Picton Property Income — Earnings and outperformance maintained

Picton Property Income (LSE: PCTN)

Last close As at 21/05/2024

GBP0.68

−1.30 (−1.88%)

Market capitalisation

GBP381m

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Research: Real Estate

Picton Property Income — Earnings and outperformance maintained

For FY23 Picton Property Income (PCTN) published resilient underlying (EPRA) earnings, which together with strong rent collection supported a 4% increase in DPS paid. The impact of market-wide property yield widening on NAV was mitigated by portfolio outperformance and low gearing. Continuing occupier demand, rent growth and mostly long-term, fixed-rate borrowings are positive indicators for further progress.

Martyn King

Written by

Martyn King

Director, Financials

Real Estate

Picton Property Income

Earnings and outperformance maintained

FY23 results

Real estate

4 July 2023

Price

71p

Market cap

£387m

Net debt at 31 March 2023

£204.4m

Net LTV at 31 March 2023

26.7%

Shares in issue

545.2m

Free float

100%

Code

PCTN

Primary exchange

LSE

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

(9.2)

0.7

(18.4)

Rel (local)

(7.9)

2.6

(21.5)

52-week high/low

93.30p

66.90p

Business description

Picton Property Income is an internally managed UK REIT that invests in a diversified portfolio of commercial property across the UK. It is total return driven with an income focus and aims to generate attractive returns through proactive management of the portfolio

Next events

Q124 NAV announcement

July 2023

Analyst

Martyn King

+44 (0)20 3077 5700

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

For FY23 Picton Property Income (PCTN) published resilient underlying (EPRA) earnings, which together with strong rent collection supported a 4% increase in DPS paid. The impact of market-wide property yield widening on NAV was mitigated by portfolio outperformance and low gearing. Continuing occupier demand, rent growth and mostly long-term, fixed-rate borrowings are positive indicators for further progress.

Year end

Net property income (£m)

EPRA
earnings* (£m)

EPRA
EPS* (p)

DPS
paid (p)

NAV** per share (p)

P/NAV
(x)

Yield
(%)

03/22

35.4

21.2

3.9

3.38

120

0.59

4.8

03/23

36.3

21.3

3.9

3.50

100

0.71

4.9

03/24e

38.4

21.8

4.0

3.58

101

0.70

5.0

03/25e

39.2

22.4

4.1

3.68

102

0.70

5.2

Note: *EPRA earnings exclude revaluation gains/losses and other exceptional items. **NAV measure is net tangible assets (NTA), currently the same as IFRS NAV.

Leasing progress while market pricing is stabilising

FY23 income increased as a result of acquisitions and asset management activity, offsetting higher property costs, affected by inflationary pressures and lower occupancy. Benefiting from the late FY22 refinancing, interest costs were relatively stable. EPRA earnings of £21.3m or 3.9p per share showed no material change (FY22: £21.2m) and covered DPS declared of 3.5p by 1.12x. Reflecting property valuation losses, EPRA NAV per share was 100p (FY22: 120p) and the NAV total return was -13.7%. At the portfolio level, PCTN continued to outperform the MSCI UK Quarterly Property Index, as it has done continuously in each of the past 10 years, with an upper quartile performance over three, five and 10 years, and since launch in 2005. Our FY24 forecasts for EPRA earnings and NAV are increased slightly and we continue to expect a modest increase in DPS.

Focused on further income growth

PCTN’s financial and operational performance continues to benefit from active asset management, including capex that aims to enhance the quality, sustainability and occupier appeal of assets. The organic growth opportunity remains strong with a c £3.0m gap between passing rents and market rents, mostly in industrials, and a £5.3m upside from letting vacant space. Driven by industrials, estimated rental value (ERV) increased by a like-for-like 9% during FY23. The balance sheet is strong; borrowing is nearly all fixed rate and long term, with undrawn facilities available to support growth. The latter may include additional opportunistic acquisitions while the company is also attuned to consolidation opportunities where there is an opportunity to create additional value, leveraging its performance record and scalable internal management platform.

Valuation: Fully covered DPS with surplus for growth

The current annualised rate of DPS (3.5p) represents a prospective yield of 5.0% and we currently forecast further growth, fully covered in FY24. The FY23e P/NAV ratio is c 0.7x, below the five-year average of c 0.94x and a peak of c 1.1x.

Investment summary

Despite growing headwinds from the war in Ukraine, sharply rising inflation and interest rates, the UK economy has avoided recession and the occupier market has, at least for now, remained resilient. Picton remains focused on growing income further, through increased occupancy and capturing reversionary rental upside, and gaining cost efficiencies through growth, where opportunities arise. While property market valuations are difficult to predict, the opening months of 2023 have shown increasing signs of stability, despite persistent inflation maintaining upwards pressure on interest rates and bond yields. Over time we would expect valuations to follow the development of income. The key elements of Picton’s investment case, covered throughout this report, include the following:

Picton provides diversified exposure to UK commercial real estate with a well-established track record of performance. Diversification adds to income stability while providing the flexibility to adapt the portfolio to changing market conditions across the cycle.

Successful asset management is underpinned by the group’s occupier focus whereby it seeks to work closely with tenants to understand their needs, enhance occupancy, improve tenant retention and maximise income.

Accretive acquisitions made in FY23 (for an aggregate £21m before costs) are yet to fully contribute to earnings and there is significant ‘reversionary’ growth potential embedded within the portfolio to support future income and capital values.

Commercial real estate has traditionally provided a medium-term hedge against inflation as, at least in part, this is reflected in rental growth and valuations over time. Increased building costs are likely to restrict new construction.

The balance sheet is conservatively positioned with moderate gearing while all structural debt, and 95% of drawn debt, is long term and fixed rate, providing protection against increasing interest rates. Shorter-term, flexible floating rate debt capacity represents just 5% of all drawn borrowings and £38m is available for opportunistic investment opportunities.

With its strong balance sheet, consistently positive track record of property outperformance, experienced management team and internal management structure, the company is well positioned to participate in sector consolidation where opportunities may arise that would create value for shareholders. We note that as an internally managed real estate investment trust (REIT), its cost structure is not directly linked to assets under management, reinforcing the positive impact of increased scale on efficiency.

Summary of FY23 financial performance

FY23 EPRA earnings were in line with our forecasts, while NAV was slightly stronger, the likelihood of which we flagged following the trading update published by the company in April. A key feature of the EPRA earnings performance was strong leasing activity amid continuing rent growth, sufficient to offset higher property costs, the result of inflationary pressures and higher void costs. While leasing activity successfully captured rental upside in the portfolio, EPRA occupancy was lower at 91%, down from 93%. In part this includes the impact of acquisitions and a small number of lease surrenders, both creating asset management opportunities, but also a more cautious approach by businesses to taking new space amid economic and political uncertainty. On a like-for-like basis, contracted rents increased 3% and, as lease incentives rolled off, passing rent by 10%. Estimated rental value increased by 10%. We discuss the property portfolio outperformance in the following section, but note that the 12% like-for-like decline in the value of Picton’s portfolio compared favourably with the MSCI UK Quarterly Index capital return of -16.1%.

Exhibit 1: Summary of FY23 financial performance

£m unless stated otherwise

FY23

FY22

FY23/FY22

Rental income

43.0

40.1

7.1%

Other income

0.4

0.2

Net property operating costs

(3.5)

(2.5)

40.9%

Void costs

(3.6)

(2.4)

51.4%

Net property income

36.3

35.4

2.3%

Total operating expenses

(6.0)

(5.8)

3.5%

Net finance expense

(9.0)

(8.5)

6.0%

EPRA earnings

21.3

21.2

0.5%

Debt prepayment fees

0.0

(4.0)

Profit on disposal of investment property

0.0

0.0

Investment property valuation movements

(110.8)

129.8

IFRS net profit/(loss)

(89.5)

147.0

EPRA EPS (p)

3.9

3.9

0.6%

IFRS EPS (p)

(16.5)

26.9

DPS declared (p)

3.50

3.45

1.4%

DPS paid (p)

3.50

3.38

3.7%

Dividend cover (x)

1.12

1.15

Net assets, IFRS & EPRA

547.6

657.1

NAV per share, IFRS & EPRA (p)

100

120

-16.6%

NAV total return*

-13.7%

27.9%

Carried value of investment properties

746.3

830.0

Net LTV

26.7%

21.2%

Source: Picton Property Income data, Edison Investment Research. Note: *Adjusts for dividends paid but does not assume reinvestment of dividends. Including reinvestment, Picton calculates NAV total return as -13.9%.

Key features included:

Rental income earned in the year increased c £3m or 7% as a result of the acquisitions and asset management (lettings, lease renewals and re-gears). 99% of rents were collected.

Income growth was partly offset by higher property and void costs, in turn reflecting inflationary cost pressures and higher average voids, with net property income increasing by c 2% to £36.3m.

Administrative costs were controlled, increasing by just £0.2m to £6.0m.

Finance costs rose slightly, by £0.5m to £9.0m, benefiting from debt refinancing in March 2022,1 offset by increased overall borrowings to fund acquisitions.

  Which extended and increased one of its two principal fixed-rate, long-term debt facilities at a reduced rate.

EPRA earnings were effectively unchanged at £21.3 (FY22: £21.2m) or 3.9p per share (FY22: 3.9p).

Four quarterly dividends of 0.875p were declared during the year, a total of 3.50p (FY22: 3.45p) and annual dividends paid increased c 4% to 3.50p (FY22: 3.38p).

Exhibit 2: Change in EPRA earnings

Source: Picton Property Income data, Edison Investment Research

Including property revaluation losses, the IFRS loss was £89.5m (FY22: £147.0m profit) and NAV per share was 100p (FY22: 120p). Adjusted for dividends paid (without assuming reinvestment), the accounting total return was -13.7%. On the company basis, which assumes reinvestment of dividends, the total return was -13.9%.

Although we expect fixed-rate debt to be held to maturity, as a result of rising market interest rates it has a fair value that is £22.8m lower than its carrying value. This positive effect is not reflected in the income statement or balance sheet, but is reflected in the EPRA net disposal value of 105p per share.

Returns driven by strong track record of portfolio outperformance

Accounting returns have averaged 10.5% pa over the past 10 years

Picton’s investment strategy is total return driven with an income focus and aims to generate attractive returns through proactive management of the portfolio, investing in assets where it believes there are opportunities to enhance income and/or value. Its dividend policy is to distribute most of the recurring income earnings to shareholders via quarterly dividends, maintaining full cover, and generating surplus cash for reinvestment back into the portfolio. Despite a challenging FY23, the cumulative 10-year NAV total return2 has been 171.9%, or an average 10.5% pa. Reflecting the total return investment strategy, capital returns have contributed c 60% of total returns.

  The change in NAV adjusted for dividends paid but not reinvested.

Exhibit 3: 10-year accounting total return history

Year ending 31 March

FY14

FY15

FY16

FY17

FY18

FY19

FY20

FY21

FY22

FY23

10-year

Opening NAV per share (p)

49

56

69

77

82

90

93

93

97

120

49

Closing NAV per share (p)

56

69

77

82

90

93

93

97

120

100

100

DPS paid (p)

3.0

3.3

3.3

3.3

3.4

3.5

3.5

2.8

3.4

3.5

32.9

Income return/dividends paid

6.1%

5.9%

4.8%

4.3%

4.2%

3.9%

3.8%

2.9%

3.5%

2.9%

67.1%

Capital return/change in NAV

14.9%

21.6%

12.7%

5.9%

10.5%

2.6%

0.7%

3.7%

24.4%

-16.6%

104.7%

NAV total return

21.0%

27.4%

17.6%

10.2%

14.7%

6.4%

4.4%

6.6%

27.9%

-13.7%

171.9%

Average annual total return

10.5%

Source: Picton Property Income data, Edison Investment Research

In common with the sector, the across-the-cycle income return has been much more stable than the capital return. Successful asset management is thus key to a sustainably enhancing total return.

Exhibit 4: Income provides a relatively more stable bedrock to performance

Source: Picton Property Income data, Edison Investment Research

Consistent portfolio outperformance

The key driver of Picton’s total return performance has been the consistently strong property portfolio return, measured before the impact of gearing or non-property costs. The company has outperformed the MSCI Quarterly Property Index in each of the past 10 years, and is ranked fifth out of 141 funds, with upper-quartile performances over three, five and 10 years and since launch in 2005. Although the FY23 property total return was negative, -8.7%, this compared favourably with the index return of -12.6%

Exhibit 5: Annual total property returns (%)

Source: Picton Property Income, MSCI. Note: Data to 31 March 2023.

Among the factors supporting this strong performance, we note PCTN’s successful record of asset management, diversified sector strategy and disciplined, opportunistic acquisition strategy:

The successful asset management is underpinned by the group’s occupier focus, whereby it seeks to work closely with tenants to understand their needs, enhance occupancy, improve retention and maximise income.

During FY23, 67% of the £5.5m total ERV at risk from lease expiry was retained through a range of asset management transactions. Completed or agreed new lettings secured £2.3m pa of rent at an average 25% premium to the March 2022 ERV, lease renewals and regears retained £0.7m pa of income at an average 6% premium to ERV, and rent reviews added a further £0.7m to passing rents, an average 7% premium to ERV.

Reinvestment back into the portfolio, including sustainability upgrades, to maintain its attractiveness to occupiers and enhance income and/or value is an important element of strategy and differentiates the company from those peers that are primarily income focused. In FY23, £6m was invested into the portfolio across more than 15 separate projects.

The company is currently reviewing, on a project-by project basis, whether it is appropriate to install renewable energy, primarily in the form of solar panels, as part of its refurbishment projects. This was recently completed on three industrial assets, and while this involves additional upfront costs, in due course it will generate a modest supplementary revenue stream.

They key voids in Picton’s property portfolio are all within the office sector (83% occupancy). Many of the properties have had been invested in over recent years to upgrade space, create occupier amenities and improve their sustainability credentials. In line with market trends, the best of these are attracting and retaining occupiers. At selected locations, in smaller units, Picton’s flexible office offering, Swiftspace, is proving successful. More radically, at three selected properties, accounting for c 8pps of sector vacancy, the company is exploring potential change of use to residential and student accommodation.

Successful stock selection and asset recycling: Picton has an unconstrained, opportunistic and primarily asset-driven approach to portfolio construction, while nonetheless maintaining a diversified portfolio. This provides the flexibility to adjust the portfolio to changing market conditions. The strong weighting to industrials in recent years (57% at end-FY23) reflects the depth of opportunities in the sector, which benefits from positive demand-supply fundamentals and continuing rental growth. Conversely, traditional retail has for some time offered only selective opportunities in the face of over-supply and falling rents, and two-thirds of sector exposure is to retail warehouses, which are better supported by trend changes in consumer spending habits and are underpinned by value-led retailers.

Exhibit 6: Development of sector weighting

Source: Picton Property Income data

Sustainability enhancement and the path to net zero carbon

A responsible approach to business and an increasing environmental focus, for the benefit of all stakeholders, has become essential. In May 2022, Picton published its net zero carbon pathway and became a signatory to the Better Buildings Partnership (BBP) Climate Commitment.3 The pathway sets out the company’s plan to achieve net zero carbon (NZC) for both operational and embodied emissions4 by 2040, 10 years ahead of the government target, including the emissions of occupiers. The focus has initially been on Scope 1 and 2 emissions, which have reduced by 24% compared with the 2019 baseline. Renewable energy is now being incorporated across larger refurbishments and, increasingly, the company is working with occupiers to reduce the most significant part of the portfolio’s emissions, which fall under Scope 3.

  The BBP is a collaboration of leading UK commercial property owners that are working together to improve the sustainability of existing real estate stock. The BBP Climate Commitment requires signatories to publish net zero carbon (NZC) pathways and delivery plans, disclose the energy performance of their assets and develop comprehensive climate resilience strategies. It targets NZC buildings by 2050 incorporating both direct and indirect investments, operational and embodied carbon, and Scope 1, 2 and 3 greenhouse gas (GHG) emissions. Although a complex area, in simple terms relating to Picton, Scope 1 emissions relate to GHGs that the company releases directly; Scope 2 emissions relate to the company’s indirect emissions such as the energy that it buys for its own heating and cooling; scope 3 emissions relate to the tenants and is the most significant and complex category.

  Embodied emissions are associated with the manufacturing, transportation and construction of building materials, as well as building disposal.

With much work still to do to meet its targets, Picton has continued to develop team training on sustainability issues and has additionally recruited a head of building surveying, who will coordinate the building fabric related improvements that are required to improve its assets.

Opportunities to increase income

Strong organic opportunity

The end-FY23 ERV of £55.8m was £12.5m or 29% ahead of passing rent of £43.3m, providing a strong opportunity to organically increase income. Void reduction represented £5.3m of the potential upside, with the balance comprising the upside from lease incentive run-off (c £4.2m) and the potential to increase existing rents to market levels at lease expiry (c £3.0m).

Exhibit 7: ERV by sector at end-FY23.

£m unless stated otherwise

Passing rent

ERV

Occupancy

Reversion

Total

Void reduction

Other*

Industrial

20.0

27.6

95%

7.6

1.3

6.3

Office

15.6

21.2

83%

5.6

3.6

2.0

Retail and leisure

7.7

7.0

94%

(0.7)

0.4

(1.1)

Total portfolio

43.3

55.8

91%

12.5

5.3

7.2

Source: Picton Property Income data and Edison Investment Research estimates. Note: Columns may not total due to rounding. *Includes £4.2m of rent free ‘run-off’ and £3.0m upside from contracted rents to market rents.

By sector, the greatest potential is within the industrial and office sectors. With occupancy high in the industrial sector (and of the eight units that are vacant, four are under refurbishment), the upside is from reversion to market rents, which continue to increase. The passing rent of the industrials portfolio increased by 13% in FY23 and the ERV grew by 18%, or £4.1m on a like-for-like basis.

At 90.5% at end-FY23, EPRA occupancy is in line with the five-year average but below the 10-year average of c 93% and almost 6% below the 10-year high. As noted above, the office sector provides significant potential from void reduction, through letting or in some cases repurposing. With service costs typically higher in the office sector, void reduction also has a disproportionately positive impact on property costs. The £3.6m office void potential represents 6pps of the total 9.5% portfolio void.

Exhibit 8: 10-year portfolio occupancy trend

Source: Picton Property Income data

Selective external growth

Utilising its strong balance sheet, the company continued to undertake opportunistic, accretive acquisitions during FY23. In May 2022 it acquired two mixed-use properties, with retail/leisure on the ground floors and offices above, in Hammersmith and Cheltenham, for £19.0m before acquisition costs. Both properties were acquired at low capital values, below their estimated replacement cost.

The Hammersmith property, currently providing office and retail space, is located close to Olympia, which is currently undergoing a £1bn redevelopment delivering a new creative district, with a new theatre, entertainment venue and hotel, office, retail and leisure space, which will enhance the surrounding area. The property offers significant asset management potential, with the £13.7m consideration, settled from available cash resources, reflecting an immediate net initial yield of 3.3%, but more than 8% once fully let. Meanwhile, Picton has applied for planning consent for conversion of some of the vacant office space to residential use. Residential values in the area are approximately £1,000 per sq ft, well ahead of the overall £417 per sq ft capital value at acquisition.

The Cheltenham property, located in the town centre, was completely refurbished in 2020 and has strong environmental credentials, with an EPC rating of B on the office and retail elements. It is fully leased to four occupiers including Tesco, Just Go Holidays and Barnardo’s, with an average lease length of 12 years to expiry and eight years to break. The consideration of £5.3m, funded from Picton’s flexible revolving credit facility, reflected a net initial yield of 7.2%, rising to 9.0% by 2026 with most leases containing fixed rent uplifts.

Attuned to external opportunities

Discounts to NAV persist across the REIT sector, prohibiting equity raising to part-fund acquisition-led growth, to increase scale and generate cost efficiencies. For as long as this persists, we expect further sector consolidation aimed at creating larger, more liquid and efficient businesses.

Picton’s internal management model means that its costs are not linked to net asset value or portfolio value, providing a clear opportunity for earnings accretion from external growth, for which its strong balance sheet, experienced management team and strong portfolio performance position it well. The company says that it has proactively considered various opportunities and is open to transactions that would create value for its shareholders.

Inflation protection from predominantly long-term, fixed-rate debt

Picton’s balance sheet is strong and substantially protected against further interest rate increases. Following a late-FY22 debt refinancing, both the company’s long-term credit facilities are fixed rate with a blended average cost of 3.7% and a blended average maturity of c 10 years. A shorter-term floating rate revolving credit facility5 (RCF) of £50m, providing flexibility to take advantage of further growth opportunities when identified, was c £12m drawn at end-FY23.

  The RCF provides the ability to draw and repay during the term of the loan.

Total drawn debt at end-FY23 was £224.5m at a blended cost (including the RCF drawings) of 3.8% with a weighted average maturity of 8.4 years. Adjusting for cash of £20.1m, net debt was £204.4m and the loan to value (LTV) ratio was 26.7%.

Exhibit 9 Summary of debt portfolio

Lender

Canada Life

Aviva

NatWest RCF

Amount drawn

£129m

£85m

£11.9m

Undrawn

Fully drawn

Fully drawn

£38.1m

Maturity

Jul-31

Jul-32

May-25

Interest rate

Fixed 3.25%

Fixed 4.38%

SONIA +1.5%

Commitment fee

N/A

N/A

0.60%

LTV covenant

65%

65%

55%

Interest cover covenant

1.75x

N/A

2.5x

Debt service cover ratio covenant

N/A

1.4x

N/A

Source: Picton Property Income, as at 31 March 2023

Portfolio summary and positioning

At 31 March 2023 (end-FY23), the externally assessed fair value of the investment portfolio was £766m (the balance sheet value includes an adjustment for lease incentives and finance leases), reflecting an EPRA net initial yield of 5.0% and a reversionary yield of 6.7%.

Exhibit 10: Key portfolio data

31-Mar-23

31-Mar-22

31-Mar-21

FY23

FY22

FY21

Portfolio valuation

£766m

£849m

£682m

Number of properties

49

47

46

Average lot size

£15.6m

£18.1m

£14.8m

EPRA net initial yield

5.0%

4.1%

4.8%

Net reversionary yield

6.7%

5.4%

6.3%

Annualised passing rent

£43.3m

£38.7m

£36.5m

Annualised reversionary rent

£55.8m

£49.8m

£45.4m

Occupancy as % estimated rental value (ERV)

91%

93%

91%

Weighted average unexpired lease term

4.6 years

4.8 years

4.9 years

Source: Picton Property Income

The portfolio comprises 49 assets, let to more than 400 individual occupiers, of which the top 10 account for 24.7% and the largest (4.8%) is various public sector entities.

Exhibit 11: Top nine occupiers

Contracted rent (£000s)

% total

Public sector

2.3

4.8%

Whistl UK Ltd

1.6

3.5%

B&Q plc

1.2

2.6%

The Random House Group Ltd

1.2

2.5%

Snorkel Europe Ltd

1.2

2.5%

XMA Ltd

1.0

2.1%

Portal Chatham LLP

1.0

2.0%

DHL Supply Chain Ltd

0.8

1.7%

4 Aces Ltd

0.7

1.5%

Hi-Speed Services Ltd

0.7

1.5%

Total top 10

11.7

24.7%

Source: Picton Property Income

Exhibit 12 shows the split of the portfolio in greater detail.

Exhibit 12: Detailed portfolio split by valuation and passing rent at end-FY23

Portfolio value by sector

Valuation (£m)

Passing rent by sector

Passing rent (£m)

Industrials

57%

£439.6

46%

£20.0

o/w South East

41%

o/w Rest of UK

16%

Office

32%

£245.2

36%

£15.6

o/w Central London

13%

o/w South-East

9%

o/w Rest of UK

10%

Retail & Leisure

11%

£81.4

22%

£7.7

o/w Retail Warehouse

7%

o/w High Street Rest of UK

2%

o/w Leisure

2%

Portfolio total

100%

£766.2

104%

£43.3

Source: Picton Property Income

During the year to 31 March 2023, MSCI data shows annual rental growth across all sectors even though valuations declined significantly as the market re-priced to higher interest rates. A feature of this re-pricing was that lower-yielding assets were the most affected, showing larger than average declines in property valuation. This extended to the relatively lower yielding industrials sector, despite strong rental growth, healthy occupier demand and generally limited supply. Reversing the trends of recent years, industrials total returns (-20.4%) were below the all-market average (-12.6%), while among the main sectors, high yielding retail assets showed the strongest performance (-7.9%). These are market averages, and no two portfolios are the same. Picton’s 8.7% return reflected positive asset management developments, despite its overweight industrials position.

We do not expect significant changes in Picton’s investment stance in the coming months. However, we expect less polarisation between sector performance than has been the case in recent years. Fundamentals in the industrial and retail warehouse sectors are strong. While general retail rents appear to have stabilised and yields are high, structural headwinds remain. Over time, Picton’s examination of alternative use in certain office sector assets may release capital for recycling and it seems likely that the company will identify reinvestment opportunities in other sectors.

The Investment Property Forum (www.ipf.org.uk) second quarterly survey of the year, based on data received from 18 organisations, whose forecasts were generated between end-March and mid-May 2023, showed a clear uplift in consensus expectations for rental growth and capital performance compared with the previous survey. The industrial and retail warehouse sector is confirmed as offering the strongest expected total returns over the next two years, supported by rental and capital growth.

Exhibit 13: Investment Property Forum Spring Forecasts

Rental value growth (%)

Capital value growth (%)

Total return (%)

2023

2024

2025

2023/7*

2023

2024

2025

2023/7*

2023

2024

2025

Office

(0.4)

0.2

1.4

1.1

(7.3)

0.3

2.1

(0.2)

(2.9)

4.9

6.8

Industrial

4.8

3.0

2.9

3.3

(0.8)

4.0

3.6

2.5

3.6

8.5

8.0

Standard retail

(0.7)

0.3

0.9

0.6

(3.3)

2.2

2.4

1.0

1.4

7.1

7.2

Shopping centre

(1.8)

(0.5)

0.5

0.0

(4.1)

0.2

0.9

(0.4)

2.7

7.4

8.0

Retail warehouse

0.0

1.0

1.0

0.8

(1.7)

3.1

2.4

1.4

4.4

9.2

8.4

West-End office

1.1

2.0

2.0

1.9

(4.3)

2.7

3.6

1.6

(1.0)

6.3

7.1

City office

(1.0)

1.6

1.6

1.2

(8.7)

0.3

3.3

(0.1)

(4.6)

4.6

7.3

All property

1.6

1.3

1.8

1.8

(3.2)

2.3

2.8

1.3

1.5

7.1

7.7

Source: Investment Property Forum. Note: *Annualised rate

Modest changes to forecasts

FY23 EPRA earnings were in line with our forecasts, while NAV was stronger, the likelihood of which we flagged following the trading update published by the company in April.

In aggregate, our FY24 forecasts are little changed, with higher gross rental income offsetting higher property costs to generate a c £0.2m increase in EPRA earnings to £21.8m or 4.0p per share. With FY23 delivering 1.12x dividend cover, we continue to forecast a 2.8% or 0.1p increase in aggregate FY24 DPS to 3.6p (1.11x covered).

We have introduced FY25 forecasts, which include additional income growth in rental income and a slower increase in non-recoverable property costs (moderating inflation and reduced void space), reflected in moderate growth in EPRA earnings (c 3%) and DPS (c 3%). The actual outcome will depend significantly on the continued resilience of the economy and occupational demand. The modest changes in NAV that we project reflect retained earnings with no assumed net valuation movement. The increase in rents compared with a flat valuation implies an additional c 20bp increase in the valuation yield, providing some offset to potential market-driven yield widening.

We estimate that each 1% increase or decrease in the total portfolio value is equivalent to an increase or decrease in FY24e NAV per share of c 1.4p.

Exhibit 14: FY23 versus expectations and forecast revisions

£m unless stated otherwise

Actual

Forecast

Previous forecast

Actual vs forecast

Change

FY23

FY24e

FY25e

FY23e

FY24e

FY23

FY24e

FY24e

Gross rental income

43.0

45.1

46.0

42.0

43.3

1.0

1.8

4.2%

Other income

0.4

0.5

0.5

0.5

0.5

(0.0)

0.0

0.0%

Non-recoverable property costs

(7.1)

(7.2)

(7.4)

(6.0)

(5.7)

(1.2)

(1.5)

25.8%

Net rental income

36.3

38.4

39.2

36.5

38.0

(0.2)

0.3

0.9%

Administrative expenses

(6.0)

(6.6)

(6.9)

(6.0)

(6.6)

0.1

0.0

-0.6%

Net interest

(9.0)

(10.0)

(9.9)

(9.4)

(9.8)

0.4

(0.1)

1.5%

EPRA earnings

21.3

21.8

22.4

21.1

21.6

0.2

0.2

1.0%

Realised & unrealised property gains/(losses)

(110.8)

0.0

0.0

(125.1)

0.0

14.3

0.0

IFRS earnings

(89.5)

21.8

22.4

(104.0)

21.6

14.5

0.2

EPRA EPS (p)

3.9

4.0

4.1

3.9

4.0

0.0

0.0

1.0%

IFRS EPS (p)

(16.4)

4.0

4.1

(19.1)

4.0

2.7

0.0

DPS declared (p)

3.5

3.6

3.7

3.5

3.6

0.0

0.0

0.0%

Dividend cover (x)

1.12

1.11

1.11

1.10

1.10

EPRA NTA per share (p)

100

101

102

98

98

3

3

2.7%

EPRA NTA total return

-13.7%

4.1%

4.2%

-15.8%

4.2%

LTV

26.7%

28.1%

28.1%

29.0%

29.1%

Source: Picton Property Income FY23 actual data, Edison Investment Research forecasts

Valuation and performance

The current level of quarterly DPS (0.875p) represents an annualised rate of 3.5p or a 5.0% yield. We forecast further increases in quarterly DPS in FY24 and FY25.

The shares trade at 0.70x the end-FY23 NAV6 per share, well below the 10-year average of 0.95x and a high of c 1.1x. In common with the UK REIT sector, Picton shares have de-rated as interest rates have risen and the current valuation is broadly in line with its level at the height of pandemic uncertainty in early 2020.

  Defined as EPRA net tangible assets (NTA) per share.

Exhibit 15: Dividend yield history (%)

Exhibit 16: Price to NAV history (x)

Source: Refinitiv prices, Picton DPS data, trailing basis.

Source: Refinitiv prices, Picton NAV data, trailing basis

Exhibit 15: Dividend yield history (%)

Source: Refinitiv prices, Picton DPS data, trailing basis.

Exhibit 16: Price to NAV history (x)

Source: Refinitiv prices, Picton NAV data, trailing basis

Exhibit 17 shows a summary performance and valuation comparison of Picton and what we consider to be its closest diversified income-oriented peers. Over one and three years, Picton’s share price performance is slightly ahead of the widely spread group average. Based on 12-month trailing DPS declared, Picton shares trade on a lower yield than the group average (7.3% excluding Regional REIT), primarily reflecting its strategy of balancing sustainable dividends with the capital requirements of active management, as well as relatively low gearing. Its P/NAV is broadly in line with the average. The company’s strong track record of property level performance, the future income and valuation growth potential embedded in its portfolio, and its strong balance sheet with relatively modest gearing all provide valuation support.

Exhibit 17: Peer valuation and price performance comparison

Price
(p)

Market cap (£m)

P/NAV
(x)*

Trailing yield (%)**

Share price performance

1 month

3 months

12 months

3 years

AEW REIT

93

147

0.88

8.6

-9%

-1%

-19%

-23%

Balanced Commercial Property Trust

66

464

0.56

7.3

-18%

-21%

-40%

-45%

CT Property Trust***

75

175

0.78

5.3

-10%

19%

-10%

-16%

Custodian

85

373

0.85

6.5

-9%

-4%

-15%

-24%

Ediston Property

58

122

0.72

8.7

-9%

-10%

-23%

-30%

LondonMetric

165

1,626

0.83

5.7

-11%

-6%

-27%

-35%

Regional REIT

47

241

0.64

14.1

-8%

-7%

-35%

-39%

Schroder REIT

40

196

0.65

8.1

-9%

-8%

-23%

-29%

abrdn Property Income Trust

48

182

0.58

8.4

-8%

-11%

-39%

-41%

UK Commercial Property REIT

48

629

0.60

7.0

-15%

-7%

-33%

-38%

Average

0.71

8.0

-11%

-6%

-26%

-32%

Picton

70

383

0.70

5.0

-11%

-1%

-20%

-26%

UK property sector index

1,179

-11%

-8%

-25%

-32%

UK equity market index

4,096

-1%

-2%

4%

-7%

Source: Company data, Refinitiv prices at 30 June 2023. Note: *Based on last reported EPRA NAV/NTA. **Based on trailing 12-month DPS declared. ***CT Property Trust is the subject of a recommended offer from LondonMetric of 0.455 new LondonMetric shares for each CT Property Trust share.

Additional details on the company and management

The company was launched in October 2005 as the ING UK Real Estate Income Trust in an offshore structure, listed on the Channel Islands Stock Exchange and the London Stock Exchange. In 2011, the company name was changed to Picton Property Income and in January 2012, management was internalised, giving the company greater flexibility to manage costs and benefit fully from the growth in assets. In 2018 it became a UK-domiciled REIT and changed its technical listing status from an investment company to a commercial company, bringing it more into line with other internally managed property company peers. Throughout this period, there has been no change in the company’s diversified, actively managed total return investment strategy.

Leadership and governance

The board comprises six members: four non-executive and two executive directors. The non-executive directors bring considerable experience from across the real estate, real estate financing and financial services sectors. The board is chaired by Lena Wilson CBE who brings a wide range of business and board experience to the group. She is on a number of boards in a non-executive capacity, including NatWest Group, and is also chair of Chiene + Tait LLP and AGS Group. Previously she was chief executive of Scottish Enterprise from 2009 until 2017 and, prior to that, was a senior investment adviser at The World Bank. The other non-executives are Mark Batten (chair of the audit and risk committee and the senior independent director), Maria Bentley (chair of the remuneration and nominations committees) and Richard Jones (chair of the property and valuation committee).

The executive board members are CEO Michael Morris and FD Andrew Dewhirst. Michael Morris has more than 25 years’ experience in the UK commercial property sector and has worked with the group since it was launched in 2005. Andrew Dewhirst joined Picton in 2011 and has over 30 years’ experience in the real estate and financial services sector. Brief biographies of the key members of the leadership team may be found on page 15 and detailed board biographies may be found on the company website.

Including the CEO and CFO, the broader Picton management team comprises 11 individuals, of whom five are property professionals.

Sensitivities

The commercial property market is cyclical, historically exhibiting substantial swings in valuation through cycles. Income returns are significantly more stable, but still fluctuate according to tenant demand and rent terms. From a sector viewpoint we also highlight the increased risks and uncertainties that attach to development activity, including planning consents, timing, construction risks and the long lead times to completion and eventual occupation. Picton is not a developer, but is exposed to similar but lesser uncertainties, as it actively invests in improvements to existing assets with the aim of enhancing long-term income growth and returns. More generally we note the sensitivity to:

Economic risk: the war in Ukraine, sharply rising inflation and a continuing rise in interest rates are creating a high level of uncertainty regarding the global and UK economic outlook. Thus far, occupier demand across most sectors has remained resilient.

Sector risk: some of the inherent cyclical risk to vacancy in commercial property can be mitigated by portfolio diversification. Picton invests across the main UK commercial property sectors, with a portfolio that is well diversified by property and by individual occupiers.

Energy performance considerations: a failure to successfully meet regulatory and/or tenant expectations for energy performance enhancement would likely affect Picton’s ability to let properties on satisfactory terms and may make properties unlettable.

Funding risks: gearing is moderate and current borrowings are overwhelmingly fixed rate and long term, protecting the company from rising interest rates. Additional shorter-term, floating rate borrowing facilities provide flexibility to fund opportunistic acquisitions.

Management risk: as Picton is internally managed there is some management risk. With a relatively small team, the loss of any senior member has the potential to be disruptive and if any of the directors were to leave, they would need to be replaced.

Exhibit 18: Financial summary

Year end 31 March (£m)

2021

2022

2023

2024e

2025e

PROFIT & LOSS

Rental income

36.6

40.1

43.0

45.1

46.0

Other income

1.5

0.2

0.4

0.5

0.5

Service charge income

5.3

6.2

8.4

9.0

9.2

Revenue from properties

43.3

46.5

51.8

54.6

55.8

Property operating costs

(2.4)

(2.5)

(3.5)

(3.2)

(3.2)

Property void costs

(2.2)

(2.4)

(3.6)

(4.1)

(4.1)

Recoverable service charge costs

(5.3)

(6.2)

(8.4)

(9.0)

(9.2)

Property expenses

(9.9)

(11.1)

(15.6)

(16.3)

(16.6)

Net property income

33.5

35.4

36.3

38.4

39.2

Administrative expenses

(5.4)

(5.8)

(6.0)

(6.6)

(6.9)

Operating Profit before revaluations

28.1

29.7

30.3

31.8

32.3

Revaluation of investment properties

12.9

129.8

(110.8)

0.0

0.0

Profit on disposals

0.9

0.0

0.0

0.0

0.0

Operating Profit

41.8

159.5

(80.5)

31.8

32.3

Net finance expense

(8.0)

(8.5)

(9.0)

(10.0)

(9.9)

Debt repayment fee

(4.0)

Profit Before Tax

33.8

147.0

(89.5)

21.8

22.4

Taxation

0.0

0.0

0.0

0.0

0.0

Profit After Tax (IFRS)

33.8

147.0

(89.5)

21.8

22.4

Adjust for:

Investment property valuation movement

(12.9)

(129.8)

110.8

0.0

0.0

Profit on disposal of investment properties

(0.9)

(0.0)

0.0

0.0

0.0

Exceptional income /expenses

0.0

4.0

0.0

0.0

0.0

EPRA earnings

20.1

21.2

21.3

21.8

22.4

Fully diluted average Number of Shares Outstanding (m)

546.8

547.3

546.9

545.2

545.2

EPS (p)

6.20

26.93

(16.42)

4.00

4.11

EPRA EPS (p)

3.68

3.88

3.90

4.00

4.11

Dividend declared per share (p)

2.93

3.45

3.50

3.60

3.70

Dividends paid per share (p)

2.750

3.375

3.500

3.575

3.675

Dividend cover (x) EPRA EPS/DPS declared

1.26

1.13

1.12

1.11

1.11

Dividend cover (x) - paid dividends

1.34

1.15

1.12

1.12

1.13

Total return

6.6%

27.9%

-13.7%

4.1%

4.2%

EPRA cost ratio (excluding direct vacancy costs)

20.8%

19.9%

21.3%

20.9%

21.3%

BALANCE SHEET

Non-current assets

669.5

834.4

749.8

755.7

761.8

Investment properties

665.4

830.0

746.3

752.3

758.4

Other non-current assets

4.1

4.4

3.4

3.4

3.4

Current assets

42.9

61.4

42.8

40.7

38.7

Debtors

19.6

22.9

22.7

22.7

22.7

Cash

23.4

38.5

20.1

18.0

16.0

Current Liabilities

(19.9)

(20.3)

(20.7)

(20.7)

(20.7)

Creditors/Deferred income

(18.9)

(19.3)

(19.6)

(19.6)

(19.6)

Current borrowings

(0.9)

(1.1)

(1.1)

(1.1)

(1.1)

Non-Current Liabilities

(164.4)

(218.4)

(224.2)

(225.1)

(226.0)

Non-current borrowings

(162.7)

(215.8)

(221.6)

(222.6)

(223.5)

Other non-current liabilities

(1.7)

(2.6)

(2.6)

(2.6)

(2.6)

Net assets

528.2

657.1

547.6

550.7

553.8

NAV per share (p)

97

120

100

101

102

EPRA NTA per share (p)

97

120

100

101

102

CASH FLOW

Operating cash flow

26.0

28.1

30.9

32.5

33.0

Net Interest

(7.5)

(8.1)

(7.9)

(9.1)

(9.0)

Tax

0.1

0.0

0.0

0.0

0.0

Net cash from investing activities

(1.3)

(33.8)

(26.8)

(6.0)

(6.0)

Ordinary dividends paid

(15.0)

(18.4)

(19.1)

(19.5)

(20.0)

Debt drawn/(repaid)

(1.8)

52.2

5.4

0.0

0.0

Net proceeds from shares issued/repurchased

(0.6)

(0.7)

(1.1)

0.0

0.0

Other cash flow from financing activities

(4.0)

Net cash from financing activities

(17.5)

29.0

(14.8)

(19.5)

(20.0)

Change in cash

(0.2)

15.2

(18.5)

(2.1)

(2.0)

Opening cash

23.6

23.4

38.5

20.1

18.0

Closing cash

23.4

38.5

20.1

18.0

16.0

Debt as per balance sheet

(163.7)

(216.8)

(222.8)

(223.7)

(224.6)

Un-amortised loan arrangement fees

(2.6)

(2.0)

(1.7)

(0.8)

0.1

Closing net (debt)/cash

(142.8)

(180.3)

(204.4)

(206.5)

(208.5)

Net LTV

20.9%

21.2%

26.7%

28.1%

28.1%

Source: Picton Property Income historical data, Edison Investment Research forecasts

Contact details

Revenue by geography

Picton Property Income Limited
27a Floral Street
London
WC2E 9EZ
020 7628 4800
www.picton.co.uk

Contact details

Picton Property Income Limited
27a Floral Street
London
WC2E 9EZ
020 7628 4800
www.picton.co.uk

Revenue by geography

Leadership team

Non-executive chair: Lena Wilson CBE

Chief executive: Michael Morris

Lena Wilson joined the board on 1 January 2021 as chair designate, assuming that role in February 2021, and is also chairman of the nomination committee. She brings a wealth of business experience to the role and currently serves as non-executive director on a number of boards, including NatWest Group, and is also chair of Chiene + Tait LLP and AGS Group. Previously, Lena was chief executive of Scottish Enterprise from 2009 until 2017 and prior to that, was a senior investment advisor at The World Bank.

Michael Morris was appointed to the board in October 2015. He has over 25 years’ experience in the UK commercial property sector and has worked with the group since launch in 2005. As chief executive he is responsible for the implementation of the company’s strategy. Prior to this, he worked in private practice, then became a senior director and fund manager at ING Real Estate Investment Management (UK). He is a member of the Investment Property Forum and has obtained the Investment Management Certificate and the IPF Diploma in Property Investment.

Finance director: Andrew Dewhirst

Head of asset management: Jay Cable

Andrew Dewhirst joined the group in March 2011 and became finance director and joined the board in 2018. Previously he was finance director of the group’s investment management subsidiary and was director of client accounting at ING Real Estate Investment Management (UK), a role he had held since 2006. At ING he was responsible for the accounting and administration of all the UK real estate vehicles and separate client accounts. He has over 30 years’ experience in the real estate and financial services sector and is an associate member of the Institute of Chartered Accountants in England and Wales and a member of the Investment Property Forum.

As head of asset management and a member of the executive committee, Jay Cable is responsible for overseeing all asset management activities in respect of the group’s property portfolio. He has worked for the group since launch in 2005, having formerly been a director at ING Real Estate Investment Management (UK). He has over 18 years of real estate experience and is a member of the Royal Institute of Chartered Surveyors and of the Investment Property Forum.

Principal shareholders as at 5 May 2023 (Sourced: Picton Annual Report)

(%)

Investec Wealth & Investment

16.2

Thames River Capital

10.8

BlackRock

5.6

The Vanguard Group

4.6

Evelyn Partners

3.9

RBC Brewin Dolphin

3.3

Alder Investment Management

3.0


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London │ New York │ Frankfurt

20 Red Lion Street

London, WC1R 4PS

United Kingdom

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abrdn Private Equity Opportunities Trust (APEO) posted a 12-month NAV total return (TR) to end-May 2023 of 7.0%, supported by continued strong portfolio earnings momentum (up 28.7% over the 12 months to end-March 2023 for APEO’s top 50 holdings). Muted global M&A volumes continue to weigh on private equity (PE) exit activity, with APEO’s capital calls in the calendar year to end-May 2023 (£74.0m) outpacing distributions (£54.1m). That said, APEO’s undrawn credit facility and cash of £243.4m at end-May 2023 provide it with decent near-term balance sheet headroom, as these cover 35% of APEO’s outstanding investment commitments (which should be drawn gradually in the coming years).

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