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Research: Real Estate
Palace continues to demonstrate its ability to grow NAV per share through its strategic recycling of assets. The disposal of a property in Maldon has realised value created through recent asset management initiatives. As with two other recent sales, this is in line with the company’s strategy to increase shareholder value through active management of the investment portfolio. We have adjusted our forecasts for the £1.56m gain in value and, although we have not assumed any additional acquisitions, would expect Palace to reinvest the proceeds in other regional property assets at attractive yields and with further scope for capital gains.
Written by
Palace Capital |
Another NAV-accretive disposal |
Property disposal |
Real estate |
14 March 2017 |
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Palace Capital is a research client of Edison Investment Research Limited |
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Palace continues to demonstrate its ability to grow NAV per share through its strategic recycling of assets. The disposal of a property in Maldon has realised value created through recent asset management initiatives. As with two other recent sales, this is in line with the company’s strategy to increase shareholder value through active management of the investment portfolio. We have adjusted our forecasts for the £1.56m gain in value and, although we have not assumed any additional acquisitions, would expect Palace to reinvest the proceeds in other regional property assets at attractive yields and with further scope for capital gains.
Year |
Revenue |
Adjusted EPRA earnings* (£m) |
Adjusted EPRA EPS (p) |
EPRA NAV/share (p) |
DPS |
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 |
4.6 |
03/17e |
14.0 |
5.0 |
20.9 |
430 |
18.0 |
5.1 |
03/18e |
13.5 |
5.5 |
21.9 |
433 |
18.0 |
5.1 |
03/19e |
13.1 |
5.8 |
23.1 |
439 |
18.0 |
5.1 |
Note: *Adjusted EPRA earnings exclude revaluation gains, profits or losses on disposals of investment properties and surrender gains on early lease terminations.
Value-added through asset management
The ICS building in Maldon is let to Rockwell Automation (which remains a tenant of Palace in Milton Keynes) and following the recent extension of the lease, has little further scope for active asset management to add value in the near term. The gain on the carried value of the property equates to c 6p per share and crystallises the value of the property management team’s work to date. It follows the disposal of two adjacent properties in September 2016 and two further disposals in February, all at significant premiums to book value and thus all NAV-accretive.
Reinvestment to come
Palace has now sold properties for a total of £7.6m in the last month, giving the company enough funds to make an acquisition of the scale of Boulton House in Manchester (its most recent purchase). While we have not allowed for further investment in our modelling assumptions, we believe that the company has a healthy pipeline of opportunities for new investment beyond improvement of its existing portfolio and we would expect management to deploy the funds in FY18 and continue to grow its income.
Valuation: Significant unrecognised value
Palace’s shares trade at c 16% below last reported EPRA NAV per share of 419p, and the company has made disposals in the last month at c 9p per share above the book value of the assets in total. With some earnings being retained and allowing for the share buyback announced on 13 March, we forecast EPRA NAV of 430p per share at 31 March 2017, the financial year-end, implying that the shares trade at a discount of 19%. This is well above the average of regional property investment peers, which trade at close to or above EPRA NAV. As illustrated on page 2, there appears to be scope for this gap to close, supported by the earnings yield. Possible catalysts include the full-year results and reinvestment of capital.
Details of the disposal
The property which has been sold is currently let to Rockwell Automation. The existing lease runs out in June 2017 and is for £375k per annum. Palace announced in December 2016 that a ten-year lease extension had been signed with mutual breaks in June 2020 and June 2024 (at three and seven years) and an agreed rent review to not less than £394,128 in June 2022. The adjacent properties, 4 and 5 Hall Road, were sold by Palace for £1.03m in September: No 4 was let on a rolling annual lease and No 5 was vacant. The ICS building has been sold for £3.9m, equating to c £52 per sq ft and a 66% premium to the £2.34m valuation as of 30 September 2016. The £1.56m gain on the book value is equivalent to 6p per share before tax.
As with the disposals announced in February, this gain was not included in our forecasts (see our note of 28 February). As with the earlier disposals, the rationale for this sale is clear; it crystallises considerable value from asset management initiatives including the lease extension, and allows Palace to recycle capital into other investments.
Adjusting for the 0.5m share buyback (at 340p, and therefore NAV accretive on a per-share basis) and without assuming further asset acquisitions, the disposal reduces our rental income and EPS forecasts from FY18, although we would expect Palace to invest the capital. We have also not assumed that any additional debt will be repaid to save finance costs, and note that our forecasts now indicate a cash balance of c £14m in March 2017, up from £9.3m at September 2016. This represents a cash drag and we therefore view our forecasts as conservative. For illustration, if we assumed that £10m could be invested in H118, with 5% purchaser’s costs and at a 7% net initial yield, our FY18 EPRA EPS forecast would rise to 22.7p and 24.0p in FY19.
Exhibit 1: Estimate changes
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 |
20.4 |
-4.1% |
424 |
430 |
1.4% |
18.0 |
18.0 |
0% |
03/18e |
13.7 |
13.5 |
-2.0% |
21.5 |
21.2 |
-1.4% |
428 |
433 |
1.3% |
18.0 |
18.0 |
0% |
03/19e |
13.4 |
13.1 |
-2.7% |
22.9 |
22.4 |
-2.1% |
433 |
439 |
1.2% |
18.0 |
18.0 |
0% |
Source: Edison Investment Research
Valuation: Further NAV gains
This additional NAV increase means that the shares now trade at a 21% discount to our FY17e EPRA NAV. This seems high compared with the peer group (Exhibit 2) and we would expect the shares to move closer to the peer average as the capital is redeployed.
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Exhibit 2: P/EPRA NAV vs EPRA EPS yield on EPRA NAV |
|
|
Source: Company data, Bloomberg, Edison Investment Research. Peers are Custodian REIT (CREI), Mucklow (MKLW), Picton Property Income (PCTN), Real Estate Investors (RLE), Regional REIT (RGL) and Schroder REIT (SREI). |
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 |
13,468 |
13,073 |
Cost of Sales |
(648) |
(1,200) |
(1,624) |
(2,321) |
(1,858) |
(1,392) |
||
Gross Profit |
2,604 |
7,437 |
12,969 |
11,648 |
11,610 |
11,681 |
||
Administrative expenses |
(649) |
(1,439) |
(2,048) |
(2,626) |
(2,554) |
(2,628) |
||
Operating Profit before revaluation |
1,955 |
5,998 |
10,921 |
9,022 |
9,056 |
9,053 |
||
Revaluation of investment properties |
19,501 |
9,769 |
3,620 |
32 |
1,500 |
0 |
||
Costs of acquisitions/profits on disposals |
270 |
(461) |
(525) |
3,183 |
0 |
0 |
||
Operating Profit |
21,725 |
15,306 |
14,016 |
12,237 |
10,556 |
9,053 |
||
Net Interest |
(573) |
(1,398) |
(2,264) |
(2,822) |
(2,427) |
(2,328) |
||
Profit Before Tax (norm) |
1,652 |
4,139 |
8,132 |
9,383 |
6,629 |
6,724 |
||
Profit Before Tax (FRS 3) |
21,153 |
13,908 |
11,752 |
9,415 |
8,129 |
6,724 |
||
Taxation |
81 |
107 |
(953) |
(1,350) |
(1,219) |
(1,009) |
||
Profit After Tax (norm) |
1,733 |
4,246 |
7,179 |
8,033 |
5,410 |
5,716 |
||
Profit After Tax (FRS 3) |
21,234 |
14,015 |
10,799 |
8,065 |
6,910 |
5,716 |
||
EPRA earnings |
1,463 |
4,707 |
7,704 |
4,850 |
5,410 |
5,716 |
||
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 |
4,995 |
5,510 |
5,816 |
||
Average Number of Shares Outstanding (m) |
5.3 |
17.1 |
24.6 |
25.7 |
25.5 |
25.5 |
||
EPS - normalised (p) |
|
32.9 |
24.8 |
29.2 |
31.3 |
21.2 |
22.4 |
|
EPS - FRS 3 (p) |
|
403.4 |
82.0 |
43.9 |
31.4 |
27.0 |
22.4 |
|
Adjusted EPS |
|
29.7 |
28.3 |
18.9 |
20.9 |
21.9 |
23.1 |
|
EPRA EPS (p) |
|
27.8 |
27.5 |
31.3 |
20.4 |
21.2 |
22.4 |
|
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 |
1.13 |
1.18 |
1.24 |
||
BALANCE SHEET |
||||||||
Fixed Assets |
|
60,086 |
104,470 |
175,738 |
181,007 |
182,507 |
184,507 |
|
Investment properties |
59,440 |
102,988 |
174,542 |
179,997 |
181,497 |
183,497 |
||
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 |
17,232 |
14,979 |
12,232 |
|
Debtors |
1,937 |
3,375 |
3,327 |
3,170 |
3,170 |
3,170 |
||
Cash |
5,123 |
12,279 |
8,576 |
14,062 |
11,809 |
9,062 |
||
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) |
(7,952) |
||
Short term borrowings |
(1,200) |
(400) |
(2,233) |
(3,241) |
(3,241) |
(3,241) |
||
Long Term Liabilities |
|
(18,599) |
(36,620) |
(71,778) |
(78,775) |
(75,539) |
(73,503) |
|
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) |
(2,066) |
(2,066) |
(2,066) |
||
Net Assets |
|
44,376 |
80,016 |
106,815 |
108,271 |
110,754 |
112,043 |
|
Net Assets excluding goodwill and deferred tax |
44,370 |
80,010 |
106,815 |
108,271 |
110,754 |
112,043 |
||
Basic NAV/share (p) |
219 |
395 |
414 |
430 |
433 |
439 |
||
EPRA NAV/share (p) |
219 |
396 |
414 |
430 |
433 |
439 |
||
CASH FLOW |
||||||||
Operating Cash Flow |
|
1,297 |
4,388 |
12,287 |
9,663 |
9,176 |
9,173 |
|
Net Interest |
(390) |
(1,593) |
(3,421) |
(2,529) |
(2,427) |
(2,328) |
||
Tax |
(13) |
(15) |
(158) |
(876) |
(1,219) |
(1,009) |
||
Preference share dividends paid |
(18) |
0 |
0 |
0 |
0 |
0 |
||
Net cash from investing activities |
2,532 |
(2,922) |
(50,012) |
(2,258) |
(20) |
(2,020) |
||
Ordinary dividends paid |
0 |
(1,766) |
(3,221) |
(4,612) |
(4,527) |
(4,527) |
||
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) |
(2,180) |
0 |
0 |
||
Net Cash Flow |
5,085 |
7,155 |
(4,141) |
5,487 |
(2,253) |
(2,747) |
||
Opening cash |
|
39 |
5,123 |
12,278 |
8,576 |
14,063 |
11,809 |
|
Other items (including cash assumed on acquisition) |
0 |
0 |
439 |
0 |
0 |
0 |
||
Closing cash |
|
5,123 |
12,278 |
8,576 |
14,063 |
11,809 |
9,062 |
|
Opening net debt/(cash) |
1,724 |
13,476 |
24,742 |
65,435 |
67,954 |
66,971 |
||
Closing net debt/(cash) |
13,476 |
24,742 |
65,435 |
67,954 |
66,971 |
67,682 |
||
Source: Company data, Edison Investment Research
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SLI’s financial performance in H1 reflected its current transitional phase with ARR remaining flat as the business is realigned to focus on value over volume through a number of initiatives. The key customer retention rate is reverting to historical levels and with an operationally geared model, we believe that only a modest recovery in new business momentum should support robust upside. Net cash stands at NZ$6m.