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Research: Real Estate
Palace Capital
Written by
Palace Capital |
NAV-accretive disposals |
Disposals of assets |
Real estate |
28 February 2017 |
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Palace Capital is a research client of Edison Investment Research Limited |
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Palace Capital (Palace) has announced the disposals of two properties: one in Leeds and one in Stockport. The rationale for each is clear and in line with the company’s strategy to deliver shareholder value through capital and income growth. The disposals, totalling £3.7m, will crystallise value from active asset management, free capital to be recycled, increase the portfolio’s average unexpired lease term to first break and reduce void costs. We have adjusted our forecasts accordingly and expect Palace will reinvest the proceeds in other regional property assets in due course.
Year end |
Revenue |
Adjusted EPRA earnings* (£m) |
Adjusted EPRA EPS (p) |
EPRA NAV/share (x) |
DPS |
Yield |
03/15 |
8.6 |
4.8 |
28.3 |
396 |
13.0 |
3.7 |
03/16 |
14.6 |
4.6 |
18.9 |
414 |
16.0 |
4.5 |
03/17e |
14.0 |
5.5 |
21.8 |
424 |
18.0 |
5.1 |
03/18e |
13.7 |
5.7 |
22.2 |
428 |
18.0 |
5.1 |
03/19e |
13.4 |
6.1 |
23.6 |
433 |
18.0 |
5.1 |
Note: *Adjusted EPRA earnings exclude revaluation gains, profits or losses on disposals of investment properties and surrender on early lease terminations.
One disposal increases value…
The sale of the long leasehold at Warwick House in Leeds for £2.15m is well above the carrying value of £1.4m, representing a 54% gain before expenses. The tenant, Interserve, pays rent of £196.3k a year, or £172.5k after ground rent due to the freeholder, Leeds City Council, and has an option to break the lease in August 2017. Palace has been able to reduce the risk of vacancy and make a disposal well above the price paid when the property was bought from Quintain in 2013 as part of the Sequel portfolio. The uplift to the carrying value is significant and shows Palace’s ability to generate capital value growth through active asset management.
…the other reduces costs
Allen House in Stockport was also bought as part of the Sequel portfolio and has been vacant since the occupier surrendered the lease in September 2015. The price of the sale (£1.55m) is slightly above the most recent valuation, but perhaps more significantly, it removes the c £185k of annual vacancy costs associated with the building. Palace has previously stated it intended to sell the property and the effect of the sale was included in our earlier forecast assumptions. The disposal frees capital for reinvestment, as does Warwick House, and is another example of the effective implementation of Palace’s strategy.
Valuation: Still at a discount to peers
Palace’s c 18% discount to our FY17 EPRA NAV forecast seems high compared with a basket of regional property investor peers, which trade at c 98% of EPRA NAV on average. As the announcements demonstrate, Palace can deliver capital value growth as well as pay a dividend yield of c 5%, comparable to REIT peers, underpinned by stable income from its portfolio. As Palace extends its track record, its investor audience is likely to broaden and the discount may narrow.
Details of the disposals and their effect on forecasts
The announced disposals of assets in Stockport and Leeds, acquired from Quintain in 2013 as part of the Sequel portfolio, are in line with Palace’s active approach to asset management and we expect them to be NAV accretive. Exhibit 1 shows details of each disposal.
Exhibit 1: Disposals
Property name |
Location |
Sector |
Size (sqft) |
Book value (£m) |
Sale price (£m) |
Net rent (£000s) |
Buyer |
Warwick House |
Leeds |
Office |
14,818 |
1.40 |
2.15 |
172.5 |
Private group |
Allen House |
Stockport |
Industrial |
68,000 |
1.55 |
1.55 |
(185.0) |
Not disclosed |
Source: Palace Capital
Warwick House in Leeds has been sold at a premium of 54% to its book value, or £0.75m, equivalent to c 2.9p per share before tax. This gain was not included in our forecasts for FY17 and is equal to half of our estimated valuation uplift in FY18, which we still expect to be generated by gains at Boulton House in Manchester and Solaris House in Milton Keynes (see our initiation note). the attractive price, the lease break coming up in August 2017 and the secondary location of the property motivated the sale. It will allow Palace to crystallise a gain on the property and recycle capital, in line with its investment strategy. The reduction in annual rent is offset by the reduction in void costs from selling Allen House in Stockport. This vacant asset, which the company had previously announced its intention to sell, had annual void costs of c £185k,. This cost reduction was already included in our forecasts, and we have now allowed for the reduction in rent from the disposal of Warwick House. This reduction in rental income reduces forecast EPRA EPS slightly and we have not allowed for any new investment. The changes to our forecasts are set out in Exhibit 2.
Exhibit 2: Estimate changes
Year end |
Rental income (£m) |
EPRA EPS (p) |
EPRA NAV per share (p) |
Dividend per share (p) |
||||||||
Old |
New |
Change |
Old |
New |
Change |
Old |
New |
Change |
Old |
New |
Change |
|
03/17e |
14.0 |
14.0 |
0.0 |
21.2 |
21.2 |
0.0 |
422 |
424 |
0.6 |
18.0 |
18.0 |
0 |
03/18e |
13.9 |
13.7 |
-0.9 |
21.8 |
21.5 |
-1.5 |
426 |
428 |
0.4 |
18.0 |
18.0 |
0 |
03/19e |
13.6 |
13.4 |
-1.2 |
23.3 |
22.9 |
-1.9 |
431 |
433 |
0.5 |
18.0 |
18.0 |
0 |
Source: Edison Investment Research
We note that management’s strategy is to recycle capital, so we expect the proceeds of the disposals to be reinvested in income-producing assets. If all £3.7m of sale proceeds were reinvested at a yield of 7% and assuming purchaser’s costs of 6%, they would generate a rental income of c £240k. If the funds were invested in the middle of FY18, our model indicates they would feed through to EPRA EPS of 21.6p per share in FY18 and 23.5p in FY19.
Valuation: NAV accretive and EPS neutral
The disposals are NAV accretive, and we continue to view Palace’s discount to NAV (currently c 18% vs our new FY17 forecast) as high compared with regional peers, which trade at around a 2% discount to stated EPRA NAV on average. This may be because of Palace’s relatively short time as a listed company, and we would expect it to move closer to the peer average as it establishes a longer track record of delivering value and income growth.
Exhibit 3: Financial summary
Year end 31 March |
£'000s |
2014 |
2015 |
2016 |
2017e |
2018e |
2019e |
|
IFRS |
IFRS |
IFRS |
IFRS |
IFRS |
IFRS |
|||
PROFIT & LOSS |
||||||||
Revenue |
|
|
3,252 |
8,637 |
14,593 |
13,969 |
13,748 |
13,436 |
Cost of Sales |
(648) |
(1,200) |
(1,624) |
(2,322) |
(1,862) |
(1,396) |
||
Gross Profit |
2,604 |
7,437 |
12,969 |
11,647 |
11,887 |
12,040 |
||
Administrative expenses |
(649) |
(1,439) |
(2,048) |
(2,511) |
(2,615) |
(2,079) |
||
Operating Profit before revaluation |
1,955 |
5,998 |
10,921 |
9,136 |
9,272 |
9,331 |
||
Revaluation of investment properties |
19,501 |
9,769 |
3,620 |
32 |
1,500 |
0 |
||
Costs of acquisitions/profits on disposals |
270 |
(461) |
(525) |
1,623 |
0 |
0 |
||
Operating Profit |
21,725 |
15,306 |
14,016 |
10,791 |
10,772 |
9,331 |
||
Net Interest |
(573) |
(1,398) |
(2,264) |
(2,822) |
(2,427) |
(2,328) |
||
Profit Before Tax (norm) |
1,652 |
4,139 |
8,132 |
7,936 |
6,845 |
7,003 |
||
Profit Before Tax (FRS 3) |
21,153 |
13,908 |
11,752 |
7,968 |
8,345 |
7,003 |
||
Taxation |
81 |
107 |
(953) |
(951) |
(1,252) |
(1,050) |
||
Profit After Tax (norm) |
1,733 |
4,246 |
7,179 |
6,985 |
5,593 |
5,952 |
||
Profit After Tax (FRS 3) |
21,234 |
14,015 |
10,799 |
7,017 |
7,093 |
5,952 |
||
EPRA earnings |
1,463 |
4,707 |
7,704 |
5,362 |
5,593 |
5,952 |
||
Adjusted for: |
||||||||
Surrender premium |
0 |
0 |
(3,172) |
0 |
0 |
0 |
||
Share-based payments |
0 |
114 |
110 |
145 |
100 |
100 |
||
Adjusted EPRA earnings |
1,463 |
4,821 |
4,642 |
5,507 |
5,693 |
6,052 |
||
Average Number of Shares Outstanding (m) |
5.3 |
17.1 |
24.6 |
25.7 |
26.0 |
26.0 |
||
EPS - normalised (p) |
|
32.9 |
24.8 |
29.2 |
27.2 |
21.5 |
22.9 |
|
EPS - FRS 3 (p) |
|
403.4 |
82.0 |
43.9 |
27.3 |
27.2 |
22.9 |
|
Adjusted EPRA EPS (p) |
|
29.7 |
28.3 |
18.9 |
21.8 |
22.2 |
23.6 |
|
EPRA EPS (p) |
|
27.8 |
27.5 |
31.3 |
21.2 |
21.5 |
22..9 |
|
Dividend per share (p) |
0.0 |
13.0 |
16.0 |
18.0 |
18.0 |
18.0 |
||
Dividend cover (x) |
N/A |
2.12 |
1.96 |
1.18 |
1.19 |
1.27 |
||
BALANCE SHEET |
||||||||
Fixed Assets |
|
60,086 |
104,470 |
175,738 |
182,597 |
184,097 |
186,097 |
|
Investment properties |
59,440 |
102,988 |
174,542 |
181,587 |
183,087 |
185,087 |
||
Goodwill |
6 |
6 |
0 |
0 |
0 |
0 |
||
Other non-current assets |
640 |
1,475 |
1,196 |
1,010 |
1,010 |
1,010 |
||
Current Assets |
|
7,060 |
15,653 |
11,903 |
16,220 |
14,060 |
11,459 |
|
Debtors |
1,937 |
3,375 |
3,327 |
3,170 |
3,170 |
3,170 |
||
Cash |
5,123 |
12,279 |
8,576 |
13,050 |
10,890 |
8,289 |
||
Current Liabilities |
|
(4,171) |
(3,487) |
(9,048) |
(11,193) |
(11,193) |
(11,193) |
|
Creditors |
(2,971) |
(3,087) |
(6,815) |
(7,952) |
(7,952) |
(7952) |
||
Short term borrowings |
(1,200) |
(400) |
(2,233) |
(3,241) |
(3,241) |
(3,241) |
||
Long Term Liabilities |
|
(18,599) |
(36,620) |
(71,778) |
(78,774) |
(75,538) |
(73,502) |
|
Long term borrowings |
(17,384) |
(35,407) |
(69,711) |
(76,709) |
(73,473) |
(71,437) |
||
Other long term liabilities |
(1,215) |
(1,214) |
(2,067) |
(2,065) |
(2,065) |
(2,065) |
||
Net Assets |
|
44,376 |
80,016 |
106,815 |
108,850 |
111,426 |
112,861 |
|
Net Assets excluding goodwill and deferred tax |
44,370 |
80,010 |
106,815 |
108,850 |
111,426 |
112,861 |
||
Basic NAV/share (p) |
219 |
395 |
414 |
424 |
428 |
433 |
||
EPRA NAV/share (p) |
219 |
396 |
414 |
424 |
428 |
433 |
||
CASH FLOW |
||||||||
Operating Cash Flow |
|
1,297 |
4,388 |
12,287 |
9,777 |
9,392 |
9,451 |
|
Net Interest |
(390) |
(1,593) |
(3,421) |
(2,529) |
(2,427) |
(2,328) |
||
Tax |
(13) |
(15) |
(158) |
(477) |
(1,252) |
(1,050) |
||
Preference share dividends paid |
(18) |
0 |
0 |
0 |
0 |
0 |
||
Net cash from investing activities |
2,532 |
(2,922) |
(50,012) |
(5,408) |
(20) |
(2,020) |
||
Ordinary dividends paid |
0 |
(1,766) |
(3,221) |
(4,617) |
(4,617) |
(4,617) |
||
Debt drawn/(repaid) |
(21,266) |
(10,600) |
21,272 |
8,241 |
(3,236) |
(2,036) |
||
Proceeds from shares issued |
23,009 |
19,664 |
19,114 |
38 |
0 |
0 |
||
Other cash flow from financing activities |
(66) |
(2) |
(2) |
(551) |
0 |
0 |
||
Net Cash Flow |
5,085 |
7,155 |
(4,141) |
4,474 |
(2,160) |
(2,601) |
||
Opening cash |
|
39 |
5,123 |
12,278 |
8,576 |
13,050 |
10,890 |
|
Other items (including cash assumed on acquisition) |
0 |
0 |
439 |
0 |
0 |
0 |
||
Closing cash |
|
5,123 |
12,278 |
8,576 |
13,050 |
10,890 |
8,289 |
|
Opening net debt/(cash) |
1,724 |
13,476 |
24,742 |
65,435 |
68,965 |
67,887 |
||
Closing net debt/(cash) |
13,476 |
24,742 |
65,435 |
68,965 |
67,889 |
68,454 |
||
Source: Palace Capital, Edison Investment Research
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