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Research: Real Estate
Regional REIT (RGL) will report its FY18 results on 28 March 2018. Several recent updates provide us with comfort that the company is on track to meet our unchanged expectations for strong total returns in FY18, and for income growth in FY19. We expect the latter to be driven by the reinvestment of disposal proceeds, occupancy and rental growth, and interest savings from the repayment of higher-cost debt.
Regional REIT |
Confirming outlook |
Business update |
Real estate |
6 March 2019 |
Share price performance
Business description
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Regional REIT is a research client of Edison Investment Research Limited |
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Regional REIT (RGL) will report its FY18 results on 28 March 2018. Several recent updates provide us with comfort that the company is on track to meet our unchanged expectations for strong total returns in FY18, and for income growth in FY19. We expect the latter to be driven by the reinvestment of disposal proceeds, occupancy and rental growth, and interest savings from the repayment of higher-cost debt.
Year end |
Net rental |
Adjusted |
EPRA NAV/ |
DPS |
P/EPRA |
Yield |
12/16 |
38.1 |
7.8 |
106.9 |
7.65 |
0.95 |
7.5 |
12/17 |
45.8 |
8.6 |
105.9 |
7.85 |
0.96 |
7.7 |
12/18e |
53.5 |
7.3 |
114.8 |
8.05 |
0.88 |
7.9 |
12/19e |
56.0 |
8.6 |
118.3 |
8.25 |
0.86 |
8.1 |
Note: *Adjusted EPS excludes revaluation movements, gains/losses on disposal, and other non-recurring items, as well as the performance fee accrual included in EPRA EPS.
Continuing to forecast strong FY18 total return…
FY18 results will be published on 28 March 2018. Our unchanged forecasts imply a strong 16.0% full year NAV total return, including increased aggregate DPS of 8.05p per share (FY17: 7.85p), confirmed by the declaration of a Q418 DPS of 2.50p per share for payment in April. Significant disposals of mature assets at prices well ahead of valuation, and at yields well below reinvestment levels, have also driven FY18 returns, position the portfolio for further growth and demonstrate the creation of value through asset management. Although the time lag to reinvestment has a temporarily negative impact on income and DPS cover, levels, earnings and dividend cover should rebound in FY19 driven by reinvestment, occupancy and rental growth, as well as interest savings from the repayment of higher-cost debt.
…with progress towards FY19 income rebound
Since our November update several announcements have indicated progress towards our FY19 expectations. Repayment of relatively expensive debt has been completed, including the £39.9m 6.5% ZDP in January 2019, and additional facilities have provided increased funding flexibility at lower cost. With disposals running ahead of reinvestment the year-end LTV fell faster than we had expected, to 38.3%, and below the medium-term target of 40%. The end-FY18 portfolio value has been confirmed at £718.4m, a 4.5% like-for-like increase on the prior year level after adjusting for portfolio transactions and capex. RGL continues to opportunistically seek reinvestment opportunities and completed a £20m acquisition in early February at a 7.92% net initial yield. Strong letting progress towards the year end and into 2019, despite Brexit uncertainty, is also positive.
Strong returns with income focus
RGL continues to generate strong total returns and its c 8.1% prospective (FY19) yield remains one of the highest in the sector. Dividend policy is progressive and we expect DPS to be fully covered by adjusted earnings in FY19.
Details of recent announcements
Since we last published on RGL in November 2018, the group has provided several updates in respect of debt refinancing measures and the repayment of higher cost debt, significant letting activity and acquisitions. It has also confirmed dividends in line with the FY18 dividend target and, despite rising Brexit uncertainty, the end-FY18 portfolio valuation appears consistent with our NAV forecasts.
In more detail the announcements include:
■
Financing. In December 2018 RGL agreed a new £36m secured 10-year facility at a rate of between 3.45–3.60% (the final rate will be set at drawdown) and extended the existing £34.3m RBS facility for one year to 2021. The new facility should provide RGL with greater flexibility in terms of capital recycling, enabling the company to draw on debt facilities for purchases without necessarily first locking in disposals. The outstanding £13m balance of the 5% ICG Longbow facility, due to mature in August 2019, was repaid in December and £39.9m was paid to the holders of the 6.5% zero dividend preference shares (ZDPs) upon maturity in January. Following this activity, the group’s cost of borrowing including hedging costs has reduced to c 3.5% with an average remaining term (as at January 2019) of 7.2 years. The year-end LTV fell to 38.3%, below the medium-term target of 40%, and benefitting from disposals running ahead of reinvestment.
■
Portfolio valuation. The 31 December 2018 portfolio value was £718.4m, a 4.5% like-for-like increase on the prior year after adjusting for portfolio transactions and capex. During the year, RGL used the strength of the investment market to dispose of mature properties to a value of £152.5m (before costs), locking in aggregate gains of £23.1m on the year opening valuations, and recycling capital into £73.3m of new opportunities at higher yields.
■
£20m office acquisition in central Birmingham. On 4 February 2019 RGL announced the completed acquisition of Norfolk House, a c 120 sq ft freehold office property with retail units, well situated in central Birmingham, adjacent to New Street station, the Bullring shopping centre and close to the proposed new HS2 station, providing enhanced rail links to London and Manchester. The property is 98.75% occupied with an annual net income of £1.69m and the £20m consideration reflects a net initial yield of 7.92%. The main tenant for the office accommodation is HMRC, occupying 49% of the property. Despite substantial capital expenditure for refurbishment having been undertaken by the vendor, RGL believes that attractive value-enhancing asset management opportunities remain.
■
Substantial letting activity. Despite some market indications that executing on lease agreements may be taking longer, in part as a result of Brexit uncertainty, RGL reported a strong finish to 2018 with momentum continuing into 2019. This included securing Bristol’s largest letting in the out-of-town office market for the second quarter running.
No changes to estimates ahead of FY18 results on 28 March
The recent announcements made by RGL seem broadly consistent with our forecasts for earnings and NAV shown in Exhibit 1 and we are making no changes ahead of the full year results. Our FY18 forecast includes the expectation of c £40m of “end-year” acquisitions that have clearly been deferred into FY19, but partly realised with the Birmingham acquisition. This has a positive impact on end-FY18 debt and LTV compared with our forecasts shown in Exhibit 1.
Since IPO (and up to H118), RGL has generated an NAV total return of 32.0% or a compound average annual return of 11.0%. This is in line with the company’s target of generating a total shareholder return of at least 10% pa and makes no adjustment for IPO costs. Our forecasts indicate further progress in H218.
The FY19 prospective yield of 8.1% continues to position RGL at the very high end of the broad UK property sector, and we forecast that the FY19 DPS will increase and be fully covered by adjusted earnings. Meanwhile, the shares trade at a c 12% discount to our forecast end-FY18 EPRA NAV per share.
Exhibit 1: Financial summary
Year end 31 December (£000's) |
2015 |
2016 |
2017 |
2018e |
2019e |
|||
PROFIT & LOSS |
IFRS |
IFRS |
IFRS |
IFRS |
IFRS |
|||
Gross rental income |
5,361 |
42,994 |
52,349 |
60,683 |
63,242 |
|||
Non-recoverable property costs |
(754) |
(4,866) |
(6,502) |
(7,197) |
(7,278) |
|||
Revenue |
|
|
4,608 |
38,128 |
45,847 |
53,487 |
55,964 |
|
Administrative expenses (excluding performance fees) |
(1,353) |
(7,968) |
(7,819) |
(10,260) |
(10,549) |
|||
Performance fees |
0 |
(249) |
(1,610) |
(5,238) |
(1,318) |
|||
EBITDA |
|
|
3,255 |
29,911 |
36,418 |
37,989 |
44,097 |
|
EPRA cost ratio |
n.m |
29.6% |
29.7% |
36.8% |
29.6% |
|||
EPRA cost ratio excluding performance fee |
n.m |
29.0% |
26.6% |
28.1% |
27.5% |
|||
Gain on disposal of investment properties |
87 |
518 |
1,234 |
16,404 |
0 |
|||
Change in fair value of investment properties |
23,784 |
(6,751) |
5,893 |
26,065 |
11,420 |
|||
Operating profit before financing costs |
|
|
27,126 |
23,678 |
43,545 |
80,457 |
55,517 |
|
Exceptional items |
(5,296) |
0 |
0 |
0 |
0 |
|||
Net finance expense |
(820) |
(8,629) |
(14,513) |
(15,756) |
(13,061) |
|||
Net movement in the fair value of derivative financial investments and impairment of goodwill |
115 |
(1,654) |
(340) |
39 |
0 |
|||
Profit Before Tax |
|
|
21,124 |
13,395 |
28,692 |
64,741 |
42,456 |
|
Tax |
0 |
23 |
(1,632) |
(355) |
0 |
|||
Profit After Tax (FRS 3) |
|
|
21,124 |
13,418 |
27,060 |
64,386 |
42,456 |
|
Adjusted for the following: |
||||||||
Net gain/(loss) on revaluation/disposal of investment properties |
(23,870) |
6,233 |
(7,127) |
(42,469) |
(11,420) |
|||
Net movement in the fair value of derivative financial investments |
(180) |
865 |
(407) |
(362) |
0 |
|||
Other EPRA adjustments including deferred tax adjustment |
0 |
557 |
4,488 |
473 |
0 |
|||
EPRA earnings |
|
|
(-2,926) |
21,073 |
24,014 |
22,028 |
31,036 |
|
Performance fees & exceptional items |
5,296 |
249 |
1,610 |
5,238 |
1,318 |
|||
Adjusted earnings |
|
|
2,371 |
21,322 |
25,624 |
27,266 |
32,354 |
|
Period end number of shares (m) |
274.2 |
274.2 |
372.8 |
372.8 |
376.4 |
|||
Fully diluted average number of shares outstanding (m) |
274.2 |
274.3 |
297.7 |
375.5 |
377.3 |
|||
IFRS EPS - fully diluted (p) |
|
|
7.7 |
4.9 |
9.7 |
17.4 |
11.3 |
|
Adjusted EPS, fully diluted (p) |
|
|
0.9 |
7.8 |
8.6 |
7.3 |
8.6 |
|
EPRA EPS, fully diluted (p) |
|
|
(1.1) |
7.7 |
8.1 |
5.9 |
8.2 |
|
Dividend per share, declared basis (p) |
|
|
1.00 |
7.65 |
7.85 |
8.05 |
8.25 |
|
Dividend cover |
n.a. |
102% |
110% |
90% |
104% |
|||
BALANCE SHEET |
||||||||
Non-current assets |
|
|
407,492 |
506,401 |
740,928 |
759,364 |
778,784 |
|
Investment properties |
403,703 |
502,425 |
737,330 |
756,478 |
775,898 |
|||
Other non-current assets |
3,790 |
3,976 |
3,598 |
2,886 |
2,886 |
|||
Current Assets |
|
|
35,803 |
27,574 |
66,587 |
115,264 |
69,081 |
|
Other current assets |
11,848 |
11,375 |
21,947 |
21,040 |
19,105 |
|||
Cash and equivalents |
23,954 |
16,199 |
44,640 |
94,224 |
49,976 |
|||
Current Liabilities |
|
|
(21,485) |
(23,285) |
(42,644) |
(95,493) |
(52,486) |
|
Bank and loan borrowings - current |
(200) |
0 |
(400) |
(39,795) |
0 |
|||
Other current liabilities |
(21,285) |
(23,285) |
(42,244) |
(55,698) |
(52,486) |
|||
Non-current liabilities |
|
|
(126,469) |
(218,955) |
(371,972) |
(349,600) |
(350,600) |
|
Bank and loan borrowings - non-current |
(126,469) |
(217,442) |
(371,220) |
(349,166) |
(350,166) |
|||
Other non-current liabilities |
0 |
(1,513) |
(752) |
(434) |
(434) |
|||
Net Assets |
|
|
295,341 |
291,735 |
392,899 |
429,536 |
444,779 |
|
Derivative interest rate swaps & deferred tax liability |
416 |
1,513 |
2,802 |
2,678 |
2,678 |
|||
EPRA net assets |
|
|
295,757 |
293,248 |
395,701 |
432,214 |
447,457 |
|
IFRS NAV per share (p) |
107.7 |
106.4 |
105.4 |
115.2 |
118.2 |
|||
Fully diluted EPRA NAV per share (p) |
107.8 |
106.9 |
105.9 |
114.8 |
118.3 |
|||
CASH FLOW |
||||||||
Cash (used in)/generated from operations |
|
|
(2,232) |
31,434 |
40,251 |
49,709 |
42,820 |
|
Net finance expense |
(424) |
(6,626) |
(9,167) |
(12,071) |
(12,061) |
|||
Tax paid |
0 |
(1,715) |
(236) |
(131) |
0 |
|||
Net cash flow from operations |
|
|
(2,656) |
23,093 |
30,848 |
37,507 |
30,759 |
|
Net investment in investment properties |
1,157 |
(99,286) |
(8,267) |
26,710 |
(8,000) |
|||
Acquisition of subsidiaries, net of cash acquired |
26,659 |
(5,573) |
(51,866) |
(2,332) |
0 |
|||
Other investing activity |
13 |
60 |
25 |
59 |
0 |
|||
Net cash flow from investing activities |
|
|
27,828 |
(104,799) |
(60,108) |
24,437 |
(8,000) |
|
Equity dividends paid |
0 |
(15,723) |
(23,321) |
(23,034) |
(30,774) |
|||
Debt drawn/(repaid) - inc bonds and ZDP |
(1,217) |
91,417 |
13,921 |
12,327 |
0 |
|||
Other financing activity |
0 |
(1,744) |
67,101 |
(1,653) |
(36,233) |
|||
Net cash flow from financing activity |
|
|
(1,217) |
73,950 |
57,701 |
(12,360) |
(67,007) |
|
Net Cash Flow |
|
|
23,955 |
(7,756) |
28,441 |
49,584 |
(44,248) |
|
Opening cash |
0 |
23,955 |
16,199 |
44,640 |
94,224 |
|||
Closing cash |
|
|
23,955 |
16,199 |
44,640 |
94,224 |
49,976 |
|
Balance sheet debt |
(126,669) |
(217,442) |
(371,620) |
(388,961) |
(350,166) |
|||
Unamortised debt costs |
(1,875) |
(2,618) |
(4,693) |
(4,195) |
(3,195) |
|||
Closing net debt |
|
|
(104,588) |
(203,861) |
(331,673) |
(298,932) |
(303,385) |
|
LTV |
25.9% |
40.6% |
45.0% |
39.5% |
39.1% |
|||
Source: Company data, Edison Investment Research
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