Custodian REIT plc — Forecasts revised after FY17 results

Custodian Property Income REIT (LSE: CREI)

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Research: Real Estate

Custodian REIT plc — Forecasts revised after FY17 results

Custodian REIT (CREI) reported a 2.2% increase in FY17 EPRA NAVPS, boosted by revaluation gains and disposal profits. With a dividend of 6.35p (+1.6%), the share price total return for the year was 10.3%. We have made minor changes to our forecasts following the results. Our EPRA NAV forecasts have increased by 1% in both FY18 and FY19, as CREI has made acquisitions worth £19m in the year to date, with another £19m under offer. Management’s focus is on long-term secure income, to deliver the earnings to cover a sustainable growth in dividends and generate less volatile returns. We believe the 9% premium to FY18e NAV is justified by the conservative gearing and one of the highest dividend yields in the sector.

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Real Estate

Custodian REIT

Forecasts revised after FY17 results

FY17 results

Real estate

11 July 2017

Price

116.25p

Market cap

£403m

Net debt (£m) at FY17

58.0

Shares in issue

347m

Free float

92%

Code

CREI

Primary exchange

LSE

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

0.9

3.8

15.3

Rel (local)

3.0

3.4

1.6

52-week high/low

121.5p

103.5p

Business description

CREI is a London Main Market listed REIT focused on commercial property in the UK outside London. It is income focused, with a commitment to pay a high but sustainable and covered dividend.

Next events

June 2017 NAV

July 2017

Analysts

Mark Cartlich

+44 (0)20 3077 5700

Julian Roberts

+44 (0)20 3077 5748

Custodian REIT is a research client of Edison Investment Research Limited

Custodian REIT (CREI) reported a 2.2% increase in FY17 EPRA NAVPS, boosted by revaluation gains and disposal profits. With a dividend of 6.35p (+1.6%), the share price total return for the year was 10.3%. We have made minor changes to our forecasts following the results. Our EPRA NAV forecasts have increased by 1% in both FY18 and FY19, as CREI has made acquisitions worth £19m in the year to date, with another £19m under offer. Management’s focus is on long-term secure income, to deliver the earnings to cover a sustainable growth in dividends and generate less volatile returns. We believe the 9% premium to FY18e NAV is justified by the conservative gearing and one of the highest dividend yields in the sector.

Year end

Gross rental income (£m)

EPRA
EPS* (p)

DPS
(p)

EPRA
NAVPS (p)

Yield
(%)

P/NAV
(x)

03/16

18.6

6.80

6.25

102

5.4

1.15

03/17

27.0

6.59

6.35

104

5.5

1.12

03/18e

31.7

6.95

6.45

106

5.5

1.09

03/19e

32.3

6.89

6.50

109

5.6

1.06

Note: *EPRA EPS are normalised, excluding gains on revaluation

FY17 results: NAV boosted by valuation gains

FY17 EPRA NAV was up 2.2% to 103.8p per share, as the portfolio value increased 30% to £416m, following the investment of £105m in 25 acquisitions. There was a 3% fall in EPRA EPS to 6.6p per share, but reported EPS were up 48%, as net profit more than doubled to £24m, boosted by a £9m valuation gain and profits on disposal. The dividend was raised 1.6% to 6.35p per share, which was 101% covered and the target for FY18 was increased 1.7% to 6.45p.

A low geared, income-focused portfolio

CREI has built a balanced portfolio of low-volatility regional UK commercial real estate, diversified by sector, location, tenant and lease term. It is focused on lot sizes of £2-10m, where CREI believes it has a competitive advantage. It has low exposure to office, a relatively high exposure to industrial, retail warehousing and alternative sectors, plus its portfolio is institutional quality in all but lot size. The net initial yield on the portfolio at year-end was 6.9%. Recent acquisitions have averaged above 7.3%, which should make them earnings enhancing and able to meet the 6.45p dividend target for FY18.

Valuation: Premium justified by above-average yield

CREI trades at a premium of 9% to our forecast FY18e NAV of 106p, which is a slight premium to the more income-orientated listed peers. This premium looks justified by its dividend yield and is supported by our dividend discount model. Given the business model of focusing on all market sectors, sub £10m lot sizes and a wide tenant base, the risk profile is reduced, which again supports the premium in our view. The company became a FTSE EPRA/NAREIT index series constituent in March 2017, which should also help to support current valuations.

FY17 results

EPRA NAV increased 2.2%

CREI reported an 8.5% total NAV return for the year to March 2017, up from 6.4% in FY16 and well ahead of the sector benchmark of 6.5%. As previously reported, EPRA NAV was up 2.2% to 103.8p per share and the portfolio increased 30% to £416m, following the investment of £105m in 25 acquisitions. The net initial yield on the portfolio was barely changed at 6.9%. The aggregate NAV was 38% higher at £352m, as CREI raised £92m of equity, at an average premium of 5% over NAV.

The fully covered dividend was raised 1.6% to 6.35p per share, which was covered 101% and the target for FY18 was increased 1.7% to 6.45p. There was a 3% fall in EPRA EPS to 6.6p per share, but reported EPS were up 48%, as net profit more than doubled to £24m, boosted by a £9m valuation gain and profits on disposal. CREI made £19m of disposals in the year to special purchasers, including owner occupiers and those looking for secure long-term income. Partly as a result of this, net gearing fell to 14% from 19% in FY16.

Management said they expect occupational demand and a limited supply of new development to continue to drive up rental growth in the regional markets. Industrial rents increased over 7% and shops were up 5%. This should support a low vacancy rate (CREI’s fell to 1.4% from over 3%), secure dividend cover and the potential for capital growth. CREI believes the occupier market should therefore have a few years still to run in the regions. However, the investment market has been more volatile and valuation increases have not followed, so the yield spread over prime and other assets is still attractive, especially in the smaller lot sizes the company focuses on.

The company also said it plans to continue its growth to achieve the economies of scale from the REIT’s fixed cost base, especially after the recent reduction in investment manager fees discussed below. The ongoing charge ratio has fallen to 1.2% as a result. At the time of the results, CREI stated that it had made acquisitions worth £19m in the year to date, with another £19m under offer.

Exhibit 1: FY17 results

£m

FY16

FY17

Change

Gross rental income

18.56

26.98

45.4%

Re-charge income

0.45

0.63

39.7%

Revenue

19.01

27.61

45.2%

Property expenses

(1.02)

(1.87)

116.6%

Net rental income

17.99

25.74

43.1%

Net result on disposal of investment properties

0.06

1.60

2755.4%

Revaluation of investment properties

3.03

9.02

197.5%

Management fees

(2.20)

(2.67)

21.4%

Administrative expenses

(0.10)

(0.48)

375.0%

Professional and directors' fees

(0.53)

(0.50)

(5.9%)

Purchase costs

(5.77)

(6.10)

5.8%

Net operating profit

12.48

26.61

113.2%

Interest income

0.22

0.19

(15.8%)

Interest expenses

(1.49)

(2.59)

73.4%

Profit before tax

11.21

24.21

116.0%

Tax charge

0.00

0.00

0.0%

Profit after tax

11.21

24.21

116.0%

EPRA Earnings

13.89

19.69

41.8%

Average shares outstanding (m)

204.20

298.73

46.3%

Basic EPS (p)

5.49

8.10

47.6%

EPRA EPS (p)

6.80

6.59

(3.1%)

DPS (p)

6.25

6.35

1.6%

EPRA NAVPS (p)

102

104

2.2%

Source: Custodian REIT data

Renewal of investment management agreement

CREI announced that the investment management agreement with Custodian Capital had been renewed for a further three years from 1 June, with 12 months' notice, following the expiry of the initial three-year term. The fees have been amended to include a step down in the property management fee from 0.75% to 0.65% of NAV above £500m, and in the administrative fee from 0.125% to 0.08% of NAV between £200m and £500m, plus a further step down to 0.05% above £500m. The effect of these changes will be to increase the cover on target dividends for the current year ending March 2018, as the administrative fee will fall immediately. Growth in NAV above £500m will therefore reduce the ongoing charges ratio and increase dividend capacity. A three-year term will also enable the investment manager to invest in the people and systems to service the agreement.

Year-to-date portfolio update

In May, CREI announced the acquisition of a 23,000 sq ft retail warehouse in Southbrook Retail Park in Gloucester. The warehouse comprises two units near the town centre and three miles from the M5, occupied by Magnet and Smyths Toys, on leases expiring in 2024 and 2021. The passing rent of £0.37m equates to a net initial yield of 7.41% at a price of £4.725m. The transaction was funded internally, thereby increasing CREI’s net gearing. Also in May, it acquired a retail site in Galashiels for £3.15m and a car dealership in York for £3.9m at net initial yields of 8.24% and 5.75% (with a 6.75% reversionary yield).

On 12 June, CREI acquired a 20,678 sq ft distribution unit in Access 26 Business Park, Langley Mill, located near Junction 26 of the M1. The unit is let to Warburtons on a lease expiring on 2 December 2022. The passing rent is £143,000 per year, so the purchase price of £2.15m produces a net initial yield of 6.29%. The acquisition was funded from existing cash resources. The company said it was a modern unit in a strong distribution location and nearby occupiers include DHL, 3663 Logistics and Travis Perkins. There is strong demand in the Midlands for good quality units with strong communication links, so management expects rental growth at the review in December this year.

On 15 June, the company acquired a 69,922 sq ft distribution unit in Eurocentral, Scotland's leading mixed-use business park on the M8 between Glasgow and Edinburgh. Nearby occupiers include DHL, Warburtons, Argos, Wincanton, Norbert Dentressangle and Morrisons. The unit is let to Next on a lease expiring on 6 March 2019. The current passing rent is £349,850 per annum, reflecting a net initial yield of 6.91%, with an expected reversionary yield of c 7.9%. The agreed purchase price of £4.75m was funded from the company's existing cash resources.

On 19 June, CREI announced the acquisition of the 23,000 sq ft Wells Green Retail Park in Sheldon, which is five miles from Birmingham city centre on the A45. The site comprises three units occupied by Dreams, Pets at Home and Halfords. Management said Halfords has recently signed a reversionary lease on its site. Other retailers nearby include Morrisons, Tesco and Aldi. The leases have expiry dates in September 2022, September 2026 and September 2027. The passing rent of £0.361m equates to a net initial yield of 6.64% on the purchase price of £5.1m. The consideration was funded from internal resources and net gearing increased to 19.6% LTV as a result.

Exhibit 2: FY18 YTD acquisitions (£m)

Location

Date

Type

Value

Annual rental

Net initial yield

Gloucester

2 May

Retail

4.73

0.37

7.41%

York

12 May

Other

3.92

0.24

5.75%

Galashiels

15 May

Retail

3.15

0.28

8.24%

Plymouth

15 May

Retail

7.49

0.54

6.74%

Langley Mill

12 June

Industrial

2.15

0.14

6.29%

Scotland

15 June

Industrial

4.75

0.35

6.91%

Sheldon, Birmingham

19 June

Retail

5.10

0.36

6.64%

YTD total

31.28

2.28

7.29%

Source: Custodian REIT data

Valuation and financials

A yield premium to peers

Following its recent strong share price performance, CREI trades at a slight premium to the average of the sector peers, based on a premium of 9% to our FY18 EPRA NAVPS forecast. The sector peers are currently on an average premium of 7% for this year. However, at 5.5% CREI’s dividend yield is 10% higher than the sector average. This is despite the inclusion in the average of Regional REIT, which, at 7.2%, has by far the highest dividend yield. In our view, the higher dividend yield justifies the 9% premium to NAV.

Exhibit 3: Comparative valuations, FY17e

Price

Market cap

NAVPS

P/NAV

DPS

Dividend

(p)

(£m)

(p)

(x)

(p)

yield

EPIC

112.0

147

104.8

1.07

5.5

4.9%

F&C Commercial Property

143.5

1,147

137

1.04

6.0

5.6%

F&C UK Real Estate Investment

106.3

256

98.4

1.08

5.0

4.7%

Picton Property Income

83.3

450

82

1.10

3.4

4.1%

Regional REIT

105.3

316

96

1.10

7.6

7.2%

Schroders REIT

63.3

328

63

1.01

2.4

3.9%

Standard Life Inv Property

90.5

352

81

1.11

4.9

5.4%

Tritax Big Box

144.6

1,971

133

1.09

6.4

4.4%

UK Commercial Property Trust

91.1

1,184

87

1.04

3.7

4.0%

Total/Average

6,557

1.07

5.0%

Custodian REIT*

116.25

403

106

1.09

6.45

5.5%

Source: Bloomberg, Edison Investment Research forecasts. Note: CREI NAVPS and DPS are FY18 forecasts, Prices as at 10 July 2017.

Forecast changes and fundraising

We have made minor changes to our forecasts following the results. Our revenue forecasts have increased 5% in both FY18 and FY19, on the back of the recent property acquisitions detailed above. Our EPRA earnings forecast has increased 0.4% for this year, to reflect the income from these additional properties. The FY18 figure has reduced slightly as we have assumed an increase in debt funding for the acquisitions, which has a knock-on effect on interest costs next year, plus there are more shares in issue, following the shares issued year to date. Nevertheless, our EPRA NAV forecasts have increased by 0.6% in both FY18 and FY19.

Exhibit 4: Forecast changes

Revenue

EPRA EPS

EPRA NAVPS

Old

New

% chg.

Old

New

% chg.

Old

New

% chg.

2018e

30.1

31.7

5.0%

6.92

6.95

0.4%

105.8

106.4

0.6%

2019e

30.7

32.3

5.0%

7.08

6.89

(2.8%)

108.7

109.4

0.6%

Source: Edison Investment Research, Custodian REIT data

CREI has continued to raise equity from existing shareholders in regular tap issues, which can be used to fund further property acquisitions. So far this year, the company has raised £9m, at an average price of 112p per share. We are not forecasting any further equity fundraising, although we believe there is likely to be more as the year progresses. In FY17, the company raised £92m of additional equity.

Exhibit 5: Equity fund-raising (FY18)

Capital increases

Price (p)

Shares (m)

Total (£m)

04/04/2017

110.0

1.00

1.10

09/05/2017

111.0

1.50

1.67

17/05/2017

111.0

1.00

1.11

23/05/2017

111.5

1.50

1.67

01/06/2017

112.5

1.00

1.13

12/06/2017

115.0

0.50

0.58

19/06/2017

116.0

0.50

0.58

26/06/2017

116.0

0.50

0.58

03/07/2017

116.0

0.50

0.58

Year to date

112.3

8.00

8.99

Source: Custodian REIT data

Exhibit 6: Financial summary

Year end 31 March

£000s

2015

2016

2017

2018e

2019e

IFRS

IFRS

IFRS

IFRS

IFRS

PROFIT & LOSS

Gross rental income

11,228

18,561

26,980

31,651

32,284

Re-charge income

342

451

630

741

776

Total revenue

 

 

11,570

19,012

27,610

32,392

33,060

Gross property expenses

(715)

(1,023)

(1,869)

(1,757)

(1,813)

Net rental income

 

 

10,855

17,989

25,741

30,635

31,247

Administrative expenses

(785)

(628)

(972)

(1,054)

(1,066)

Operating Profit before revaluations

10,070

17,361

24,769

29,580

30,182

Revaluation of investment properties

6,083

3,031

9,016

8,316

9,034

Costs of acquisitions/profit on disposals

(5,575)

(5,712)

(4,504)

(1,643)

0

Management fees

(1,542)

(2,200)

(2,671)

(3,316)

(3,455)

Operating Profit

9,036

12,480

26,610

32,938

35,868

Net Interest

(289)

(1,273)

(2,405)

(2,425)

(2,823)

Profit Before Tax

 

 

8,747

11,207

24,205

30,512

33,045

Taxation

(2)

0

0

0

0

Profit After Tax

8,745

11,207

24,205

30,512

33,045

Profit After Tax (EPRA)

8,237

13,888

19,693

23,839

23,904

Average Number of Shares Outstanding (m)

146.1

204.2

298.7

343.0

347.0

EPS (p)

 

 

5.99

5.49

8.10

8.90

9.52

EPRA EPS (p)

 

 

5.64

6.80

6.59

6.95

6.89

Dividend per share (p)

 

5.25

6.25

6.35

6.45

6.50

Dividend cover (x)

1.1

1.1

1.0

1.1

1.1

BALANCE SHEET

Fixed Assets

 

 

207,287

318,966

415,812

457,048

466,189

Investment properties

207,287

318,966

415,812

457,048

466,189

Other non-current assets

0

0

0

0

0

Current Assets

 

 

1,921

9,973

12,996

13,492

15,148

Debtors

1,072

4,518

7,189

8,435

8,610

Cash

849

5,455

5,807

5,057

6,538

Current Liabilities

 

 

(5,411)

(8,165)

(12,572)

(13,471)

(13,779)

Creditors/Deferred income

(5,411)

(8,165)

(12,572)

(13,471)

(13,779)

Short term borrowings

0

0

0

0

0

Long Term Liabilities

 

 

(23,811)

(65,714)

(64,359)

(87,817)

(87,817)

Long term borrowings

(23,811)

(65,143)

(63,788)

(87,246)

(87,246)

Other long term liabilities

0

(571)

(571)

(571)

(571)

Net Assets

 

 

179,986

255,060

351,877

369,252

379,741

Net Assets excluding goodwill and deferred tax

179,986

255,060

351,877

369,252

379,741

NAV/share (p)

101

102

104

106

109

EPRA NAV/share (p)

101

102

104

106

109

CASH FLOW

Operating Cash Flow

 

 

6,936

8,177

23,066

24,274

26,860

Net Interest

(204)

(1,285)

(2,200)

(2,425)

(2,823)

Tax

0

0

Net cash from investing activities

(123,944)

(107,853)

(92,126)

(32,920)

0

Ordinary dividends paid

(5,546)

(12,220)

(18,493)

(22,124)

(22,556)

Debt drawn/(repaid)

23,811

41,700

(1,000)

23,458

0

Proceeds from shares issued

99,796

76,087

91,105

8.988

0

Other cash flow from financing activities

0

0

0

0

0

Net Cash Flow

849

4,606

352

(750)

1,481

Opening cash

 

 

0

849

5,455

5,807

5,057

Other

0

0

0

0

0

Closing cash

 

 

849

5,455

5,807

5,057

6,538

Source: Custodian REIT data, Edison Investment Research

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Frankfurt +49 (0)69 78 8076 960

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Germany

London +44 (0)20 3077 5700

280 High Holborn

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United Kingdom

New York +1 646 653 7026

295 Madison Avenue, 18th Floor

10017, New York

US

Sydney +61 (0)2 8249 8342

Level 12, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

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

295 Madison Avenue, 18th Floor

10017, New York

US

Sydney +61 (0)2 8249 8342

Level 12, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

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European Assets Trust (EAT) aims to achieve long-term capital growth through investment in small and medium-cap companies in Europe (ex-UK). The investment approach is fundamental and bottom-up; EAT has a solid long-term track record and a high distribution policy underpins an attractive 5.2% yield. 2016 was a challenging year for EAT and NAV total return underperformed the index by 15.9pp. Since then, the performance has stabilised and the shares have returned to a modest premium to NAV (including income). The manager, Sam Cosh, is confident of the trust’s investment philosophy and process and is positive on the economic outlook.

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