Custodian REIT plc — Forecasts revised after FY17 results

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.

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.

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.

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.

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.

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.