Picton Property Income — Reinstating forecasts following robust Q121

Rent collection for the March quarter has increased slightly to 86% (as at 24 July), with agreed deferrals of 9%. Of the balance, 2% forms part of active management transactions (typically the exchange of a short-term rent free period in exchange for other lease enhancements such as the removal of break options or an extension of the term) and 3% remains unpaid and due.

So far, 72% of the June quarter rents have been received but this increases to 85% including agreed monthly payments that are expected to be received by the end of the quarter. Agreed deferrals represent 5% and active management 3%. The balance of 7% represents unpaid rents that are due. The June data appear encouraging as we had anticipated a lower collection of June rents whereas the 72% collection rate compares with 71% for March after the same number of days.

On a like-for-like basis the portfolio valuation decreased by 0.8%, or £5.3m. We view this as a strong performance in current market conditions (the MSCI Monthly Digest shows a negative 3.5% capital return for the period) and significantly benefitted from a positive performance from Picton’s industrial assets resulting from asset management initiatives. Picton’s office assets showed a slight decline in value with estimated rental values stable in the regions and reducing just 1% in London. In common with the sector, the retail and leisure assets showed a more marked decline. Across the sectors, the external valuations reflect where rents remain unpaid.

At the reduced quarterly dividend rate of 0.625p per share, dividends declared for Q121 (c £3.4m) were 118% covered by EPRA earnings of c £4.0m, while the relatively small decline in property valuations, combined with the modest c 22% gearing at the start of the quarter, meant that the NAV performance was robust. At 92.2p, the NAV per share was 1.3% lower than at end-FY20.

Included within the £4.0m of EPRA earnings in Q121 is the accounting recognition, as income, of rents due that while not yet collected are expected to be received. However, this is after a £0.8m provision (Q420: £0.5m) against rent receivables, bringing the total to £1.3m or c 30% of rents that are currently unpaid.

The portfolio value movement shown in Exhibit 3 also captures continuing capital expenditure, mostly related to refurbishment of the Stanford Building, which is unlikely to be recognised in the portfolio valuation and NAV until completion and letting.

The pandemic came too late to significantly impact the year ended 31 March 2020 (FY20) although the results reported for the year did include a prudential c £0.5m non-cash provision against March quarter rent collections and a negative impact on year-end valuations and NAV. Our forecasts for FY21 were withdrawn at the start of the pandemic due to the heightened uncertainty about the extent and duration of the pandemic and its potential impact on accounting income, cash rent collection and capital values. Although a good deal of uncertainty remains, we believe it is now reasonable to make tentative forecasts, supported by published cash rental collection data, the Q120 performance and recent trends in market valuations. However, we note that our confidence in these forecasts is lower than normal and that the actual results could be materially higher or lower in several respects.

The factors that will determine future rental income include:

For FY21 we have assumed that:

FY21 rental income is thus assumed to be £35.6m (including a c £0.9m IFRS smoothing adjustment) compared with the £36.2m contracted passing rent (before IFRS adjustment) at the start of the year.

In some instances, the assumed aggregate £2.0m provisions taken against rents receivable may represent concessions with occupancy and rent income continuing, but in most cases we would expect a reduction in contracted income and an increase in occupancy until such time as re-letting occurs. Our FY22 forecast assumes an improvement in contracted passing rent to £38.2m by end-FY22 which implies a net capture of the reversionary potential in FY22 of c £3–4.0m.

Taking account of recent market trends and the unusually wide range of market forecasts, Exhibit 4 shows our best guess at capital value movements across the market for FY21 and applied to the Picton portfolio as at end-FY21. Reflecting the strong performance in Q121 we have allowed for Picton’s industrial assets to do a little better than we expect for the market as a whole, but otherwise we have made no allowance for portfolio-specific asset management initiatives. Given the level of uncertainty our assumptions are best treated as an illustration. For FY22 we see the possibility for some improvement in valuations if market conditions return to a more normal situation. We would also expect the leasing progress that we have assumed to support capital values as well as benefiting income. However, given the scale of uncertainty we have for now assumed flat capital values in FY22.

Based on these assumptions our forecast end-FY21 EPRA NAV per share is 88p (FY20: 93p and Q120: 92p). Alternatively, each 1% increase/decrease in the total portfolio value is equivalent to an increase/decrease in EPRA NAV per share of c 1.2p. For the end-Q121 EPRA NAV (88p) to fall to match the current share price (68p) would require a c 20% reduction in the portfolio value.

Based on our income assumptions we expect Picton to increase the level of quarterly DPS payments in the second half of the year and our 2.75p aggregate FY21 DPS forecast assumes quarterly declarations of 0.75p per share in Q321 and Q421 after 0.625p per share in both Q221 and Q221. At 2.75p the aggregate DPS is 1.17x covered by our forecast EPRA earnings and for DPS to be covered by rental receipts requires 95% of IFRS rental income to be collected. As the IFRS rental income is already reduced by rent receivables provisions, full cash cover requires 91% collection of the start-year contracted rent roll.

Our income assumptions for FY22 imply further scope for DPS to increase and we assume a return to aggregate DPS of 3.5p for the year. At this level DPS is 1.04x covered by EPRA EPS and with collection of a part of the FY21 deferred rents continuing into FY22, the cash cover of DPS should be higher.

Our forecasts are shown in detail in Exhibit 7 and a summary is shown in Exhibit 5. For FY21 we show a comparison with our pre-pandemic forecasts, withdrawn in March 2020. We provide FY22 forecasts for the first time.

Our forecast 2.75p FY21 DPS represents a 4.0% prospective FY21 yield (or 3.7% based on the current quarterly rate of DPS of 0.625p or 2.5p annualised). If DPS further increases to 3.5p in FY22 as our forecasts indicate, the prospective FY22 yield is 5.0%. Meanwhile, the 26% discount to the Q121 NAV compares with an average 3% discount over the past five years.

In Exhibit 6 we show a summary performance and valuation comparison of Picton and what we consider to be its closest diversified income-oriented peers. In terms of valuation we show the trailing yield based on aggregate declared DPS over the past 12 months, as well as the forward-looking yield based on the most recently declared DPS annualised. Neither is entirely satisfactory as the sector remains in a state of flux, with some companies having indicated a reduced DPS payout for the time being and some postponing DPS payments altogether until later in the year. It will take some time before the full-year prospective DPS outlook becomes clearer and a true comparison can be made. We also note that this historical data does not reflect our expectation that Picton’s DPS will increase later in the year. Picton shares have outperformed the peer group over most periods which we attribute to its strong track record of property level performance, the future income and valuation growth potential embedded in its portfolio, and its strong balance sheet with relatively modest gearing.