Raven Russia — Update 4 April 2016

Raven Property Group (LSE: RAV)

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Research: Real Estate

Raven Russia — Update 4 April 2016

Raven Russia

Martyn King

Written by

Martyn King

Director, Financials

Real Estate

Raven Russia

Robustly facing a difficult environment

FY15 results outlook note

Real estate

4 April 2016

Price

29.5p

Market cap

£201m

US$/£1.425

Net debt ($m) as at 31 December 2015

716.5

Shares in issue

682.6m

Free float

85.3%

Code

RUS

Primary exchange

LSE

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

(14.5)

(27.2)

(39.5)

Rel (local)

(14.6)

(25.8)

(34.1)

52-week high/low

58.2p

29.0p

Business description

Guernsey-based Raven Russia is listed on the main market of the LSE and invests, for the long term, in modern, high-quality warehouse properties in Russia, with the aim of delivering attractive distributions to shareholders over time.

Next event

AGM

May 2016

Analysts

Martyn King

+44 (0)20 3077 5745

Andrew Mitchell

+44 (0)20 3681 2500

Raven Russia is a research client of Edison Investment Research Limited

Raven worked hard in 2015 to mitigate the impact of a harsh trading environment. Management focused on maintaining income at the best level achievable, in whatever currency the market will allow, while protecting cash balances. It ended the year with $202m in cash, a significant share of the current market cap. Underlying profits provided management the room for continued distributions while maintaining the balance sheet prudence necessary for Raven to participate in the upside when conditions improve. A rouble/oil price recovery or easing of sanctions are potential catalysts.

Year end

Revenue ($m)

NOI*
($m)

EPS**
(c)

adj. NAV***
(p)

DPS
(c)

P/adj. NAV***
(x)

Yield
(%)

12/14

257.6

192.3

8.9

74

6.0

0.40

20.3

12/15

219.7

174.1

7.9

49

2.0

0.60

6.8

12/16e

192.4

150.1

5.0

50

1.0

0.59

3.4

12/17e

181.2

140.7

4.1

52

1.0

0.57

3.4

Note: *NOI is net operating income. **EPS is underlying and fully diluted, excluding valuation movements, depreciation, share-based payments and exceptional items. ***NAV is underlying and fully diluted, excluding goodwill, deferred tax on valuation gains, fair value movements on derivate contracts and cumulative FX movements on preference shares.

Weathering the storm

Underlying profits declined 13% to $65m but revaluation losses of $256m contributed to an IFRS loss of $192m and a fully diluted underlying NAV per share decline to 70 cents (c 49p) from 106 cents (c 74p). Revaluation losses reflect weakness in rents that is yet to fully feed through to earnings along with the full year effect of the decline in occupancy to 82% at the year end versus 94% at end 2014. A 1p final distribution by way of a tender offer is proposed, making 2p for the year. Raven entered the Russian economic and currency crisis in good shape and continues a cautious strategy aimed at maximising cash flow and paying down debt so as to be in a position to benefit from a turn in the market.

Waiting for recovery

More than one year on from the start of the rouble crisis, most forecasters look for the decline in Russian GDP to end during this year with a modest recovery beginning in 2017. With market rents currently below replacement cost, little new supply is expected, while demand for space continues, making for an improving demand-supply balance in a market that appears structurally under-penetrated. Our revised forecasts, explained in detail given the uncertainty and complexity of the factors at play, continue to look for net operating income (NOI) declines from a lower point than we had expected at this stage. Nevertheless, our forecasts indicate positive cash flow, sufficient to reduce net debt and meet modest continued distributions.

Valuation: Support pending market recovery

Our forecast 1p distribution is a 3.3% yield, while the c 40% discount to NAV provides additional comfort. A rouble/oil price rally should be supportive of rental income and cash flow and indirectly, NAV. At 130p, the preference shares yield is a little over 9% on a fixed coupon.

Investment summary

Raven’s FY15 results release is realistic about the harsh environment that the company is facing. However, the report also details the company’s active leasing efforts aimed at defending income and cash flow, cost containment, and defensive management of the balance sheet. The year-end cash balance was $202m, a significant proportion of the current market capitalisation, and the decline in underlying pre-tax profit was kept to 13%. This was below our forecast struck after the interim results and we expect the effect to be more pronounced in the current year from the increase in vacancy and market pressure on rents. We show our downwardly revised estimates on page 10.

After reviewing the key features of the 2015 results and the market environment, we also look in more detail at the portfolio structure and leasing developments. Following this, on page 6, we explain in great detail the basis for our investment property NOI estimates, the basis for our group financial forecasts, valuation work, and the key to understanding how sensitive these are to positive or adverse future developments.

Key features of the 2015 results

At 1.498m sqm there was no material change in the completed portfolio during the year. Portfolio occupancy was 82% at 31 December 2015 compared with 89% at 30 June and 94% at 31 December 2014. The decrease was driven by space vacated at maturity, but more significantly by early terminations of weaker covenants and some larger tenants seeking supply chain efficiencies.

Annualised contracted net operating income (NOI) on the property portfolio was $162.0m at 31 December 2015, down from $187.5m at 30 June and $199.3m at 31 December 2014. The reduction in annualised contracted NOI reflects the roll-over of maturing leases and lease renegotiations at the currently reduced market rent levels in addition to increased vacancy.

The completed investment portfolio was externally valued at year-end by Jones Lang LaSalle, using an income capitalisation method, at $1.36bn compared with $1.61bn at 31 December 2014, generating an unrealised loss on revaluation of $251.1m. The revaluation loss reflects the negative effects of the valuer’s assumptions for lower expected rental values, particularly in the short term, higher expected vacancy, and somewhat higher valuation yields. The carrying value of the (non-active) development assets, assessed on a residual value basis, reduced from $48.0m to $39.1m, largely reflecting a negative revaluation impact of $5.4m.

At the beginning of 2015, contractual maturities amounted to c 140,000sqm with c 323,000sqm in 2016. Management’s strategy has been to maintain cash flow in the current difficult market environment (pressure on tenants, significant new supply) and it has sought to renew the soon-to-expire leases at the earliest opportunity. During the year 80,000sqm of the 140,000sqm maturing in 2015 and 101,000sqm of the 2016 maturities were renegotiated and extended. Significantly, the remaining maturity profile carried forward into 2016 has been increased by the failure of a large tenant to execute on a long-term lease over 42,000sqm of space occupied on a pre-letting agreement until February of 2016. We discuss the lease maturity profile in detail on page 6.

Net operating and related income (including the subsidiaries, Roslogistics and Raven Mount in addition to the investment portfolio) declined to $174.1m from $192.3m in 2014. H215 fell to $78.7m from $95.5m in H115. The logistics subsidiary Roslogistics saw a decline of $6.8m (to $9.0m) due primarily to translation effects on its rouble-denominated revenues. Property portfolio NOI declined by $11.9m to $162.7m.

Administrative expenses declined from $34.6m to $30.0m. On an underlying basis, adjusted for D&A, abortive project costs, and goodwill impairment, there was an increase from $27.0m to $30.0m, fully explained by bad debt costs (on contracted rents) of $3.7m (2014: nil).

The decline in underlying operating profit (adjusted for foreign exchange movements and revaluation movements) was kept to 2%, from $150.8m to $147.8m. It did however benefit from an unexpectedly strong contribution of $2.5m from Raven’s share of joint ventures (2014: $1.0m). Pre-tax operating cash flow was $144.9m or 98% of underlying operating profit. FX movements were relatively small in the year, with a significant movement in the rouble/$ rate having occurred late in the previous year. The P&L showed a gain of $1.2m (2014: a negative $15.5m), with a loss of $1.8m (2014: $41.0m loss) in other comprehensive income.

Net financial costs were higher on an underlying basis ($82.8m versus $75.7m in 2014), largely reflecting the draw-down of debt facilities at the beginning of the year and a slight increase in the weighted average cost of debt, from 6.99% at the end of 2014 to 7.26% at the end of 2015. On a reported basis, which also includes derivative fair value movements and amortisation of loan issue costs there was a y-o-y decline from $93.4m to $92.3m.

Underlying PBT was $65.0m versus $75.1m in 2014, a decline of 13%. Adjusted for FX movements, which are part of reported underlying profits, PBT fell from $90.6m to $63.7m, a decline of 30%. The average number of shares was 6.4% lower (667.8m versus 715.0m), reflecting ongoing buybacks resulting from distributions being offered through tender offers. Underlying EPS on a fully diluted basis was 11% lower at 7.94 compared with 8.94c in 2014. H215 EPS was 3.02c compared with 4.91c in H115.

The cash balance remained strong, ending the year at $202.3m compared with $171.4m at end 2014 and $220.9m at the mid-year stage. Bank debt increased to $918.7m from $892.7m, with debt drawn during the year of $81m and continuing amortisation (repayment) of $58m. Outstanding sterling-denominated preference shares were carried at $156.6m at the year end, down from $164.3m due largely to FX translation. The average maturity of the bank debt fell slightly from 4.8 years to 4.0 years with one ($15.0m) facility due to expire this year and two (aggregate $148m) in 2017. Interest rates on variable rate debt are hedged with swaps and caps on US LIBOR fixed rate facilities.

Capturing the effect of the property revaluations, adjusted NAV per share on a fully diluted basis was $0.70 at 31 December 2015 compared with $1.06 per share at the end of 2014.

A final distribution of 1p per share has been proposed, by way of a tender offer to buy-back 1 in 40 shares at 40p per share. That will take total distributions for the year to 2p (2014: 6p), in line with management’s earlier guidance that it would seek to maintain a conservatively liquid balance sheet. We note that operating cash flow after financing costs (including preference dividends) but before ongoing debt amortisation ($58m in 2015) was $52.4m or c 5.0p per share (2014: $82.8m or c 7.3p per share).

Market environment has been harsh

As is well known, the Russian economy has been severely hit by a combination of weak oil prices and international sanctions. GDP declined, the Russian rouble collapsed, and inflation increased to double-digit levels. GDP slowed sharply in 2014 and contracted by 3.7% in 2015. However, most forecasters are indicating that much of the adjustment has been made and that the economy will stabilise during 2016 and begin to grow again in 2017, despite the renewal on international sanctions for another year in March 2015. The World Bank (in its January 2016 update) expects a further 0.7% decline this year and growth of 1.3% next; the IMF World Economic Outlook update (also from January) follows a similar pattern of expectations (-1% and then +1%). Inflation has been easing on an annual basis as the worst effects of the rouble devaluation feed through. Annual CPI inflation declined to 8.1% in February 2016 having peaked at 16.9% in March 2015. With the fall in inflation, interest rates too have eased, with government bond rates falling below 10% from a peak of c 17% in late 2014.

Exhibit 1: Rouble vs US$

Exhibit 2: Brent crude oil in US$

Source: Bloomberg

The weakness of the economy has the effect of reducing the demand for new lettings and the opportunities to renew existing leases, and has put downward pressure on market rents. The rouble weakness (it has halved in value versus the US dollar since sanctions were imposed in 2014) has put enormous pressure on tenants with US dollar-pegged leases, with some simply unable to cope and others opting for rouble-denominated rents at levels where the US dollar equivalent is well below the levels previously seen in the market, albeit indexed to Russian inflation.

These negative effects of economic weakness were exacerbated by a significant amount of new supply, already in development when the crisis hit, being delivered to market. The majority of this space was developed speculatively with no end tenant in place. In 2014, c 1.6m sqm of new modern warehouse space was completed in the Moscow region (75% of the Raven portfolio) according to JLL. This 16% increase on the 9.6m sqm opening stock had been planned in the context of a structurally undersupplied market with persistent low vacancy and a low ratio of warehouse space per capita relative to other major European locations. New supply continued at a high level into H115 as projects that could not be shelved were completed, adding an additional c 600k sqm, but slowed in H215, taking the annual new supply to 839k sqm. The market vacancy rate increased from 7.9% at the end of 2014 to an estimated 10.5% (on a stock of 12.0m sqm) at the end of 2015. JLL forecasts 700k sqm of new supply in 2016, half of which has either been leased or sold at an early stage of construction, and take-up of 900k sqm. Take-up of space has continued with large retailers in particular seeking to improve their supply chains. E-commerce is expanding with traditional retailers reporting strong growth in online sales, which should support demand for well-located warehouses around the major cities. JLL forecasts a reduction in the vacancy rate to 7.5% by the end of 2016.

Given the developing market situation, from late 2014 warehouse landlords responded by dropping asking prices on new lease agreements in order to protect occupancy and cash flow. Colliers estimates that across the market as a whole asking rents dropped from an average $125 per sqm in Q3 2014 to c $75 per sqm in early 2015. As vacancy continued to increase landlords further responded to the currency-induced pressures on current and prospective tenants by agreeing to rouble-denominated rents at levels not dissimilar in rouble terms to pre-crisis levels, but significantly lower in US dollar terms. Across all sectors rents are for now rouble-denominated for new lettings, although the majority include indexation to Russian CPI.

Rent pressure has been greatest in the market for new tenants, where developers are forced to aggressively compete so as to be able to let space. For existing tenants, contractual lease terms provide some friction to the adjustment process and in lease renegotiations any decision to move rather than renew must include the consideration of the costs and difficulties involved in moving and re-training staff, and possible disruptions to supply chains and existing business.

The effect on Raven’s portfolio

Raven has a completed portfolio of 1.5m sqm gross lettable area (GLA) of modern Grade A warehouse space and 16k sqm of fully let non-core office space in St Petersburg (Constanta). Contracted occupancy at the end of 2015 was 82% for the overall portfolio and 81% for the core warehouse assets, down from 94% at the end of 2014.The warehouses portfolio is predominantly situated in the Moscow regions (nine assets), with the balance split between St Petersburg and the regions (two completed assets in each). There are no current development projects although Raven does have a land bank of 273 hectares, of which 84 hectares provide land resources for additional phases as demanded at existing completed properties.

Raven’s letting strategy has always been to target what it believes will be the stronger tenants ie, international and larger domestic businesses, which are more likely to fulfil their rental obligations, on secure long-term leases. Diversification of the tenant profile provides additional protection against adverse developments in any particular sector. The largest tenant accounts for 11% of GLA and the top 10 tenants account for 45%.

Over the past year, the tenant mix (by GLA) has shifted slightly towards international tenants (56% of the total at the end of 2015 versus 49% at the end of 2014) with domestic tenants showing a corresponding decline.

Exhibit 3: Warehouse space by region as at 31 December 2015 (based on sqm)

Exhibit 4: Warehouse space by tenant origin as at 31 December 2015 (based on sqm)

Source: Company data

Source: Company data

Exhibit 3: Warehouse space by region as at 31 December 2015 (based on sqm)

Source: Company data

Exhibit 4: Warehouse space by tenant origin as at 31 December 2015 (based on sqm)

Source: Company data

In terms of sectors, the most obvious shift in tenant mix during the year was the decline in distribution, falling to 11% (by GLA) from 20%. Tenants in the distribution sector, dealing predominantly in imported goods, were more exposed to the competitive problems created by the rouble decline. Indeed, this is the main issue that all tenants have faced, whether domestic or international, irrespective of sector. The large retailer tenants are an area of relative strength in the portfolio, whether local or the large international players. While third-party logistics appears a relatively high focus for Raven (49%), the majority of this represents large international operators such as DHL, Itelia, DSV, Kuhne and Nagel (as well as Roslogistics).

Exhibit 5: 31 December 2014 warehouse space tenant mix (based on sqm)

Exhibit 6: 31 December 2015 warehouse space tenant mix (based on sqm)

Source: Company data

Source: Company data

Exhibit 5: 31 December 2014 warehouse space tenant mix (based on sqm)

Source: Company data

Exhibit 6: 31 December 2015 warehouse space tenant mix (based on sqm)

Source: Company data

From the back end of 2014 management turned its focus to renegotiating near-term maturing leases to defend occupancy and cash receipts. As it says in the annual report, management has focused on maintaining income at whatever level, and in whatever currency the market will allow, while protecting cash balances. Exhibit 7 shows the progress that it made on renegotiations and extensions of existing leases, particularly during H1, but continuing through H2. Of the 140k sqm of space maturing in 2015, 80k sqm was renegotiated or extended, as was a material proportion of the 2016 maturities. This exhibit also shows the pick-up in cancellations of leases across the maturity profile, particularly in H2 as tenants with business models that cannot adapt to the new weak rouble/weak growth environment failed or were managed out.

Exhibit 7: Letting summary, 2015

000sqm

2015

2016

2017-18

2019-23

Maturities as at 01 January 2015

140

323

309

564

Renegotiated & extended H115

79

84

13

0

Renegotiated & extended H215

1

17

24

0

Vacated/terminated H115

50

34

0

0

Vacated/terminated H215

10

12

59

32

Remaining 01 January maturities at 31 December 2015

0

176

213

532

Source: Company data

Exhibit 8 provides an update on the opening 2016 position. The 2016 maturities now include the 42k sqm of space that was occupied by Dixy under a PLA at the end of 2015, but which is now vacant. As of 1 January 2016, remaining maturities before the end of 2018 totalled 570k sqm versus 772k sqm as of 1 January 2015.

Exhibit 8: Opening lease maturity profile, 2016

000sqm

2016

2017

2018

2019-27

Remaining 01 January 2015 maturities at 31 December 2016

176

161

52

532

Impact of 2015 lease extensions

4

49

71

94

New leases

5

0

8

28

PLA

42

0

0

0

Maturities as at 01 January 2016

228

210

131

654

Maturities as % let portfolio

19

17

11

53

Source: Company data

With the results management reported that since the beginning of 2016 a further 86,800 sqm of renewals and re-lettings had been completed and letters of intent on 29,200 sqm had been signed. The average term of these deals is 3.3 years at an equivalent rent of $73 per sqm, in roubles with Russian inflationary indexation.

Historically, Raven has negotiated rents that are pegged to the US dollar and while the majority of NOI is still US dollar pegged, the proportion of rouble-denominated rents is likely to increase substantially from the 9% share of contracted warehouse NOI seen at the end of 2015 (up from 7% at H1). This traditional model of US dollar-pegged rents effectively transferred FX risk to the tenant but also relieved the tenant of much of the inflation indexation risk, US inflation being consistently lower than Russian. While the growth of rouble-denominated rents will see increasing FX risk revert to Raven, any improvement of the rouble versus the US dollar would represent an immediate benefit while indexation of rents to rouble inflation provides protection against further decline.

Where might rental income settle?

The key determinant of Raven’s future profits and cash flow, and ultimately property values and NAV, will be the development of property net operating income (NOI); rental income less direct property operating expenses. There are quite a number of moving parts to this and any future forecast in current market conditions is highly uncertain. However, we have set out in some detail the assumptions behind our near-term estimates (for 2016 and 2017), as well as a potential scenario for medium-term development.

Annualised contracted property NOI at the end of 2015 was $162m, down from $188m at mid-year and $192m at the end of 2014. This is the run-rate of contracted revenues at that point in time and includes the contractual value of any letters of intent (LOI) or pre-letting agreements (PLA) that will not actually contribute to P&L revenues until the lease begins, as well as the internal use of space by Raven’s small logistics subsidiary (Roslogistics), which eliminated from P&L revenues in the group consolidation. We estimate that the difference between average contracted occupancy and P&L revenue was c $17.5m in 2015 versus c $17.2m in 2014. It was lower at H115 (we estimate c $5.6m, largely reflecting the Roslogistic use of space) when the 42k sqm of space occupied by Dixy at Noginsk was included in P&L revenues; given the contractual dispute with the prospective tenant, Dixy, that will result in the space not being occupied this was carried under PLA in H2. The space has subsequently been vacated and we assume it will appear as vacant space in H116, unless it is re-let.

The decline in 2015 NOI, most clearly in H215, reflected a number of different factors:

Maturing contracted space that could only partially be re-let.

The impact of re-letting vacant space at lower market rents.

Raven’s termination of lease contracts with weaker tenants for whom the impact of the economy and exchange rate has made it impossible for them to honour their lease commitments. Raven does pursue non-payment of rent through the legal process but this has an uncertain outcome and to minimise the risk of bad debs it is more inclined to terminate the lease and be in a position to re-let.

Lease renegotiations with existing clients which may include lower rents for extended leases or lower initial rents, denominated in roubles but with higher (rouble based) inflation indexation.

We think it reasonable to assume that most of those tenants that are unable to meet lease commitments at or around the current $/rouble exchange rate will by now have terminated their agreements. There will be many more who would welcome some relief in their existing rental terms but who are able to meet their commitments within their long-term planning, and for whom the alternative of entering into potentially more volatile rouble-denominated rents and/or incurring the cost and disruption of relocation is similarly unattractive. This leaves the ability to extend maturing leases and/or re-let space, and the terms on which this can be achieved as the most obvious key drivers to NOI from here.

For modelling purposes, we had previously made the assumption that all maturing space would be re-let, at NOI of $100 per sqm (versus an average of c $142 per sqm at the end of 2014), but with a six month lag or void period. To capture the potential impact of tenant defaults we had also assumed bad debts at the rate of 2.5% of NOI pa. The effect of these assumptions was to model a progressive drop in average NOI per sqm while the assumed void period implied a drop in occupancy to 81%. The increase in lease terminations, particularly during H215, as market conditions worsened over an extended period have had the effect of 1) accelerating vacancy; and 2) accelerating the transition towards a lower level of rents.

At this point in time we think it appropriate to adjust our previous modelling framework slightly by:

Assuming that more of the remaining tenanted space will be renewed at maturity but at a lower rent. We assume that 75% of maturing space will see leases renewed with no void period.

We continue to assume that there will be a six-month lag in re-letting the 25% of maturing space that does not renew at maturity. For H116 we have assumed the level of renewals and re-lettings reported year to date (86,800 sqm) as well as year to date completed letters of intent (29,200 sqm), but no more.

For both renewals and re-lettings, we assume rents equivalent of $75 per sqm in 2016 and H117, based on rouble/$=70, applied to a blend of rents between c R4,500 per sqm for new leases to new tenants and c R6,000 per sqm for renewing existing tenants who are likely to wish to avoid the cost and disruption of moving. The average is R5,250 per sqm. From H217 we assume that there is some normalisation of the market with longer maturity leases being fixed at the equivalent of $100 per sqm.

Our base case also assumes that occupancy will begin to improve from H117, after holding steady at an average 82% in 2016. In modelling terms we assume that from H117, new leases are equal to space vacated six months earlier, plus 2.5% of the overall portfolio (ie, a 5% pa vacancy reduction until H219 when occupancy would be back at 98%). We would justify this assumption in terms of the quality and location of the Raven portfolio, the continued take-up of space in the market, forecasts for improving economic growth, and the drop off in new supply compared with continuing take-up.

By way of illustration, we have extended this analysis out to 2020, by which time an implied c 86% of the portfolio would have transitioned to the assumed new rent levels. We call it an illustration because we have not attempted to publish such long-term forecasts and we are conscious that this would be highly speculative, with the actual outcome likely to differ materially, either positively or negatively. Our purpose is to give some indication of the potential direction and speed of travel. We note that we have not increased rents through indexation, even though it is likely to be the case that an increasing proportion of rents will be rouble based and indexed to Russian inflation that is currently c 8%. Implicitly, we are assuming that leases are either US dollar linked (with no growth or indexation) or that the US dollar equivalent of rouble rents will be constant with indexation to inflation equally matched by rouble depreciation. The increase in 2017-20 illustrated average annual NOI is purely the result of assumed improving occupancy as the assumed average level of rents is lower than previously illustrated. We note that with no recovery in rents from the $75 per sqm level to the $100 per sqm level assumed from H217, the illustrated year-end NOI in 2020 would be c $130m rather than c $158m, or c $105m if applied fully to the entire portfolio.

Exhibit 9: Summary of contracted property investment NOI assumptions and forecasts

$m

Year-end contracted NOI

Average contracted NOI assumptions

% chg

Average occupancy %

Average rent
per sqm

Old

New

2015

162.0

82

132

2016e

149.1

163.3

155.6

(5)

82

124

2017e

142.8

156.0

146.0

(6)

86

112

2018 - illustration

160.1

152.3

154.9

2

91

116

2019 - illustration

162.5

140.9

161.2

14

96

112

2020 - illustration

157.7

150.3

160.1

6

98

109

Source: Company data, Edison Investment Research

For the P&L account, we have assumed a constant $15m pa deduction from the contracted NOI shown above to make allowance for the Roslogistics internally occupied space and some indeterminate amount of PLA/LOIs that will not immediately generate revenue. However, we no longer deduct the 2.5% of contracted NOI that we previously allowed for bad debts. We note that 2015 was the first year that Raven had ever experienced bad debts and we imagine that these will be at least much smaller or negligible in future given the shake-out of weak tenants that has already occurred.

Exhibit 10: Reconciliation of contracted and accounting NOI for property investment (only)

$m

2015

2016e

2017e

Period end contracted NOI

162.0

149.1

142.8

Average NOI (calculated half-yearly)

184.1

155.6

146.0

Roslogistics, LOI/PLA

(21.4)

(15.0)

(15.0)

Property investment NOI reported in P&L

162.7

140.6

131.0

Source: Company data, Edison Investment Research

Financials and estimate revisions

FY15 results were weaker than we had modelled with NOI c $10m lower than forecast. Underlying cost control was good and associate earnings were strong which limited the EBIT miss to c $6m. However, after finance charges PBT (adjusted for valuation movements) was c $10m below forecast, with a similar shortfall on an underlying basis. Including revaluation movements, the IFRS loss after tax was $192.3m, driving the decline in NAV per share.

Exhibit 11: Results versus forecast and estimate revisions

NOI* ($m)

EBIT ($m)

EPS** (c)

DPS (p)

NAV per share*** (p)

Old

New

% change

Old

New

% change

Old

New

% change

Old

New

% change

Old

New

% change

2015

184.4

174.1

(5.6)

149.5

143.8

(3.8)

8.94

7.94

(11.2)

3.00

2.00

(33.3)

0.67

0.49

(26.9)

2016e

165.8

150.1

(9.5)

134.2

119.8

(10.7)

6.90

5.01

(27.4)

3.00

1.00

(66.7)

0.68

0.50

(27.3)

2017e

N/A

140.7

N/A

N/A

109.4

N/A

N/A

4.09

N/A

N/A

1.00

N/A

N/A

0.52

N/A

Source: Company data, Edison Investment Research. *Net operating income. **Underlying and fully diluted, excluding valuation movements, depreciation, share-based payments and exceptional items. ***Underlying and fully diluted, excluding goodwill, deferred tax on valuation gains, fair value movements on derivate contracts and cumulative FX movements on preference shares.

We have adjusted our forecasts as shown in Exhibit 11, and we have introduced 2017 estimates for the first time. There are a number of uncertainties and quite a number of moving parts that make forecasting the crucial NOI contribution quite challenging; however, we explain our assumptions and methodology in detail in the section above. Exhibit 12 shows our forecasts for NOI by division.

Exhibit 12: Divisional NOI summary

$000s

2014

2015

2016e

2017e

Property investment gross revenues

230,108

202,287

175,744

163,765

Property investment net operating income

174,541

162,678

140,595

131,012

Roslogistics gross revenues

24,399

15,267

14,678

15,412

Roslogistics net operating income

15,793

8,972

8,457

8,716

Raven Mount gross revenues

3,089

2,151

2,000

2,000

Raven Mount net operating income

1,974

2,474

1,000

1,000

Group total gross revenues

257,596

219,705

192,422

181,177

Group total net rental and related income

192,308

174,124

150,051

140,728

Source: Company data, Edison Investment Research

In 2015, the legacy UK subsidiary Raven Mount successfully sold legacy land plots that it holds in the UK while its JV UK second-home developer enjoyed strong sales. We assume a more modest revenue and profit contribution in future. Roslogistics the third-party logistics subsidiary recorded broadly stable rouble turnover, a good result in market conditions, but saw a 37% decline in US dollar terms. We forecast 10% growth in rouble revenues in 2016 as the company benefits from recent contract wins, but with further negative impact from the average rouble exchange rate.

We anticipate that Raven will benefit from continued cost control although our estimates imply an increase in cost above the H215 level. We have included a notional amount for share based payment charges (excluded from underlying earnings), noting that management is consulting with shareholders on revised management incentive plans that will better suit current market conditions that the old scheme.

We assume no revaluation movements on the property assets and no FX impacts.

The decline in finance charges reflects our anticipation of reducing debt levels, with the cost of borrowing unchanged and constant.

We have allowed for a small income distribution of 1p per year, anticipating that management will wish to maintain a distribution while focusing on debt reduction. As always, we model this as a cash payment although we would anticipate that continuing distributions by way of tender offer are more likely.

Exhibit 13: Key financial data – profit & loss account

31 December ($000s)

2014

2015

2016e

2017e

Gross revenue

257,596

219,705

192,422

181,177

Property operating expenditure & cost of sales

-65,288

-45,581

-42,370

-40,449

Net rental and related income

192,308

174,124

150,051

140,728

Administrative expenses

-34,630

-30,494

-28,758

-29,808

Share based payments and other long term incentives

-2,354

-3,594

-2,500

-2,500

FX losses

-15,471

1,223

0

0

Share of profit of joint ventures

955

2,518

1,000

1,000

Operating profit/(loss) before realised/unrealised property gains (EBIT)

140,808

143,777

119,793

109,420

Realised/unrealised gains on investment property

-145,404

-256,548

0

0

Operating profit

-4,596

-112,771

119,793

109,420

Net finance expense

-93,448

-92,284

-86,485

-83,005

Charge on preference share conversion

0

0

0

0

Profit before tax

-98,044

-205,055

33,309

26,416

Tax

9,855

12,697

-3,997

-3,170

Profit after tax

-88,189

-192,358

29,312

23,246

EPRA adjustments

Realised/unrealised gains on investment property

145,404

256,548

0

0

Profit on maturing forward derivatives

-819

0

0

0

Change in fair value of derivatives

9,805

4,994

0

0

Movement in deferred tax thereon

-8,205

-24,562

0

0

EPRA earnings

57,996

44,622

29,312

23,246

Company underlying earnings (net, exc pref conversion charge)

66,652

54,560

33,120

27,054

Reported EPS - fully diluted ($c)

-12.33

-28.81

4.43

3.51

EPRA EPS - fully diluted ($c)

7.78

6.49

4.56

3.62

Company underlying EPS - fully diluted ($c)

8.94

7.94

5.01

4.09

Distributions per ordinary share (p)

6.00

2.00

1.00

1.00

Period end number of shares (m)

737.6

682.6

682.6

682.6

Period end number of shares exc own held (m)

688.5

642.4

642.4

642.4

Average number of shares (m) - basic

715.0

666.8

642.4

642.4

Average number of shares (m) - fully diluted

745.5

687.2

661.5

661.5

Source: Company data, Edison Investment Research

We have not assumed revaluation movement in our forecasts, nor have we assumed any FX movements.

Cash flow and balance sheet

The main movement on the balance sheet during 2015 was the $256.5m (c 38 cents per share) negative revaluation movement on property assets, the majority of which relates to the let investment portfolio. Weakness in estimated rental values, the move to rouble rents and rouble weakness versus the US dollar are the main factors driving the revaluation loss. Prime yields are barely changed y-o-y at c 12.0% in Moscow, c 13.3% in St Petersburg, and c 14.5% in the regions. The valuation was undertaken by JLL in accordance with RICS Valuation and Appraisal guidelines.

The revaluation movement is non-cash but it does have the impact of pushing up the ratio of debt to portfolio value, despite ongoing debt amortisation ($57.8m in the year). Exhibit 14 shows that gross bank debt (excluding preference shares) has been increasing versus the (declining in 2014 and 2015) value of (investment and development) property assets. However, in terms of total debt (including preference shares) net of cash, the ratio is actually lower than it was in 2012 – reflecting on the one hand the 2013 preference share part-conversion into equity and on the other, the high level of current cash balances.

New Russian tax legislation that came into force from 1 January 2016 allows the tax authorities to challenge the sale of property assets made by way of offshore SPVs, bringing such sales effectively ‘onshore’ and thereby liable for payment of capital gains tax. Our understanding is that the new legislation is aimed particularly at the use of offshore structures that are in place with the aim of avoiding capital gains tax and the details of how this will operate in practice remain unclear. This is particularly the case with transactions involving genuine offshore company ownership. Nevertheless, there remains a possibility that any such liability could be pursued from the purchaser, and that this could be reflected in underlying transaction values. Given this uncertainty, the underlying NAV calculation no longer adds back deferred tax liabilities in respect of revaluation gains ($49.3m at H115), although there is a hope that the situation may change in future.

Exhibit 14: Debt as a % of property assets

Source: Company data, Edison Investment Research

Our cash flow analysis in Exhibit 16 shows our forecast that net debt will decline further over the next two years despite the difficult trading environment that we have factored in. The balance sheet forecast in Exhibit 14 indicates that gross debt will fall more than net debt given our expectation that ongoing amortisation at $60m pa will exceed free cash flow.

Our forecasts indicate a stabilisation in ratio of period end contracted NOI to bank interest expense over 2016e and 2017e at c 2.2x (2015: 2.3x).

Exhibit 15: Key financial data – balance sheet

31 December ($000s)

2014

2015

2016e

2017e

Investment property

1,593,684

1,333,987

1,336,988

1,339,988

Investment property under construction

47,958

39,129

39,130

39,130

Goodwill

2,375

2,245

2,245

2,245

Derivative financial instruments

6,853

5,585

5,585

5,585

Deferred tax asset

35,766

6,145

6,145

6,145

Other non-current assets

58,888

43,631

43,633

43,633

Total non-current assets

1,745,524

1,430,722

1,433,726

1,436,726

Inventory

1,389

1,381

1,381

1,381

Trade & other receivables

52,623

50,264

50,265

50,265

Derivative financial instruments

432

233

233

233

Cash & equivalents

171,383

202,291

161,373

114,393

Total current assets

225,827

254,169

213,252

166,272

Total assets

1,971,351

1,684,891

1,646,978

1,602,998

Trade & other payables

84,962

53,384

53,383

53,383

Derivative financial instruments

1,253

2,097

2,097

2,097

Interest bearing loans & borrowings

55,252

104,724

50,000

50,000

Total current liabilities

141,467

160,205

105,480

105,480

Interest bearing loans & borrowings

837,429

814,021

808,743

748,743

Preference shares

164,300

156,556

156,556

156,556

Derivative financial instruments

4,153

1,794

1,794

1,794

Deferred tax liabilities

89,118

55,619

55,619

55,619

Other non-current liabilities

37,595

31,653

31,653

31,653

Total non-current liabilities

1,132,595

1,059,643

1,054,365

994,365

Total liabilities

1,274,062

1,219,848

1,159,845

1,099,845

Net assets (and shareholders' equity)

697,289

465,043

487,133

503,153

NAV adjustments

Goodwill

-7,806

-5,134

-7,379

-7,379

Deferred tax on revaluation gains

55,250

0

0

0

Cumulative FX loss on preference shares

13,955

4,956

4,956

4,956

Fair value of derivatives

-5,322

-5,159

-5,159

-5,159

Adjusted NAV

753,366

459,706

479,551

495,571

Fully diluted NAV per share ($c)

1.10

0.72

0.75

0.78

Adjusted fully diluted NAV ($c)

1.06

0.70

0.72

0.75

Fully diluted NAV per share (p)

0.77

0.50

0.53

0.54

Adjusted fully diluted NAV (p)

0.74

0.49

0.50

0.52

Source: Company data, Edison Investment Research

Exhibit 16: Key financial data – cash flow

31 December ($000s)

2014

2015

2016e

2017e

Profit before taxation

-98,044

-205,056

33,309

26,416

Adjustments for:

Depreciation, goodwill impairment, and amortisation

5,224

1,599

1,308

1,308

Provision for bad debt

0

3,720

0

0

Share of profits of joint ventures

-955

-2,518

-1,000

-1,000

Revaluation of investment properties/properties under construction

145,404

256,548

0

0

Share based payments

2,354

3,594

2,500

2,500

Net interest expense

93,448

92,284

86,485

83,005

Other including loss on disposal, inventory write-down, FX, and preference conversion charge

15,480

-1,223

0

0

Receipts from joint ventures

983

3,954

1,000

1,000

Working capital changes

9,845

-8,020

-1

0

Tax paid

-4,945

-8,731

-3,997

-3,170

Net cash generated from operating activity

168,794

136,151

119,603

110,058

Payments for investment property under construction

-105,582

-20,028

0

0

Property improvements & movements in completion provisions

0

0

-3,000

-3,000

Acquisition of subsidiary undertakings, net of cash acquired

-12,873

0

0

0

Interest received

3,208

2,909

2,800

1,600

Other investing activity

16,353

29,986

-1,308

-1,308

Net cash generated from investing activity

-98,894

12,867

-1,508

-2,708

Bank borrowing costs paid

-70,979

-69,465

-69,322

-64,642

Exercise of warrants

524

177

0

0

Net own shares (acquired)/disposed

-68,928

-41,906

0

0

Issue of preference shares

0

0

0

0

Ordinary dividends

0

0

-9,726

-9,726

Pref dividends

-18,225

-17,156

-19,963

-19,963

Other investing activity

-3,610

-5,107

0

0

Change in net debt from investing activity

-161,218

-133,457

-99,011

-94,331

Other items

-28190

-10717

0

0

Change in net debt

-119,508

4,844

19,084

13,019

Opening net debt

601,790

721,298

716,454

697,370

Closing net debt

721,298

716,454

697,370

684,350

Source: Company data, Edison Investment Research

Valuation

Raven’s strategy has focused on growing income and shareholder distributions. Currently the strategy is highly defensive; it is still focused on maximising cash flow, but with a greater emphasis on long-term security and debt reduction. It is intended to see Raven through the current crisis and position it to be able to benefit from a market recovery. As a result, we believe that a long-term investment in Raven will remain very much about cash flow and yield.

Yield

As discussed above, we forecast ordinary share distributions of 1p per share for 2016 and 2017 after 2p in 2015 and 6p in 2014, before the Russian crisis hit. In part, the forecast decline reflects our expectation of lower profitability and cash flow. But it also reflects prudence as Raven continues to target debt reduction and a healthy cash balance.

Exhibit 17: Net operating income after interest payments

$000s

2015

2016e

2017e

Net cash generated from operating activities (after tax)

136,151

119,603

110,058

Interest received

2,909

2,800

1,600

Bank borrowing costs paid

(69,465)

(69,322)

(64,642)

Preference share dividends

(17,156)

(19,963)

(19,963)

Total net operating income after interest

52,439

33,119

27,054

Per share total net operating income after interest (p)

5.4

3.5

2.9

Distributions per ordinary share (p)

2.0

1.0

1.0

Source: Edison Investment Research

Exhibit 17 shows our expectations for operating cash flow net of tax and after interest payments (both bank debt and fixed preference share coupons). While we anticipate a further decline, we expect it to remain healthily positive and well in excess of the modest distribution that we forecast. However, this is before debt amortisation, which runs at c $60m pa, and so any distribution is only possible in our forecasts by reducing cash balances from the current high level, or being able to refinance maturing debt to a higher level. At the current share price this 1p distribution would represent a yield of c 3.3%.

The preference shares earn a cumulative dividend of 12% pa payable on the fixed issue amount per share of 100p. These illiquid shares last traded at a price of 130p, which represents a prospective yield of a little more than 9%.

NAV

The NAV per share, on a diluted IFRS basis at FY15 year end was $0.70 (FY14: $0.98) and was the same on a fully diluted adjusted basis (FY14: $1.06). Using a £/$ exchange rate of 1.425 the equivalent fully diluted adjusted NAV in sterling is 49p and the P/NAV 0.60x. However, we do not consider P/NAV to be the main driver of share price or best indicator of value. The investment market in Russia remains relatively immature making portfolio values more volatile.

Sensitivities

The duration of the Russian economic downturn is impossible to predict and similarly the future course of the internationally imposed sanctions. We would refer readers to the detailed risk section in the Raven Russia annual report. By way of summary, we would identify the following issues as being of particular relevance.

The weakness of the Russian economy is negatively affecting market appetite for new lettings, the renewal of existing leases, and is dampening rents. Raven has traditionally targeted strong tenants on long leases (7-10 years at inception) and has sought to manage the risk by having a diversified tenant base. There is little development being planned and over the medium term, the market appears to remain structurally under-supplied in any normal environment.

The weak oil price and the rouble have been closely correlated. The vast majority of Raven’s revenues have been pegged to the US dollar, matching US dollar debt, but as the rouble weakness continues to put pressure on tenants with US dollar leases, there is a trend towards rouble-denominated rents. The US dollar equivalent of these rents is well below the level previously achieved but is partly compensated by indexation to Russian inflation, providing potential protection against further rouble depreciation.

Increases in interest rates will have no material immediate impact as Raven’s variable cost of debt is hedged with the use of swaps and caps on US LIBOR or fixed rate facilities. As existing facilities mature, the cost could be affected depending on interest rates at the time and the appetite of lenders to provide loans. The drop in rents has had a negative effect on the debt service cover ration and (through the impact on valuations) the loan to value ratio. However, the majority of Raven’s debt facilities have a relatively high amortisation profile (c $60m pa in aggregate) with an ongoing benefit to both debt service coverage ratio (DSCR) and loan to value (LTV). There is minimal recourse to the holding company and no cross-collateralisation between projects in the event that one or other should default.

The legal system in Russia is still in the early stages of development and the tax system is revised regularly. The key tax treaty for the group is that between Russia and Cyprus, which allows Raven’s properties to be held by subsidiaries domiciled in this low tax jurisdiction.

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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

245 Park Avenue, 39th Floor

10167, New York

US

Sydney +61 (0)2 9258 1161

Level 25, Aurora Place

88 Phillip St, Sydney

NSW 2000, Australia

Wellington +64 (0)48 948 555

Level 15, 171 Featherston St

Wellington 6011

New Zealand

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

245 Park Avenue, 39th Floor

10167, New York

US

Sydney +61 (0)2 9258 1161

Level 25, Aurora Place

88 Phillip St, Sydney

NSW 2000, Australia

Wellington +64 (0)48 948 555

Level 15, 171 Featherston St

Wellington 6011

New Zealand

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