Seeking to participate in sector consolidation
Picton has for some time made clear its view that consolidation is a positive for the sector, creating companies with increased scale, providing improved share liquidity, better access to capital and the potential for operational and financial synergies to drive faster earnings growth. In particular, the company has been open to opportunities to leverage its strong portfolio performance track record and internal management structure, able to support an increased asset base without a proportional increase in costs.
In November 2023, the company confirmed discussions with UKCM regarding a possible all-share merger, on an EPRA NTA for EPRA NTA basis. However, later that month Picton was informed by UKCM that its largest shareholder, Phoenix Life Limited, which controls approximately 43% of UKCM’s share capital, did not support a merger on the terms proposed. Picton subsequently confirmed that it no longer intended to make an offer for UKCM.
While merger discussions with UKCM have ended, we expect Picton to seek similar opportunities and it is worth examining the strategic logic on which the proposed transaction was based.
The diversified portfolios of UKCM and Picton are complementary and both companies seek to provide investors with an attractive level of income together with the potential for capital and income growth. The combined gross assets would have been c £2.1bn (c £0.8bn from Picton and £1.3bn from UKCM).
Although UKCM benefits from relatively low external management charges, a merger with Picton would have provided the enlarged company with a significant cost saving opportunity. UKCM’s administrative expenses in the six months to 30 June 2023 were £4.5m or 0.7% of average net assets, of which the largest element was the external management fees of £3.4m. Total administrative expenses incurred by Picton in the six months to 30 September 2023 were £3.4m, less than the equivalent figure for UKCM of £4.5m, but a higher 1.0% of its lower average net assets. From this lower cost base, Picton manages a portfolio that comprises more properties than UKCM (c 49 at the interim stage compared with 39 for UKCM) let to a larger number of tenants (c 400 vs c 200), providing a further indication of the potential to remove costs from a combined vehicle, not simply confined to external management fees.
Exhibit 1: Picton and UKCM portfolio structures
|
Sector weights at 30 September 2023 |
|
Picton |
UKCM |
Industrial weighting |
58.0% |
58.8% |
o/w South East |
42.1% |
33.7% |
o/w Rest of UK |
15.9% |
25.1% |
Office weighting |
31.6% |
12.2% |
o/w London City & West End |
7.1% |
1.9% |
o/w Inner & outer London |
5.4% |
|
o/w South East |
8.8% |
4.8% |
o/w Rest of UK |
10.3% |
5.5% |
Retail & Leisure weighting |
10.4% |
19.5% |
o/w Retail Warehouse |
6.8% |
12.1% |
o/w High Street Rest of UK |
2.1% |
|
o/w Supermarkets |
- |
2.1% |
o/w Leisure |
1.5% |
5.3% |
Other weighting |
- |
9.5% |
o/w Student accommodation |
- |
4.7% |
o/w Hotels* |
- |
4.8% |
Total |
100.0% |
100.0% |
Source: Picton H124 report. UKCM 30 September 2023 factsheet. Note: *UKCM has one hotel that is under development and targeted to open in the third quarter of 2024.
At a portfolio level, Picton has outperformed its benchmark MSCI UK Quarterly Property Index in each of the past 10 years and has delivered upper quartile performance since inception in 2005. UKCM uses an alternative benchmark, the MSCI UK Balanced Portfolios Quarterly Property Index, the performance of which differs slightly from that adopted by Picton. Over the past one, three, five and 10 years, UKCM has also outperformed its benchmark, although less so. Over 10 years the Picton portfolio has generated a total return of 9.9% pa compared with 6.7% pa for UKCM.
Exhibit 2: Portfolio level performance versus respective benchmarks
Annualised total return per annum |
1 year |
3 years |
5 years |
10 years |
Picton |
-7.6% |
6.6% |
5.9% |
9.9% |
Benchmark: MSCI UK Quarterly Property Index |
-12.0% |
2.2% |
1.2% |
5.9% |
UKCM |
-12.9% |
4.5% |
2.5% |
6.7% |
Benchmark: MSCI UK Balanced Portfolios Quarterly Property Index |
-13.3% |
2.0% |
1.3% |
6.0% |
Source: Picton data taken from H124 financial report to 30 September 2023. UKCM data taken from quarterly factsheet for three months to 30 September 2023.
Picton’s strong property returns have been the main driver of financial performance, supporting an average 9.5% pa accounting total return, without assuming reinvestment of dividends, over the c 10-year period beginning 1 January 2014 to 30 September 2023 (end-H124).
Exhibit 3: Picton accounting/EPRA NTA* total return (dividends not reinvested)
Pence per share |
2014 |
2015 |
2016 |
2017 |
2018 |
2019 |
2020 |
2021 |
2022 |
9m 2023 |
1/1/2014–30/9/2023 |
Opening EPRA NTA |
53.8 |
66.0 |
75.7 |
80.4 |
88.6 |
92.5 |
95.2 |
95.5 |
112.8 |
102.2 |
53.8 |
Closing NTA |
66.0 |
75.7 |
80.4 |
88.6 |
92.5 |
95.2 |
95.5 |
112.8 |
102.2 |
99.0 |
99.0 |
Dividend paid |
2.25 |
3.00 |
3.23 |
3.30 |
3.40 |
3.50 |
3.50 |
2.83 |
3.30 |
2.63 |
30.93 |
Capital return |
22.7% |
14.7% |
6.2% |
10.2% |
4.4% |
2.9% |
0.3% |
18.1% |
-9.4% |
-3.1% |
84.0% |
Dividend return |
4.2% |
4.5% |
4.3% |
4.1% |
3.8% |
3.8% |
3.7% |
3.0% |
2.9% |
2.6% |
57.5% |
Total return (TR) |
26.9% |
19.2% |
10.5% |
14.3% |
8.2% |
6.7% |
4.0% |
21.1% |
-6.5% |
-0.6% |
141.5% |
Annual average TR |
|
|
|
|
|
|
|
|
|
|
9.5% |
Source: Picton data, Edison Investment Research. Note: *EPRA net tangible assets.
With property return being the driver, we calculate an average 4.8% total return for UKCM over the same period.
Exhibit 4: UKCM accounting/EPRA NTA* total return (dividends not reinvested)
Pence per share |
2014 |
2015 |
2016 |
2017 |
2018 |
2019 |
2020 |
2021 |
2022 |
9m 2023 |
1/1/2014–30/9/2023 |
Opening EPRA NTA |
73.7 |
83.7 |
86.7 |
86.5 |
93.0 |
93.4 |
89.8 |
86.7 |
102.0 |
79.7 |
73.7 |
Closing NTA |
83.7 |
86.7 |
86.5 |
93.0 |
93.4 |
89.8 |
86.7 |
102.0 |
79.7 |
80.7 |
80.7 |
Dividend paid |
4.1 |
3.7 |
3.7 |
3.7 |
3.7 |
3.7 |
2.3 |
2.9 |
5.2** |
2.6 |
35.4 |
Capital return |
13.5% |
3.6% |
-0.2% |
7.5% |
0.4% |
-3.9% |
-3.5% |
17.6% |
-21.9% |
1.3% |
9.5% |
Dividend return |
5.5% |
4.4% |
4.2% |
4.3% |
4.0% |
3.9% |
2.6% |
3.4% |
5.1% |
3.2% |
48.0% |
Total return (TR) |
19.1% |
8.0% |
4.0% |
11.8% |
4.4% |
0.1% |
-0.9% |
21.0% |
-16.8% |
4.5% |
57.5% |
Annual average TR |
|
|
|
|
|
|
|
|
|
|
4.8% |
Source: UKCM data, Edison Investment Research. Note: *EPRA net tangible assets. **2022 includes a special dividend paid of 1.92p.
While remaining open to value-creating M&A, Picton continues to be proactive in pursuing organic asset management initiatives aimed at building on its performance track record. In this respect, asset repurposing, mostly of selected office assets, is significant.
Asset repurposing should unlock value
During H124 Picton continued to grow contracted rents and estimated rental value (ERV), albeit modestly. Contracted rent benefited from new lettings, renewals and regears, and reviews, all on average above March ERV and/or previous contracted rents. However, including lease maturities, on an EPRA basis, occupancy reduced to c 90% from c 91% at end-FY23. The £10.4m gap between ERV (£56.2m) and contracted rents (£45.8m) comprised £2.8m reversion potential from increasing current rents to market levels and £4.5m from letting vacant space. The top five portfolio voids, accounting for 63% of the total, were all office properties, and reducing voids can often bring twin benefits from increased income and reduced empty property costs. Notwithstanding the positive leasing and regear activity that Picton achieved in its office properties in H124, it has identified opportunities to respond proactively to significant changes in the market by adapting some of its assets to alternative use.
There are currently three projects under way, at Angel Gate in London EC1, Longcross in Cardiff and Charlotte Terrace in London W14.
At Angel Gate (14% of the portfolio void), during H123, Picton identified an opportunity to secure planning consent for the conversion of 30,000 sq ft of vacant office space to residential use, with plans for 34 dwellings. After extensive dialogue with the local authority, the company has since been able to release (from Article 4 restrictions) the remaining 34,000 sq ft, enabling residential use across the whole property. Picton says that it is now in the process of bringing this asset to the market for disposal in early 2024.
At Longcross (12% of the portfolio void), contracts have been exchanged for its sale to an experienced purpose-built student accommodation developer. The transaction is conditional on planning permission, which will be submitted by June 2024. The sale price is dependent on the exact planning consent obtained and, in particular, upon the number of rooms secured, subject to a collar and cap. Picton says that in all scenarios the transaction is NAV accretive.
Charlotte Terrace (11% of the portfolio void) comprises four adjoining buildings, which total 28,500 sq ft of office space and 4,400 sq ft of retail space, arranged over five floors. It is located close to Olympia, which is currently undergoing a £1bn redevelopment delivering a new creative district, with a new theatre, entertainment venue, hotel, office, retail and leisure space that is expected to enhance the surrounding area. Having achieved vacant possession in one of the four buildings, a planning application has been submitted for alternative residential use.
On a lesser scale, but nonetheless reflective of its active approach to asset management, at Colchester Business Park (14% of the portfolio void), Picton secured planning permission for the change of use of a vacant office suite, enabling it to be let to a healthcare occupier. An office building became vacant on the last day of the period, accounting for 60% of the void, with the majority of the remaining void, a recently refurbished industrial unit, under offer.
