Palace’s FY17 results were ahead of our estimates, with rental and other income of £14.3m and a £3.1m revaluation gain, taking EPRA NAV per share up 7% to 443p, from 414p at 31 March 2016. Operating profit was £15.6m and EPRA earnings (net of revaluation gains and share-based payments) of £5.4m equated to 21.2p per share (EPRA EPS in FY16 of 31.3p included a surrender premium of £3.2m). Palace reports an adjusted earnings figure, which tracks profits from recurring revenue: this came to £6.7m or 22.2p per share, up 20% from £5.6m (18.9p) in FY16. The board has proposed a dividend of 9.5p in respect of H2, taking the annual dividend to 18.5p, a 16% increase on the 2016 dividend of 16p and covered 1.2x by adjusted earnings.
These results were driven by Palace’s active management of the investment portfolio, including the conversion of offices in Dartford to residential use, and their subsequent leasing, increased occupancy from 89% to 91% (excluding Hudson House in York, which is held for development) and sales of 13 non-core properties for a total of £12.6m, 37% above their book value of £9.2m. These and other initiatives contributed to the £3.1m revaluation gain (up 5.7% or 4.5% on a like-for-like basis), along with a slight contraction in yields from c 7.8% to 7.6% (weighted average net equivalent yield). The reduction in contracted rental income due to the disposals should be more than offset on completion of a £20m acquisition, which is expected to be finalised soon.
Administrative expenses were £2.9m (FY16: £2.0m) mainly due to higher headcount (11, including the board, up from nine a year earlier), and the company now has the resources to manage and deliver returns from a larger portfolio, providing scalability for the future. Finance costs were £3.0m, including £0.2m charged for early termination of debt. Palace has refinanced one facility and repaid two others in the year and now has total debt facilities of £82.3m, of which £78.7m is drawn. Palace’s bank debt has an average margin of 2.35% over Libor. 30% of debt is fixed and the average maturity is 4.6 years (similar to the portfolio WAULT of 5.8 years).
Palace has over £15m of unencumbered properties and £11.2m in cash, which will allow the company to make the announced £20m acquisition using existing resources and facilities. Net loan to value of 37% is in line with expectations; we assume the acquisition is made with 50% gearing, which would raise net LTV to 42% by the end of 2018. The average cost of debt was reduced from 3.1% to 2.9% over the year, while the average maturity was extended from 3.9 to 4.6 years.
The effective tax rate of 5.4% was controlled using brought-forward losses and capital allowances. The charge of £3.2m in the year included £0.7m of tax payable on the profits in the year and a £2.5m deferred tax charge reflecting capital allowances in excess of depreciation and losses used in the year.
The 29p increase in EPRA NAV per share, combined with the 18p paid in dividends in the year, represents a total accounting return of 11.4% on NAV at the start of the year, 34% higher than our estimate.
Palace also provided an update on asset management progress, and we list the salient points below:
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Boulton House in Manchester was the only acquisition during the year, bought for £10.6m on a net initial yield of 5.5%, expected to rise to 6.9% on a conservative rental value of £12 per sq ft. The vacant space in the building, as well as the ground floor reception area, has now been refurbished at a cost of £0.7m and Palace is negotiating with potential tenants over rents ahead of expectations at the time of purchase.
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As noted above, 13 assets were sold in FY17 for £12.6m, generating disposal gains of £3.2m having been held at a book value of £9.2m. Among these was an asset on Hall Road in Maldon where the lease was extended to 10 years from 3.5 and enabled Palace to sell the asset for £3.9m, having established that the local planning authority would resist any change of use for the site.
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A new planning application has been submitted for Hudson House in York, where permission for a change of use had already been granted. The new application is for 127 residential apartments, 34,000sqft of offices and 5,000sqft of commercial space on the ground floor. Discussions with the city council are underway.
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Broad Street Plaza in Halifax continues to trade well. 40% of leases in the property have minimum rental uplifts, which will increase net initial yield to over 8% by August 2017, from 7.25% at acquisition in March 2016. The weighted average unexpired lease term of the scheme is 13 years.
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The Copperfields in Dartford was previously an office and commercial building, but the offices became vacant due to lack of demand. The Permitted Development Rights legislation introduced in 2013 allowed Palace to convert these into 13 apartments, which have now all been let to the council for 10 years with annual 2.5% rent increases, converting the property into a core, income-producing asset.
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Two leases have been renewed at Point Four Industrial Estate, Avonmouth, and two more have had rent reviews that removed forthcoming breaks from the contracts. The one vacant unit is being refurbished and rents in the estate have risen 10% over the year.
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The Bank of England’s lease at Bank House in Leeds has been extended to July 2023 with a minimum increase from the current level of £117,300 pa to £232,000 pa at the review in 2020, reflecting a modest £7.50 per sq ft. The vacant first floor has been refurbished and tenants are being sought who want to pay less than the £28 per sq ft, which is common for prime rents in the area. Redevelopment and refurbishment plans for the building are being considered in the medium term.
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The tenant at Marsh Barton Trading Estate in Exeter has gone into administration, as was the case with the previous tenant in March 2016 (which the current tenant bought out of administration). At the time of the previous tenant’s administration, Palace instructed architects to draw up redevelopment plans for the site. These are at an advanced stage and Palace hopes to submit a planning application in H118 for a new building of c 100,000sqft.
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The occupier of Unit 2 of Kiln Farm, Milton Keynes, exercised their option to terminate in March 2016. Palace negotiated a dilapidation settlement and has refurbished it to the same standard as the adjacent unit. Tenants are now being sought, at a higher rent than next door, which should provide useful evidence for the rent review there in December 2018.
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Sol Central in Northampton will shortly undergo repairs to the roof and external lighting and a new pre-let is being sought before Palace commits funds to fully transform the space, introducing restaurants to a scheme that currently has a 10-screen cinema, a 151-room hotel, a gym and 375 car parking spaces.
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A lease expiry in June 2017 on the second floor of 249 Midsummer Boulevard in Milton Keynes will allow Palace to upgrade that space and the common areas for c £450k, with the aim of increasing rental tone. The large site has potential for significant development in the medium term.
Palace’s active management strategy has contributed to the increase in EPRA NAV, and the geographic focus outside London has also been of benefit since year-end: the new UK business rates introduced in April 2017 actually reduced aggregate rates on the portfolio, ensuring continued affordability for tenants, while many rates in London rose significantly, potentially weighing on future rent increases.
The outlook for Palace remains positive: in the near term, irrecoverable costs related to development projects are likely to fall, which will help improve profitability further. We expect the company to complete the announced potential acquisition soon and, although other buying opportunities have been limited, they do exist and Palace continues to seek portfolios near public transport hubs, which offer a chance to improve rental values and are of a size that will help the company fulfil its aspiration to join the main market.
