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Research: Real Estate
Palace Capital (PCA) has provided an update on the impact of COVID-19 and its response to the crisis, including a focus on rent collections and maintaining a healthy liquidity position until the full impact becomes clearer. Payment of the previously declared Q320 DPS has been cancelled but progress continues at the flagship Hudson Quarter development, albeit at a slower pace.
Palace Capital |
Adjusting to COVID-19 |
COVID-19 and |
Real estate |
8 April 2020 |
Share price performance
Business description
Next events
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Palace Capital is a research client of Edison Investment Research Limited |
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Palace Capital (PCA) has provided an update on the impact of COVID-19 and its response to the crisis, including a focus on rent collections and maintaining a healthy liquidity position until the full impact becomes clearer. Payment of the previously declared Q320 DPS has been cancelled but progress continues at the flagship Hudson Quarter development, albeit at a slower pace.
Year end |
Net rental income (£m) |
Adj. PBT* |
Adj. EPS* |
EPRA NAV/ |
P/NAV |
DPS |
Yield |
03/18 |
14.9 |
8.5 |
21.2 |
414 |
0.45 |
19.0 |
10.3 |
03/19 |
16.4 |
8.9 |
17.3 |
407 |
0.45 |
19.0 |
10.3 |
03/20e |
18.3 |
8.0 |
16.7 |
391 |
0.47 |
14.3 |
7.7 |
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.
Focus on rent collection and liquidity
PCA says that the FY20 underlying earnings, expected in June 2020, are currently expected to be broadly in line with previous expectations, but the independent external valuers will highlight the material uncertainty that exists across the entire sector as a result of COVID-19 impacts. In common with peers, PCA has seen a slowdown in rent collections, and has cancelled payment of the Q320 DPS to maintain liquidity and provide flexibility to negotiate constructively with the worst affected tenants, and deal with any loan covenant issues that may arise. Given management’s comments we have maintained our FY20 adjusted earnings forecast and have assumed a resumption of DPS payments in Q420. However, due to the uncertainty as to the extent and duration of the effects of the pandemic, we note the risk to our NAV forecast and have withdrawn our FY21 estimate.
Medium-term opportunities for optimising value
While market and economic conditions are currently highly uncertain, PCA has a range of opportunities to optimise both income and capital values in various market conditions over the medium term. The end-H120 estimated rental value (ERV) of the portfolio was 30% ahead of passing rent, while asset management plans for each property have identified a range of initiatives that can be phased in over time to provide counter-cyclical value-add opportunities. The early residential sales and pre-letting of commercial space at Hudson Quarter underline the attractiveness of this flagship scheme.
Valuation: Significant discount to NAV
Based on our assumed payment of a Q420 DPS of 4.75p, the shares yield c 8% and are trading at around 50% of the H120 reported EPRA NAV per share. A comparison with the wider sector is made difficult by the current market-wide uncertainties and the fact that not all companies have yet updated the market on their near-term position and response.
Additional details
Working with tenants to protect rental income
Across the main commercial property sectors, landlords are reporting a slowdown in rent collection as tenants strive to adjust to the impacts of COVID-19. Not surprisingly, collections from retail tenants are most affected at this stage, and to a lesser extent warehouse distribution and offices. PCA’s portfolio is regional (ie not central London) and is focused on office and industrial assets (62% by value at H120) with relatively low exposures to retail (9%) and retail warehouse (4%), with two large leisure assets (15%). PCA intends to support occupiers, especially smaller and independent businesses that may be less resilient, and has already received a variety of requests for rent deferrals, a move from quarterly to monthly prepayments, and rent waivers. Each is being reviewed on a case by case basis, taking account of the tenant business model and risk profile, as well as the availability of government aid.
Overall, as at close of business on 1 April 2020, and adjusted for agreed rent payment adjustments, PCA had received 70% of all rents due and expects this collection rate to increase further.
Continuing to progress Hudson Quarter
Within the constraints of government regulations, work is continuing at the company’s flagship Hudson Quarter development in York, although the January completion date may need to be extended. The development is well situated within the city walls and just a minute’s walk from the railway station and comprises three residential buildings and a commercial building.
As at 31 March 2020, sales contracts have been exchanged on 28 (£7.55m by value) of the 127 residential apartments and a further 17 (£4.7m by value) were under offer. Sales continued up to the end of March when the marketing suite was temporarily closed and only two cancellations of sales have been received in recent weeks. As recently announced, 4,500 sq ft of the commercial space, comprising 35,000 sq ft of grade A offices and 5,000 sq ft of other commercial space and car parking, has been pre-let to Knights solicitors on the ground floor of one of the residential blocks at a record rent for York of £25 per sq ft.
Financials and valuation
Balance sheet and liquidity
Palace has c £155m of borrowing facilities, well spread among a range of lenders with no maturities in the next two years and including a £26.5m development facility in respect of Hudson Quarter. At end-H120 gross outstanding debt was £108.1m (including unamortised debt facility fees) with undrawn debt facilities of £46.5m, comprising the development facility (nil drawn at H120) and a £20m revolving credit facility (RCF). Net LTV was c 34%.
Updating on the position at 31 March 2020, PCA reports healthy liquidity with cash of £14.7m and a further £5.0m that can be drawn down imminently from the RCF. Hudson Quarter development is now fully funded by the development facility and for the time being all other major capital expenditure has been put on hold. PCA believes that maintaining maximum liquidity at this time is a prudent approach, in order to comply with its lenders’ loan covenants. It says that interest cover tests ranging from 225% to 250% are of note and estimates that rental income would need to fall by more than 40% on average for these to require any form of curing and that lenders have provided assurance that they would stand by the company during this unprecedented time should this prove necessary.
Leaving FY20 underlying earnings unchanged
The main COVID-19 impacts began during March and PCA says that as a result underlying earnings for the year that ended 31 March 2020 (FY20) are currently expected to be broadly in line with previous expectations, although there is clearly more uncertainty about property valuations and NAV. We have maintained our FY20 underlying earnings forecast, set out in detail in our December 2019 update, while revising our DPS expectation.
For the time being we have assumed a resumption of quarterly DPS payments for Q420, but this depends very much on the duration and impact of the current situation. PCA says that a recommendation on the final dividend will be taken at the time of the announcement of the FY20 results, which is expected in early June 2020. PCA also says that until there is clarity on the full impact of the crisis it is not commenting on the outlook for the financial year just begun (FY21) and accordingly we have withdrawn our FY21 estimates.
Based on our assumed payment of a Q420 DPS of 4.75p, the shares yield c 8% and are trading at around 50% of the H120 reported EPRA NAV per share. A comparison with the wider sector is made difficult by the current market-wide uncertainties and the fact that not all companies have yet updated the market on their near-term position and response.
Exhibit 1: Financial summary
Year end 31 March (£000s) |
2017 |
2018 |
2019 |
2020e |
PROFIT & LOSS |
||||
Rental & other income |
14,266 |
16,733 |
18,750 |
20,722 |
Non-recoverable property costs |
(2,055) |
(1,824) |
(2,318) |
(2,464) |
Net rental income |
12,211 |
14,909 |
16,432 |
18,258 |
Dividend income from listed equity investments |
43 |
53 |
||
Administrative expenses before share based payments |
(2,678) |
(4,011) |
(3,790) |
(3,943) |
Share-based payments |
(237) |
(174) |
(332) |
(250) |
Operating Profit (before capital items) |
9,296 |
10,724 |
12,353 |
14,118 |
Revaluation of investment properties |
3,101 |
5,738 |
(382) |
(5,552) |
Gains/(losses) on disposals |
3,191 |
274 |
(652) |
(24) |
Loss on revaluation of listed equity investments |
(214) |
101 |
||
Operating Profit |
15,588 |
16,736 |
11,105 |
8,643 |
Net finance expense |
(3,011) |
(3,432) |
(4,672) |
(4,996) |
Profit Before Tax |
12,577 |
13,304 |
6,433 |
3,648 |
Taxation |
(3,191) |
(773) |
(1,263) |
3,729 |
Profit After Tax (FRS 3) |
9,386 |
12,531 |
5,170 |
7,377 |
EPRA adjustments: |
||||
Revaluation of investment properties |
(3,101) |
(5,738) |
382 |
5,857 |
Gains/(losses) on disposals |
(3,191) |
(274) |
652 |
24 |
Deferred tax charge |
2,200 |
(299) |
243 |
0 |
Other adjustments |
155 |
308 |
1,143 |
1,063 |
EPRA earnings |
5,449 |
6,528 |
7,590 |
14,320 |
Adjusted for: |
||||
Non-recurring items |
0 |
698 |
0 |
(2,850) |
Share-based payments |
237 |
174 |
332 |
250 |
Adjusted earnings |
5,686 |
7,400 |
7,922 |
11,720 |
Company adjusted PBT |
6,677 |
8,472 |
8,942 |
7,991 |
Average fully diluted number of shares outstanding (000s) |
25,738 |
34,980 |
45,898 |
46,020 |
Basic EPS - FRS 3 (p) |
36.5 |
35.8 |
11.3 |
14.8 |
Fully diluted EPRA EPS (p) |
21.2 |
18.7 |
16.5 |
22.4 |
Fully diluted adjusted EPS (p) |
22.2 |
21.2 |
17.3 |
16.7 |
Dividend per share declared (p) |
18.5 |
19.0 |
19.0 |
14.3 |
EPRA dividend cover (x) |
1.14 |
0.98 |
0.87 |
1.57 |
BALANCE SHEET |
||||
Fixed Assets |
183,959 |
253,984 |
261,064 |
266,691 |
Investment properties |
183,916 |
253,863 |
258,331 |
263,139 |
Goodwill |
0 |
0 |
0 |
0 |
Other non-current assets |
43 |
121 |
2,733 |
3,552 |
Current Assets |
13,692 |
46,292 |
55,256 |
47,136 |
Trading properties |
0 |
0 |
14,367 |
27,137 |
Assets held for sale |
0 |
21,708 |
11,756 |
0 |
Cash |
11,181 |
19,033 |
22,890 |
14,710 |
Other current assets |
2,511 |
5,551 |
6,243 |
5,288 |
Current Liabilities |
(8,197) |
(11,520) |
(16,000) |
(9,158) |
Creditors |
(6,161) |
(8,834) |
(10,001) |
(7,322) |
Short term borrowings |
(2,036) |
(2,686) |
(5,999) |
(1,836) |
Long-term liabilities |
(79,895) |
(105,457) |
(119,997) |
(126,005) |
Long-term borrowings |
(75,758) |
(97,157) |
(112,017) |
(122,226) |
Deferred tax |
(2,187) |
(6,531) |
(5,580) |
(204) |
Other long-term liabilities |
(1,950) |
(1,769) |
(2,400) |
(3,575) |
Net Assets |
109,559 |
183,299 |
180,323 |
178,664 |
EPRA net assets |
111,759 |
190,011 |
186,968 |
180,203 |
Basic NAV/share (p) |
436 |
400 |
393 |
388 |
Diluted EPRA NAV/share (p) |
443 |
414 |
407 |
391 |
CASH FLOW |
||||
Operating Cash Flow |
10,294 |
9,899 |
11,920 |
12,551 |
Net Interest |
(2,516) |
(2,704) |
(3,385) |
(3,946) |
Tax |
(1,047) |
(395) |
(1,639) |
(1,554) |
Net cash from investing activities |
(3,352) |
(67,725) |
(11,560) |
(12,241) |
Ordinary dividends paid |
(4,617) |
(6,744) |
(8,718) |
(8,737) |
Debt drawn/(repaid) |
6,467 |
8,151 |
17,954 |
5,754 |
Proceeds from shares issued |
29 |
70,000 |
0 |
0 |
Other cash flow from financing activities |
(2,897) |
(3,434) |
(162) |
(627) |
Net Cash Flow |
2,361 |
7,048 |
4,410 |
(8,800) |
Opening balance sheet cash |
8,576 |
10,937 |
17,985 |
22,395 |
Restricted cash |
244 |
1,048 |
495 |
1,115 |
Other items (including cash assumed on acquisition) |
0 |
0 |
0 |
0 |
Closing balance sheet cash |
11,181 |
19,033 |
22,890 |
14,710 |
Closing balance sheet debt |
77,794 |
99,843 |
118,016 |
124,062 |
Unamortised debt costs |
936 |
1,552 |
1,334 |
1,041 |
Closing net debt/(cash) |
67,549 |
82,362 |
96,460 |
110,393 |
Net LTV (excl. restricted cash and adjusted for unamortised debt costs) |
36.9% |
29.8% |
33.7% |
37.8% |
Source: Palace Capital accounts, Edison Investment Research
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