 999-year leases when Palace bought SM Newcastle, but it still owns the freehold. Palace will receive rents from 2 St James’s Place and from the retail part of 3 St James’s Place. The former contains 82,500 sqft of offices, which are fully let to tenants including the National Lottery Charities Board, Eldon Insurance Services, Serco and UBS, for net income of £1.605m per annum. The retail space produces £0.16m of rent per annum, for total net rental income of £1.765m, a net initial yield of 8.6%.

The office rents equate to £19.45 per sqft, while Lambert Smith Hampton, a commercial property consultant, reports that prime office rents in Newcastle were £23 in Q217 and are expected to rise in 2017 due to a shortage of grade A supply. At full occupancy and with positive rental dynamics in Newcastle, the valuation outlook is also positive. While we have not assumed any yield contraction in our estimates, if the new assets were valued at a net initial yield of 7.5%, the valuation would rise by c £3m, or 11p a share.

Effects on estimates

We had already allowed for a £20m acquisition in our estimates but had only assumed a 7.5% net initial yield and 5% costs, so our net rental income figure has been adjusted upwards. We had assumed that the deal would be funded with £10m of new debt at Palace’s average cost of debt of 2.9% margin above Libor. We now assume that the new loan (£11.5m) is at 2.5% above Libor. As a result, our estimated interest expense is slightly increased, with an impact on earnings. We have also increased our 2019e dividend assumption in line with Palace’s progressive dividend policy which slightly affects NAV in that year.

Exhibit 1: Changes to estimates

Rental income (£m)

Adjusted EPRA EPS (p)

EPRA NAV per share (p)

Dividend per share (p)

Old

New

Change (%)

Old

New

Change (%)

Old

New

Change (%)

Old

New

Change (%)

03/18e

14.0

14.1

0.5

21.4

21.7

3.2

449

449

0.2

19.0

19.0

0.0

03/19e

14.7

14.8

0.3

26.6

24.9

(6.3)

456

455

(0.3)

19.0

19.5

2.6

Source: Edison Investment Research

The effects on our estimates can be seen in Exhibit 1. The increase in income flows through to higher earnings, which in turn have a small effect on NAV. We have not changed our dividend assumptions, but note that dividend cover has risen to 1.16x in FY18 and 1.45x in FY19, from 1.13x and 1.40x, respectively.

Valuation

Palace continues to trade at a discount to last reported EPRA NAV (443p) of c 17%, higher than most other investors in regional real estate. The average for the peer group is a 2% discount, which would put Palace at 436p per share, 18% above the current price. At that level the prospective dividend yield would still be an attractive 4.4% (currently 5.1%). This acquisition provides further evidence of management’s ability to find favourably-priced assets in good locations in the UK’s regional cities. As Palace’s track record extends and the portfolio grows, we would look for the discount to diminish to at least the peer average, and we would point to possible valuation gains from yield contraction, which is not included in our forecasts.

Exhibit 2: Listed regional property investors’ discounts to last reported NAV

Source: Company data, Bloomberg. Prices at 2 August 2017

Exhibit 3: Financial summary

Year end 31 March

£'000s

2014

2015

2016

2017

2018e

2019e

PROFIT & LOSS

IFRS

IFRS

IFRS

IFRS

IFRS

IFRS

Revenue

 

 

3,252

8,637

14,593

14,266

14,082

14,755

Cost of Sales

(648)

(1,200)

(1,624)

(2,055)

(1,540)

(1,055)

Gross Profit

2,604

7,437

12,969

12,211

12,542

13,700

Administrative expenses

(649)

(1,439)

(2,048)

(2,915)

(3,186)

(3,425)

Operating Profit before revaluation

1,955

5,998

10,921

9,296

9,357

10,275

Revaluation of investment properties

19,501

9,769

3,620

3,101

1,500

0

Costs of acquisitions/profits on disposals

270

(461)

(525)

3,191

(1,000)

0

Operating Profit

21,725

15,306

14,016

15,588

9,857

10,275

Net Interest

(573)

(1,398)

(2,264)

(3,011)

(3,074)

(3,139)

Profit Before Tax (norm)

1,652

4,139

8,132

9,476

6,282

7,136

Profit Before Tax (FRS 3)

21,153

13,908

11,752

12,577

6,782

7,136

Taxation

81

107

(953)

(3,191)

(1,017)

(1,070)

Profit After Tax (norm)

1,733

4,246

7,179

6,285

5,265

6,066

Profit After Tax (FRS 3)

21,234

14,015

10,799

9,386

5,765

6,066

Deferred tax charge

2,200

Debt termination cost

155

EPRA earnings

1,463

4,707

7,704

5,449

5,265

6,066

Adjusted for:

Surrender premium

0

0

(3,172)

237

0

0

Share-based payments

0

114

110

0

200

200

Adjusted EPRA earnings

1,463

4,821

4,642

5,686

5,465

6,266

Company adjusted PBT

1,382

4,828

5,595

6,677

6,482

7,336

Average undiluted number of shares outstanding (m)

5.3

17.1

24.6

25.7

25.2

25.2

EPS - normalised (p)

 

32.9

24.8

29.2

24.4

20.9

24.1

EPS - FRS 3 (p)

 

403.4

82.0

43.9

36.5

22.9

24.1

Adjusted EPS

 

29.7

27.7

18.9

22.2

21.7

24.9

EPRA EPS (p)

 

27.8

27.5

31.3

21.2

21.7

24.9

Dividend per share (p)

0.0

13.0

16.0

18.5

19.0

19.5

Dividend cover (x)

N/A

2.12

1.96

1.14

1.14

1.28

BALANCE SHEET

Fixed Assets

 

60,086

104,470

175,738

183,959

205,459

207,459

Investment properties

59,440

102,988

174,542

183,916

205,416

207,416

Goodwill

6

6

0

0

0

0

Other non-current assets

640

1,475

1,196

43

43

43

Current Assets

 

7,060

15,653

11,903

13,692

4,348

5,799

Debtors

1,937

3,375

3,327

2,511

2,511

2,511

Cash

5,123

12,279

8,576

11,181

1,837

3,288

Current Liabilities

 

(4,171)

(3,487)

(9,048)

(8,197)

(8,197)

(8,197)

Creditors

(2,971)

(3,087)

(6,815)

(6,161)

(6,161)

(6,161)

Short term borrowings

(1,200)

(400)

(2,233)

(2,036)

(2,036)

(2,036)

Long Term Liabilities

 

(18,599)

(36,620)

(71,778)

(77,708)

(88,678)

(90,642)

Long term borrowings

(17,384)

(35,407)

(69,711)

(75,758)

(86,728)

(88,692)

Other long term liabilities

(1,215)

(1,214)

(2,067)

(1,950)

(1,950)

(1,950)

Net Assets

 

44,376

80,016

106,815

111,746

112,932

114,419

Net Assets excluding goodwill and deferred tax

44,370

80,010

106,815

111,746

112,932

114,419

Basic NAV/share (p)

219

395

414

434

440

446

EPRA NAV/share (p)

219

396

414

443

449

455

CASH FLOW

Operating Cash Flow

 

1,297

4,388

12,287

10,294

8,577

10,495

Net Interest

(390)

(1,593)

(3,421)

(2,516)

(3,074)

(3,139)

Tax

(13)

(15)

(158)

(1,047)

(1,017)

(1,070)

Preference share dividends paid

(18)

0

0

0

0

0

Net cash from investing activities

2,532

(2,922)

(50,012)

(3,108)

(20,020)

(2,020)

Ordinary dividends paid

0

(1,766)

(3,221)

(4,617)

(4,779)

(4,779)

Debt drawn/(repaid)

(21,266)

(10,600)

21,272

5,861

10,970

1,964

Proceeds from shares issued

23,009

19,664

19,114

29

0

0

Other cash flow from financing activities

(66)

(2)

(2)

(2,291)

0

0

Net Cash Flow

5,085

7,155

(4,141)

2,605

(9,344)

1,451

Opening cash

 

39

5,123

12,278

8,576

11,181

1,837

Other items (including cash assumed on acquisition)

0

0

439

0

0

0

Closing cash

 

5,123

12,278

8,576

11,181

1,837

3,289

Opening net debt/(cash)

1,724

13,476

24,742

65,435

68,563

88,877

Closing net debt/(cash)

13,476

24,742

65,435

68,563

88,877

89,390

Source: Palace Capital data, 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

295 Madison Avenue, 18th Floor

10017, 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

295 Madison Avenue, 18th Floor

10017, 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

295 Madison Avenue, 18th Floor

10017, 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

295 Madison Avenue, 18th Floor

10017, New York

US

Sydney +61 (0)2 8249 8342

Level 12, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

Share this with friends and colleagues