Positive income-driven returns continuing

Picton Property Income 29 January 2019 Review
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Picton Property Income

Positive income-driven returns continuing

NAV update

Real estate

29 January 2019

Price

84.50p

Market cap

£456m

Net debt (£m) as at 31 December 2018

171.1

Net LTV as at 31 December 2019

25.0%

Shares in issue

539.0m

Free float

100%

Code

PCTN

Primary exchange

LSE

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

0.4

(1.2)

(2.7)

Rel (local)

(0.9)

1.0

10.2

52-week high/low

93.4p

79.4p

Business description

Picton Property Income is an internally managed UK REIT that invests in a diversified portfolio of commercial property across the UK. The investment objective is to provide investors with an attractive level of income and the potential for capital growth.

Next event

FY19 results

May 2019

Analysts

Martyn King

+44 (0)20 3077 5745

Andrew Mitchell

+44 (0)20 3681 2500

Picton Property Income is a research client of Edison Investment Research Limited

Picton property delivered a solid performance in the three months to December 2018 (Q319), generating an NAV total return of 1.2% (or a compound annual 4.9%). A good level of dividend cover was maintained and the company progressed a number of asset management initiatives targeted at capturing reversionary income potential and enhancing long-term total return.

Year end

Net rental
income (£m)

EPRA EPS*
(p)

DPS
(p)

EPRA NAV/
share (p)

P/EPRA NAV
(x)

Yield
(%)

03/17

42.4

3.81

3.33

82

1.03

3.9

03/18

38.4

4.19

3.43

90

0.93

4.1

03/19e

38.5

4.26

3.57

93

0.91

4.2

03/20e

37.0

4.22

3.68

95

0.89

4.4

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

Solid Q319 returns and active management

The 0.875p quarterly DPS, annualising at 3.5p per share, and Picton’s first payment under the REIT regime, was 123% covered by income earnings. The portfolio value and net asset value both edged up, with NAV per share increasing 0.3% to 92.5p. There were no portfolio transactions during the period but active asset management continued, aimed at capturing the significant reversionary income potential contained in the portfolio (£6.4m at H119; £2.9m related to vacant space and the remainder represented the potential uplift from lease renewals, rent reviews and contracted uplifts). Lease renewals/re-gears and new lets, covering c £3m of annual rents were completed or agreed, at levels above ERV. Six lease surrenders were also completed/agreed, with the aim of re-letting at higher market rents (on average 23.2% above the passing rent level).

Reversionary potential supports growth prospects

Portfolio performance continues to benefit from an overweight in industrial and regional office property, where market rents and valuations have continued to grow, and a significant underweighting of retail and leisure (with no shopping centre exposure), where rents and values are under pressure. Income earnings prospects benefit from the significant reversionary potential, and a positive market supply-demand balance in the industrial and regional office sectors, with limited new development and occupational demand continuing to drive market rental growth, despite signs of leasing decisions taking longer to complete. With increased economic and market uncertainties, not least Brexit related, capital values are more difficult to call. However, with moderate (c 25%) gearing and £26m of undrawn debt facilities, Picton is well placed to seize any opportunities that may emerge.

Income focus, with an eye to sustainable growth

Picton offers a current yield of 4.1% and trades at a 9% discount to the Q319 NAV. Although it has a strong income focus its yield is lower than the peer average (c 5.7%), reflecting strong cover (Q319: 1.23x). This cover provides scope to reinvest into the portfolio in ways designed to support occupancy and income growth with the specific goal of enhancing long-term total return.

Management for income generating solid returns

Picton delivered a solid performance in the three months to December 2018 (Q319), generating an NAV total return of 1.2% (or a compound annual 4.9%), maintaining a good level of dividend cover, and progressing a number of asset management initiatives targeted at capturing reversionary income potential.

Net asset value edged up to £498.1m (30 September: £497.1m). In per share terms, the increase was 0.3%, from 92.2p to 92.5p. A 0.875p dividend per share paid during the quarter in respect of Q219, with dividend cover remaining strong at 123% (Q219: 129%). A dividend of 0.875p per share has been declared for Q319 and will be paid on 28 February, the first payment under the REIT regime. The quarterly DPS is equivalent to an annualised 3.5p, representing a yield of 4.1%.

Exhibit 1: Summary of quarterly NAV movement

£m

Per share (p)*

NAV at 30 September 2018

497.1

92.2

Movement in property values

0.1

Income earnings, net of tax

5.8

1.1

Dividends paid

(4.7)

(0.8)

Other

(0.2)

NAV at 31 December 2018  

498.1

92.5

Source: Picton Property Income. Note: * Per share values are rounded.

The balance sheet showed only modest changes during the period and gearing remains modest at 25.0% (30 September: 25.5%). The debt had a maturity of 10.1 years at 31 December, and was 87% fixed rate. The average interest cost is c 4.0%. Picton has £26m available from its undrawn revolving credit facilities, providing the flexibility to take advantage of investment opportunities that may arise.

With no portfolio transactions during the quarter, the portfolio value increased by 0.1% or £1.0m to £684m (the balance sheet value above is stated net of lease incentives), with the industrial sector, strongly represented in the portfolio, continuing to drive growth, up 2.3%. The office sector saw a slight (0.4%) decline, in part due to asset management driven surrender activity. In the retail and leisure sector the main driver of the 3.2% reduction in value was weaker sentiment in the regional retail and warehouse sectors. Although modest, the 0.1% total valuation increase was ahead of the 0.2% quarterly decline registered by the MSCI Monthly Digest. Based on contracted net income, the net initial yield (NIY) at 31 December was 5.4%, similar to the level at 30 September, with a reversionary yield of 6.5% (30 September: 6.4%).

Exhibit 2: Portfolio summary

(%)

Portfolio weighting

Like for like change in value

Sector

December 2018

September 2018

Industrial

44.7%

43.7%

2.3%

South East

31.5%

30.6%

Rest of UK

13.2%

13.1%

Offices

34.3%

34.5%

-0.4%

London City & West End

4.2%

4.1%

Inner and Outer London

8.3%

8.3%

South East

11.0%

11.0%

Rest of UK

10.8%

11.1%

Retail & Leisure

21.0%

21.8%

-3.2%

Retail warehouse

8.3%

8.6%

High Street - rest of UK

5.1%

5.6%

High Street - South East

5.7%

5.7%

Leisure

1.9%

1.9%

Total portfolio

100.0%

100.0%

0.1%

Source: Picton Property Income

With the interim results (H119) Picton provided details of the £6.4m reversionary income potential, at that date, in the existing portfolio. Of this, £2.9m reflected the opportunity to let additional space, with the remainder representing the potential uplift from lease renewals, rent reviews and contracted uplifts. During Q319, Picton completed six lease renewals/re-gears and secured eight rent reviews, at an average 9.9% ahead of the September 2018 ERV, with a combined rent of £2.1m. In addition, six new lettings were completed and one agreed, with a combined rent of £0.9m, on average 2.1% below the September ERV. At the same time, the company completed five surrenders and one agreement to surrender as part of its ongoing asset management. Although in some cases this will have a short-term impact on income, the intention is to re-let the properties at higher rents. On average the market rents are 23.2% ahead of the passing rent, while the surrender payments received were in excess of £0.3m. At Parc Tawe in North Swansea, Picton has completed an agreement with Lidl to lease the former Homebase unit, the subject of a CVA in H119, moving Lidl from its existing smaller premises on the site and making it the anchor occupier. Lidl will pay an annual £0.39m rent on the space previously occupied by Homebase, on a 20-year lease, with a break after 15 years, and subject to five-yearly RPI-based rent reviews capped at 2%. Homebase had been paying rent of £0.44m on a lease expiring in 2022, but had sought a 90% reduction under its CVA.

Forecasts and valuation

No change to forecasts

We are making no changes to the estimates that we set out in our update published following the interim results to 30 September. These reflect an expectation of continuing growth in like-for-like rental income in the industrial portfolio and to a lesser extent, within the office portfolio. For industrial assets, we assume 2% growth in H219 and a further 2% for FY20 as a whole. For office, we assume 1% growth in H219 and 1% growth for FY20 as a whole. In retail and leisure, we assume no rental growth and look for the asset management driven vacation of Stanford House to temporarily reduce end-FY19 contracted rents by an additional c £1m (in addition to the c £0.5m H119 impact). This will more than offset any positive impact from re-letting space affected by retail failures in H119. We have prudently assumed that only around £1m of the c £1.5m contracted income forgone is recovered by end FY20, with no material impact on revenue in the period. For the group as a whole, our forecasts reflect an end FY19 contracted rent roll of £39.8m (H119: £40.3m), with £41.5m at end FY20.

Our forecasts include modest revaluation gains driven by expected rental growth, focused on the industrial sector where Picton is strongly weighted, with no assumption of a change in market yields, either up or down. However, there has clearly been an increase in market uncertainty, most obviously with respect to the effects of Brexit. With a NIY of 5.4%, we estimate that a 0.25% increase in market yields would reduce FY20 NAV per share by c 5p per share, while a 0.25% reduction would increase it by c 7p per share.

Income focus supporting share price

Picton has a strong focus on income and pays fully covered quarterly dividends that currently annualise at 3.5p per share (a prospective yield of 4.1% at the current share price) while continuing to invest in the portfolio to support future income growth. In Exhibit 3 we show the trend in EPRA NAV per share during the past almost six years ended December 2018. During this period, Picton has generated an aggregate NAV total return of 126.5%, or a compound annual average 15.3%.

Exhibit 3: EPRA NAV total return

Year ending 31 March

9 months 2019

Cumulative 2014–19

2014

2015

2016

2017

2018

Opening EPRA NAV per share (p)

49

56

69

77

82

90

49

Closing EPRA NAV per share (p)

56

69

77

82

90

93

93

DPS paid (p)

3.00

3.00

3.30

3.30

3.40

2.63

19

EPRA NAV total return

21.0%

26.9%

17.6%

10.2%

14.7%

5.2%

126.5%

Compound annual total return

15.3%

Source: Company data, Edison Investment Research. Note: Annual data differ slightly from Picton’s published data which assume dividend reinvestment during the year.

In Exhibit 4 we show a summary performance and valuation comparison of Picton and what we consider to be its closest income-oriented peers. Over the past year Picton shares have performed more strongly than the peer group average as well as the broader UK property sector and the FTSE All-Share Index. The valuation comparison is based on last reported EPRA NAV per share and trailing 12-month DPS declared – on this basis, the Picton yield is below the peer average and the P/NAV slightly above. We believe that the shares continue to benefit from the company’s income focus, a less volatile element of property returns across the cycle compared with capital values, its good level of dividend cover and relatively modest gearing.

Exhibit 4: Peer comparison

Price (p)

Market cap (£m)

P/NAV* (x)

Yield* (%)

Share price performance

1 month

3 months

12 months

From 12M high

Ediston Property

101

213

0.88

5.7

-2%

-3%

-9%

-12%

F&C UK Real Est Inv

88

211

0.82

5.7

-3%

-7%

-16%

-20%

F&C Com Prop

126

1007

0.89

4.8

-1%

-6%

-12%

-19%

Custodian REIT

115

452

1.06

5.7

-1%

-3%

0%

-7%

Regional REIT

97

360

0.85

8.2

4%

-3%

-4%

-6%

Schroder REIT

54

282

0.79

4.6

-3%

-8%

-15%

-19%

Standard Life Inv Prop

88

358

0.96

5.4

8%

-2%

-7%

-9%

Average

0.89

5.7

0%

-5%

-9%

-13%

Picton

84

453

0.91

4.2

0%

-3%

-3%

-10%

UK property index

1,662

5.2

7%

-2%

-8%

-12%

FTSE All-Share Index

3,720

4.8

1%

-3%

-12%

-14%

Source: Company data, Edison Investment Research. Prices as at 28 January 2019. Note: *Last reported EPRA NAV per share and trailing 12-month DPS declared.

Exhibit 5: Financial summary

Year end 31 March

£'000s

2016

2017

2018

2019e

2020e

IFRS

IFRS

IFRS

IFRS

IFRS

PROFIT & LOSS

Rents receivable, adjusted for lease incentives

39,663

40,555

41,412

40,842

40,480

Surrender premiums

339

263

200

442

200

Dilapidation receipts

108

1,090

1,111

530

600

Other income

660

6,003

132

79

0

Revenue

 

 

40,770

47,911

42,855

41,893

41,280

Service charge income

5,153

6,487

5,927

6,061

6,000

Total revenue

 

 

45,923

54,398

48,782

47,954

47,280

Gross property expenses

(10,001)

(12,011)

(10,335)

(9,447)

(10,300)

Net rental income

 

 

35,922

42,387

38,447

38,507

36,980

Administrative expenses

(1,510)

(1,613)

(1,914)

(1,812)

(1,500)

Operating Profit before revaluations

 

 

34,412

40,774

36,533

36,695

35,480

Revaluation of investment properties

44,171

15,087

38,920

12,461

10,000

Profit on disposals

799

1,847

2,623

379

0

Management expenses

(2,901)

(3,636)

(3,652)

(4,006)

(4,000)

Operating Profit

76,481

54,072

74,424

45,529

41,480

Net finance expense

(11,417)

(10,823)

(9,747)

(9,283)

(8,726)

Profit Before Tax

 

 

65,064

43,249

64,677

36,246

32,755

Taxation

(216)

(499)

(509)

(445)

0

Profit After Tax

64,848

42,750

64,168

35,801

32,755

Profit After Tax (EPRA)

19,878

20,566

22,625

22,961

22,755

Average Number of Shares Outstanding (m)

540.1

540.1

539.7

539.0

539.0

EPS (p)

 

 

12.01

7.92

11.89

6.04

6.08

EPRA EPS (p)

 

 

3.68

3.81

4.19

4.26

4.22

Dividends declared per share (p)

 

 

3.300

3.325

3.425

3.570

3.680

Dividend cover (x)

1.12

1.15

1.22

1.19

1.15

Ongoing charges ratio (excluding property expenses)

1.1%

1.2%

1.1%

1.0%

1.0%

BALANCE SHEET

Fixed Assets

 

 

649,406

615,187

670,679

678,145

691,645

Investment properties

646,018

615,170

670,674

678,120

691,620

Other non-current assets

3,388

17

5

25

25

Current Assets

 

 

37,408

49,424

50,633

35,688

36,240

Debtors

14,649

15,541

19,123

14,614

14,970

Cash

22,759

33,883

31,510

21,074

21,270

Current Liabilities

 

 

(47,521)

(20,635)

(22,292)

(19,915)

(20,378)

Creditors/Deferred income

(18,430)

(20,067)

(21,580)

(19,107)

(19,570)

Short term borrowings

(29,091)

(568)

(712)

(808)

(808)

Long Term Liabilities

 

 

(222,161)

(202,051)

(211,665)

(192,274)

(192,274)

Long term borrowings

(220,444)

(200,336)

(209,952)

(190,559)

(190,559)

Other long term liabilities

(1,717)

(1,715)

(1,713)

(1,715)

(1,715)

Net Assets

 

 

417,132

441,925

487,355

501,644

515,233

Net Assets excluding goodwill and deferred tax

 

 

417,132

441,925

487,355

501,644

515,233

NAV/share (p)

77

82

90

93

96

Fully diluted EPRA NAV/share (p)

77

82

90

93

95

CASH FLOW

Operating Cash Flow

 

 

33,283

36,283

35,088

30,733

32,211

Net Interest

(8,836)

(9,211)

(9,125)

(8,950)

(8,726)

Tax

(426)

(232)

(328)

(80)

0

Net cash from investing activities

(68,123)

48,691

(17,811)

9,777

(3,524)

Ordinary dividends paid

(17,822)

(17,957)

(18,487)

(18,883)

(19,766)

Debt drawn/(repaid)

14,591

(46,450)

9,183

(23,033)

0

Net proceeds from shares issued/repurchased

0

0

(893)

0

0

Other cash flow from financing activities

Net Cash Flow

(47,333)

11,124

(2,373)

(10,436)

196

Opening cash

 

 

70,092

22,759

33,883

31,510

21,074

Closing cash

 

 

22,759

33,883

31,510

21,074

21,270

Debt as per balance sheet

(249,535)

(200,904)

(210,664)

(191,367)

(191,367)

Un-amortised loan arrangement fees

0

(3,740)

(3,376)

(2,885)

(2,885)

Closing net (debt)/cash

 

 

(226,776)

(170,761)

(182,530)

(173,178)

(172,982)

Net LTV

34.6%

27.3%

26.7%

25.2%

24.7%

Source: Company data, Edison Investment Research

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This report has been commissioned by Picton Property Income and prepared and issued by Edison, in consideration of a fee payable by Picton Property Income. 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.

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This report has been commissioned by Picton Property Income and prepared and issued by Edison, in consideration of a fee payable by Picton Property Income. 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.

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New Zealand

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United Kingdom

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Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

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

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