Town Centre Securities — Reinvigorating strategy

Financial performance during the pandemic has demonstrated the relative resilience of TCS’s multi-sector property investment portfolio, focused on the strong regional markets of Leeds and Manchester. Management expects the hard-hit, capital-light and normally cash-generative car parking operations (c 30% of pre-pandemic operating profits) to recovery quickly as the lockdown eases. The property investment strategy, focused on active asset management and redevelopment, to optimise income and maximise the use of available capital, is being accelerated in response to the pandemic. Retail asset sales have been stepped up, while key office refurbishment projects in Leeds and Manchester were continued to completion, providing income and capital potential once re-let. With most of the sale proceeds used to repay debt, near-term income dividend-paying capacity is reduced; in the medium-term, and as trading conditions improve, TCS should be better positioned to grow, including exploiting its substantial strategic development pipeline.

Retail & leisure exposure had already reduced from c 70% (by portfolio value) at end-FY16 to c 47% at end-FY20 and was 39% at H121 with asset sales continuing since. H121 pure retail exposure was 26% and focused on more defensive areas such as supermarkets, convenience and discount retailing. Rent collection has been consistent and reassuring on a quarterly basis through to March 2021, at c 88% collected/agreed to be collected, and by late March was above 92% for the most recent quarter. Although property valuations were materially weaker in FY20 (-6.9% like-for-like), total property return was ahead of the MSCI Quarterly UK Property Index and the H121 like-for-like decline of 0.8% was highly robust. The Merrion Centre continues to perform notably more strongly than the traditional shopping centre sector. The most recent H121 results showed small EPRA earnings of £0.2m after pandemic impacts estimated by management at £3.2m and car park operating profit (before valuation movements) of c £0.4m compared with £4.4m in FY19.

Including a full period impact from H121 asset sales, and continuing lockdown impacts in H221, we forecast an EPRA earnings loss of £0.4m in FY21, before further negative property revaluation movements, taking EPRA NTA per share to 269p (H121: 278p). We forecast no H221 DPS (H121: 1.75p). Assuming a continuation of lockdown easing, we expect a significant improvement in FY22, and building in FY23, across all business lines but led by the car parking operations. The management team is strongly aligned with shareholders and is committed to restoring dividends as soon as is practicable. We forecast 4.0p in FY22 and 7.25p in FY23, fully covered by EPRA earnings and a FY23e yield of 5.4%, while the shares trade at a c 50% discount to FY21e EPRA NAV, despite a focus on better performing regional markets.

The main sensitivities (see page 17) are related to the broader macroeconomic background and the cyclical nature of the commercial property market, with COVID-19 and Brexit creating additional uncertainties. Commercial property has historically exhibited substantial swings in property valuation through cycles; income returns are significantly more stable, but still fluctuate according to tenant demand and rent terms. Management identifies the single greatest risk to the business model as the impact that further reductions in property values could have on banking covenants and future borrowing headroom. To mitigate this risk the company has accelerated disposal of mature and non-core assets, reducing H121 net LTV to 48.6%.

Town Centre Securities (TCS) is a UK Real Estate Investment Trust (REIT) operating a mixed use and increasingly diversified portfolio of commercial property across the UK, but with a strong regional focus, primarily in the two strongly performing northern cities of Leeds and Manchester (91% by value at 31 December 2020, end-H121), as well as Scotland and (mainly suburban) London. The property portfolio is intensively managed, exploiting a strong and detailed knowledge of the communities in which the company operates (especially in Leeds where the group is based) to enhance income and capital values over the long-term, and maximise the use of available capital.

Significant and ongoing repositioning of the portfolio in recent years, driven by capital recycling, has seen the significant reduction in retail and leisure exposure offset by increases in offices, hotels and residential assets. In addition to the income producing assets the existing portfolio contains an extensive pipeline of potential development projects, primarily in Leeds and Manchester, with an estimated gross value – once funded and developed – of more than £600m. This significant long-term growth opportunity is not captured within the carried book value and represents an attractive differentiating factor for the group.

Alongside property investment, the car parking operation (CitiPark) is a strong and profitable standalone business in its own right. It has a good track record of growth and provides a complementary earnings stream, not driven by the property cycle, capable of monetising development sites what would in some cases be empty, non-income producing development assets. CitiPark represented c 30% of group operating profit prior to the pandemic and while unsurprisingly it has seen a significant negative impact from the lockdowns it has remained profitable and management expects a swift recovery as the economy re-opens.

The combined value of TCS’ investment properties, developments, joint ventures and car parks at end-H121 was £331.4m with a passing rent of £23.1m.

Dividends have historically been a core element of shareholder return and until the pandemic forced a reduction in FY20 DPS, TCS had built an unbroken 58-year track record of increased or maintained dividend payments. In FY20 the aggregate annual DPS was reduced from 11.75p to 5.0p and the uncovered DPS of 1.75p declared for H121 reflected management expectations of a post-lockdown easing earnings recovery, led by CitiPark, while underlining the continuing commitment to distributions.

TCS was founded in 1959 by Arnold Ziff, father of the current chief executive and chairman, Edward Ziff. The company listed on the London Stock Exchange soon afterwards, in 1960, and became a UK REIT in 2007. Members of the Ziff family continue to have a substantial interest in the company and through a relationship agreement the Ziff family concert party represents a combined shareholding of c 52%. The principal family shareholders are Edward, his brother, Michael Ziff, and sister, Ann.

This strong family interest aligns the interests of management and all shareholders and significantly contributes to shaping the company’s long-term strategic horizon and a continuing focus on dividend payments as a key element of shareholder returns. Family control makes access to new external equity capital more complex (requiring significant family shareholders to participate or be willing to cede control), and this is compounded by the recent wide valuation discount to NAV; and this has created an additional incentive to optimise the use of existing capital resources through the intensive management of existing assets and active capital recycling to fund new initiatives.

The executive team members represented on the board are the chairman and chief executive (Edward Ziff) and the managing director for CitiPark (Ben Ziff, Edward’s son). Following the departure of group property director (Lynda Shillaw) in FY20 this role has been split into separate property and development roles reporting directly to the chairman and chief executive. Following the departure of CFO, Mark Dilley, in February 2021, the finance function reports directly to the CEO. Biographies for the executive directors can be found on page 20.

The board of directors consists of six members, the two executive members plus four non-executive members. The non-executive members are Michael Ziff (appointed July 2014), Ian Marcus (January 2015), Paul Huberman (January 2015), and Jeremy Collins (February 2018); together they bring substantial experience across a wide range of relevant areas including retail, retail property development and management, investment banking, and finance, and corporate governance. Biographies can be found on the company’s website.

Management recognises that property values and income can reach mature levels where the potential for future returns become muted, especially in a lower growth environment. As a result, a key element of the strategy for long-term value creation is the recycling of capital from such assets into new opportunities, including an exceptionally strong pipeline of development opportunities from within the existing estate.

Following a relatively quiet year in terms of sales and purchases in FY20 there was a strong pick-up in sales activity in H121 as the COVID-19 crisis prompted an acceleration the multi-year retail and leisure disposal programme. Management indicates that it plans further disposals. The FY21 year to date disposals (£45.3m completed and £46.7m including agreed sales) take aggregate investment property sales since the beginning of FY17 to £95.6m, of which c 96% has been retail & leisure sector assets. During this period TCS has acquired properties amounting to £30.6m (of which just 24% were retail & leisure sector assets) and in addition has invested more than £40m into refurbishment and development projects. The latter includes the ibis Styles and Premier Inn hotels in Leeds, the Merrion House office redevelopment, the Burlington House private residential scheme development in Manchester and refurbishment of the 123 Albion Street and Dulcie House offices in Leeds and Manchester.

The significant, and ongoing, repositioning of the portfolio can be clearly seen in Exhibit 4. The portfolio has become increasingly diversified with a significant reduction in retail and leisure exposure offset by increases in offices, hotels, and residential assets.

The retail & leisure exposure in the portfolio had fallen to 39% by end-H121 (and we estimate c 38% currently on a pro-forma basis including H221 disposals) while pure retail exposure was just 26%, with a focus on defensive areas such as supermarket, discount, and convenience retailing.

During H121 TCS has sold 6 retail assets for a combined £41.2m, only slightly below book value (within 2%), targeting ex-growth assets, and comprising:

So far in H221 TCS has announced:

Management has indicated that further disposals are likely as it seeks to optimise its capital allocation and adjust its exposures, but this is not reflected in our forecasts. Disposal proceeds have initially been applied to reducing borrowings although over the medium-term we expect redeployment of capital into non-retail & leisure assets to replenish the income base as well as investment in the group’s large development pipeline.

TCS is not looking to exit the retail and leisure sector altogether and remains committed to selected retail formats in the right locations. The Merrion Centre, the group’s single largest asset, is well placed in the centre of Leeds, adjacent to the Leeds Arena amidst a large and growing student population. It has been transformed over the past 10 years from a classical shopping centre to a truly mixed-use destination reflective of its location. The centre incorporates offices, a hotel and restaurant, and car parking in addition to retail & leisure. The Merrion Centre retail and leisure exposure accounts for c two-thirds of the group total. It includes a significant food and beverage offering, accounting for 29% of the space at end-FY20, with a focus on the convenience and discount segments of the market that are less affected by online shopping, with Morrisons supermarket accounting for an additional 12%. With various redevelopment opportunities still existing, TCS continues to see the Merrion Centre as a valuable long-term opportunity. As we discuss in the financial section below, the reduction in retail and leisure exposure within the TCS portfolio, and the increased focus on food and convenience formats have mitigated the impact of the pandemic on both rent collections performance and portfolio valuation performance.

TCS has a regionally focus property portfolio with an emphasis on the northern cities of Leeds (69%) and Manchester (22%) which together represented represent 91% of the end-H121 portfolio by value. These cities remain core to the group’s strategy and are home to the majority of the group’s extensive pipeline of development opportunities that should be a major driver of future growth. Leeds and Manchester are two of the largest conurbations in the UK and have attracted significant investment from both UK and international investors, attracted by strong economic growth over the past five years. Despite a high level of uncertainty with respect to the UK economy, the continuing political agenda to rebalance economic activity more evenly towards the north, combined with significantly lower occupational costs compared with London and the south-east should continue to be positive factors. In the office sector there is a growing view that encouraged by the pandemic, the regions will continue benefit from continuing business relocation out of London and the adoption of (London) hub and (regional) spoke strategies. Meanwhile, with rent levels remaining relatively low, development activity has been modest and a tight supply of Grade A office space should support good quality secondary assets.

Despite the pandemic, TCS pressed ahead with key office refurbishment projects in Leeds and Manchester. The £4.0m refurbishment of 123 Albion Street in Leeds reached practical completion in late calendar 2020 and with its central Leeds location, in close proximity to the Merrion Centre, and is receiving healthy occupier interest. The property was acquired for £12.0m in 2018 at a high yield of 12.5%, reflecting near-term tenant departures, which could be used by TCS to upgrade the property and enhance its income and capital, using its local knowledge and active asset management expertise. Post completion, the available space has all been let and TCS expects to deliver a running yield in excess of 8.5%. The valuation, which increased by £2.5m to £14.6m in FY20, increased further to £16.3m in H121, and management expects a further increase by end-FY21. The £2.2m refurbishment of Ducie House in Manchester has also now completed and management expects strong interest. It was acquired in 2018 and solved a right of light issue at Eider House (valued at £1.5-£2.0m), where TCS now has planning permission for a PRS development. Net income is expected to increase by c £0.3m as a result of the refurbishment and TCS expects a post investment return in excess of 8.5%. Reflecting the refurbishment, the property value increased by c £1.0m to c £9.0m at end-H121 and management expects this to increase further as vacant space is let.

TCS also has a very significant pipeline of development opportunities within its current portfolio, much of it with detailed planning consent or forming part of the local strategic framework (Exhibit 7). Management estimates the gross development value at c £601m with an income potential of c £34.0m, representing a significant potential for future growth in income and capital, subject to financing (potentially through joint ventures), the full value of which is not captured in the current net asset value. Most of the projects, by value, are situated within two strategic development sites in Manchester (Piccadilly Basin) and Leeds (Whitehall Road), two strong regional markets. Other projects include further developments at the Merrion Centre. The development pipeline has been built up over time and TCS takes a conservative long-term approach to development, exploiting opportunities when it believes the timing is right and market conditions supportive, controlling the pace of development and ensuring that it does not overcommit its financial resources.

The projects are listed in Exhibit 7 in line with management’s current best view of the likely order in which they may proceed, although this is subject to material variation according to changes in the marketplace. Top of the list is Eider House, a second residential private rented sector development and following the successful completion and letting of Burlington House in FY20. TCS sees long-term value in residential property, particularly in prime sites with major transport links and intends to proceed with Eider House, although the exact timing remains under review.

The TCS car parking operation, known as CitiPark, is a strong standalone business in its own right, with a good track record of growth that has unsurprisingly been punctuated the pandemic lockdowns. Despite a significant negative impact from COVID-19 in the last four months of FY20 and through much of FY21 it has remained profitable and TCS expects a strong rebound as the economy re-opens. CitiPark provides the group with a low capital intensity, complementary earnings stream, independent of the commercial property cycle and capable of monetising development sites what would in some cases be empty, non-income producing development assets.

CitiPark provides a total of c 8,500 car parking spaces, spread across 19 sites, including freehold sites, leasehold car parks, and three car parks that are operated under management contracts. Two recent management contracts won are the Manchester Arena car park, building on a successful existing partnership with John Lewis in Cheltenham. CitiPark sees car park management services as a growth opportunity for the business going forward.

To support its growth, CitiPark has invested in technologies to improve its customer service, operational efficiency and marketing reach. The development of “touchless” online and mobile payment and booking may well be advantageous in the current climate. The main investment projects have included:

Increasingly, CitiPark is looking to expand beyond its traditional car park activities. It already runs three solar energy farms in Leeds and Manchester and has recently internalised its previously outsourced parking enforcement activities, seeing an opportunity to reduce costs and add an additional revenue stream. A strategic investment in YourParkingSpace, an online parking marketplace, has recently completed a further growth financing, including a £5m investment by Pelican Capital. As part of the transaction, TCS exercised its third and final investment option and now has a 19.9% voting share (plus a 1.2% non-voting share with conversion option). Its equity investment has been externally fair valued at £1.5m compared with the £1.0m cost.

During FY20 and H121, the pandemic has had a material impact on financial performance and has required a shift in financial focus towards maximising capital and managing cash flows. With asset disposals focused on the retail and leisure sector the strategic repositioning of the portfolio has been accelerated. A summary of recent financial performance is shown in Exhibit 9 below.

Including a £3.6m COVID-19 impact (management estimate) in the last quarter of the year, H220 recorded a EPRA earnings loss of c £2.0m, reducing full year EPRA earnings to £2.1m (FY19: £6.4m) or EPRA EPS of 3.9p (FY19: 12.0p). The COVID-19 impact comprised:

Despite a longer period of lockdown measures, the H121 pandemic impact was reduced to £3.2m (management estimate) and TCS generated a small £0.2m profit on an EPRA basis. The result was also affected by disposals (£0.4m net of interest saving on repayment of debt from the proceeds); loss of income during refurbishments was offset by dilapidation receipts. The H121 COVID-19 impact comprised:

Including net realised and unrealised property revaluation losses the statutory IFRS result remained in loss during H121 (c £3.5m loss) but at a much-reduced level compared with H220 (c £23.9m loss). EPRA net tangible assets per share continued to reduce in H121 but also at a much-reduced rate (c 2.5% compared with c 15% in H220). The final FY20 DPS of 1.75p was paid shortly after the end of H121 (January 2021) and a H121 DPS of 1.75p, uncovered by EPRA EPS of 0.4p, is due to be paid in June 2021.

Net debt continued to reduce during H121, and at a faster pace than asset values, such that net loan to value (net LTV)1 reduced from 53.2% at end-FY20 to 48.6%. Financial headroom (cash and available borrowing facilities) at end-FY21 was £12.8m.

Exhibit 10 shows a summary of the total group portfolio, including the investment portfolio, development assets, car parking assets and the TCS share of joint venture assets, as at end-H121, and does not reflect the disposals made since. The total portfolio value at end-H121 was £331.4m (end-FY20: £372.m). Completed rental income-generating investment properties represented 80% of the total by value (£264.6m) and 90% by estimated rental value, or ERV (£20.6m). Income is also generated by the car parking activities from both dedicated car park assets as well as certain land sites earmarked for medium-term development. Investment property ERV was £3.6m (c 20%) ahead of the £17.0m passing rent, representing one source of potential income growth from the current portfolio.

Disposals were the main driver of the reduction in the portfolio value and, allowing for this as well as capex, the underlying like-for-like decline in value was extremely moderate in H121 when viewed against the market backdrop at 0.8% (6.9% decline in FY20) or c £2.5m. Although across the market retail and leisure have been hardest hit by the pandemic, TCS’s assets in the sector continued to outperform (H121 like-for-like decline of 5.5%), benefiting from the focus on supermarkets and discount and convenience formats. The mixed-use Merrion Centre saw a decline of just 3.7%. Substantially offsetting the decline in retail and leisure values, office and development values increased. Offices showed a c 3% like-for-like increase, driven by Merrion House (+3.2%) and completion of the refurbishment at 123 Albion St (+5.9%). Development values increased by 6.1%, driven by a 9.7% increase in Piccadilly Basin in Manchester reflecting a strong private rented sector market locally.

Across the UK commercial property sector, retail and leisure tenants have been hardest hit by the pandemic and have therefore struggled most to maintain rent payments. Against this backdrop TCS has shown a consistently robust level of collections over the past year with management stressing the importance of strong tenant relationships, often built up over a number of years. With the lockdown easing TCS says that it is now seeing collection levels improving on a quarter-by-quarter basis and that it expects this improvement to continue.

The most recent update on rent collections performance covers the period to 21 April 2021. Between March 2020 and March 2021 of the £25.2m of rent and service charges (including VAT) billed by TCS 88% had been successfully collected (87%) or remained to be collected under agreed deferral arrangements (1%). Of the remaining amounts billed (c £3.0m), c £1.6m had been waived in return for improvements in the terms or length of leases and £1.4m remains outstanding and due.

For the most recent quarter2, the collection rate was 92%, comprising 80% cash collected and 12% deferred by agreement. The remaining amounts billed (c £0.4m) remains due and subject to discussions with tenants.

Cumulatively, since March 2020, the collection rate id 89%, comprising 86% cash collected and 3% deferred by agreement. Not all outstanding and due rents (c £1.8m) represent an inability to pay by the tenant and in some cases are likely to reflect the impact of the continuing (until at least 30 June 2021) suspension of landlord lease forfeiture rights for non-payment on the payment patterns of tenants who are otherwise able to pay.

During FY20, TCS provided c £1.5m against outstanding rent receivables, ending the year with a provision balance of c £1.8m. During H121, an undisclosed provision was netted against rental income rather than being separately disclosed and, although no update on the provision balance is available, we expect this to have increased.

In this section we review the recent divisional performances in more detail as well as our forecasts. Across the divisions, underlying our forecasts is the expectation that lifting the pandemic lockdown will be sustained and that remaining restrictions will be relaxed in time such that conditions will have normalised for FY22.

Management estimates the net negative pandemic impact on the property investment business at £1.2m in H220 and £0.5m in H121, primarily related to charges against rent receivables, partly offset by pandemic-driven cost savings. The H121 charges against receivables were accounted for as a reduction in gross revenues, while the H220 charges were shown separately. H220 also included a number of other non-recurring items, including a c £0.8m provision against previously incurred costs in respect of the abandoned George Street development project, and a £0.5m write-off of service charge receivables, unrelated to the pandemic (H120 included a positive £0.5m dilapidations payment). In total, the H220 non-recurring items amounted to c £2.5m, such that on an underlying basis, the H121 operating result (before valuation movements) was at a broadly similar level to H220. H121 remained marginally profitable after a greatly reduced revaluation loss compared to with H220.

Our forecasts assume a c £2.5m annualised revenue impact from the H121 disposals with the full year impact in FY22 offset by the first benefits of re-letting at Ducie House and 123 Albion Street (we assume c £1.3m on an annualised basis). We have also assumed an additional £0.4m net in receivables impairment in H221 (taken as a revenue reduction). We anticipate a further reduction in property valuation in H221, amounting to c £3.1m or around 1.5% on a like-for-like basis, although we would describe this as illustrative given the level of uncertainty. On a similar basis, we assume no valuation change in FY22 and FY23. By way of comparison, the most recent consensus forecasts published by the Investment Property Forum (IPF) are for an all-property valuation gain of 1.8% in each of 2022 and 2023, driven by the industrial sector. The consensus for standard retail is a decline of 1.6% in 2022 followed by a small 0.2% gain in 2023; shopping centre values are forecast to decline by 3.8% in 2022 and 1.6% in 2023.

CitiPark has been significantly impacted during the pandemic by lower levels of revenue and relatively inflexible cost base, in particular rent and rates (with car parks unable to benefit from the government’s business rates relief scheme). Nevertheless, the business remained profitable and adjusted for management’s £2.3m estimate of the net pandemic impact delivered a similar £2.9m operating profit in H121 as in H120. On this adjusted basis operating profits were ahead of the underlying £2.4m reported for H220 (after adding back the £2.0m pandemic impact estimated by management).

TCS expects the car park business to recover quickly as the lockdown easing measures take effect, an expectation that is supported by the monthly revenue data shown in Exhibit 14. Revenues fell to c 20% of normal levels during the first lockdown but quickly recovered to almost two-thirds of normal as this ended, only to fall again when the further measures were introduced. Clearly much uncertainty remains, and our forecasts anticipate a similar performance in H221 as in H121 with a recovery in revenues in FY22 to c 80% of the FY19 (pre-pandemic) level. We do not anticipate revenues returning to more normal levels until FY23 although this could prove to be conservative given the range of growth initiatives targeted by the business and discussed above.

The ibis Styles Hotel is situated at the Merrion Centre and operated under management contract. It remained operational despite the pandemic, providing key-worker accommodation but revenues were nevertheless significantly negatively affected, with a c £0.4m net revenue/operating profit impact on TCS in each of H220 and H121.

The monthly revenue data for the hotel (Exhibit 16) show a similar but more muted pattern to CitiPark coming out of the first lockdown. Our forecasts allow for a partial recovery in FY22 with net revenues/operating profit recovering to pre-pandemic levels (c £0.6m pa) in FY23.

Total borrowing facilities at end-H121 amounted to c £208m, comprising £99.5m of long-term, fixed-rate borrowing (5.375% First Mortgage Debenture Stock 2031) and £108m of shorter-term, floating rate revolving bank credit facilities. During H121, TCS had the opportunity to repurchase £6.5m of the debenture at only slightly above par value, reducing the average cost of debt and increasing LTV headroom within the facility.

There are three revolving bank debt facilities: a £33m facility with NatWest, extended since year end by one year on similar terms and margin and now to expire in April 2022; a £35m Lloyds facility with an initial three-year term that expires in June 2021 with two one-year extensions, currently in the process of being requested; a £35m Handelsbanken facility due to expire in June 2023; and a £5m overdraft facility.

The end-H121 balance sheet financial liabilities of £195.6m include finance lease/IFRS 16 lease liabilities and excluding these the debenture/bank borrowings were £150.0m, secured by fixed charges on the portfolio. The debenture has a minimum asset cover ratio requirement of 1.50x.

The end-H121 weighted average maturity of the debt was 6.1 years, with a weighted average cost of debt of 4.1%. Allowing for cash of c £2.5m, net debt was £147.6m (end-FY20: £183.6m) and the loan to value ratio (LTV) was 48.6% (FY20: 53.2%).

Management has identified the single greatest risk to the business model as the impact that further reductions in property values could have on banking covenants and future borrowing headroom. Borrowing headroom at end-H121 was £12.8m (end-FY20 was £14.8m), or c 4% of portfolio value. The headroom is below the c £57m of undrawn borrowing due to the existing fixed asset charges that were in place. TCS expects continuing asset sales and, if necessary, a potential restructuring of the security pool (enabling a more efficient use of the available assets) to provide additional headroom.

Our cash flow forecasts are shown in the financial summary (Exhibit 21), indicating a small reduction in net debt over the forecast period, with no change in gross borrowings and a small net cash surplus.

Our last published forecasts pre-date the onset of the pandemic and therefore publication of the FY20 results. Because of the pandemic impact on the closing months of FY20, the published results were clearly below our forecast, but would have been slightly ahead but for the c £3.6m negative pre-tax pandemic impact estimated by management. Our previous FY21 estimate is significantly reduced as a result of:

We expect the recovery in revenues, earnings, DPS and NAV to begin in FY22. Given the strong emphasis that management places on dividends we are forecasting a reduced but uncovered DPS in FY21, partly anticipating the potential for FY22 recovery.

Our forecast for FY21 EPRA NTA per share is a c 7% reduction to 269p (FY20: 285p; H121: 278p), with modest improvements in FY22/FY23. Compared with our forecasts, a 1% increase/decrease in the overall property portfolio valuation increases/decreases FY21 NAV per share by c 7p.

For the UK commercial property sector as a whole income returns have historically been much more predictable over time compared with the observed significant swings in capital values and capital returns across cycles. This same pattern can be seen in the TCS returns despite the significant pandemic impact on CitiPark. Weaker capital returns since FY19, particularly in FY20 as the pandemic hit, reduced the rolling 5-year average annualised total return (change in NAV plus dividends paid) quite materially between end-FY19 (+5.4% pa) and end-H121 (-1.7% pa) although the income returns show a relatively small change between the periods. Our forecasts imply a negative total return in FY21 (4.2%) due asset disposals (reducing income) and further COVID-19 pressures, including a reduced DPS. For FY22/23 our forecasts imply positive returns (1.6% and 2.9% respectively) driven entirely by income returns (we forecast no change in portfolio values) reflected in a rebuilding of DPS. Although the forecast FY22/23 returns are relatively modest by historical standards, risk free rates remain low (the 10-year UK gilt yields remain below 1%) and given the significant (c 50%) discount to EPRA NTA at which TCS shares are trading, our DPS forecasts for FY22/23 represent a much more significant return on the share price.

In Exhibit 20 we show a summary valuation comparison of TCS with what we consider to be a group of peers from within the broad property sector, including companies focused on regional property and those with significant retail exposure. For consistency of comparison, the valuation data are presented on a trailing basis, using the last reported RPRA NAV/NTA and 12-month trailing DPS declared.

The share price performance data provide a mixed picture with the share prices of many stocks, the companies with significant shopping centre exposure (eg Capital & Regional and Hammerson), recently showing recovery from very low levels. The share prices of companies with a more diversified sector exposure, particularly when this diversified exposure is combined with an income focus (eg Custodian, Picton, Regional REIT, Schroder REIT) experienced less weakness during the first half of 2020 and are consequently showing a less pronounced recovery.

Despite its increasingly diversified exposures across the property sector as well as through its CitiPark car parking operation, and the relatively robust recent performance of the property business in terms of rent collection and capital values, TCS trades at one of the lowest P/NAV ratings in the group. In part, this may be explained by its relatively higher gearing and lower share trading liquidity (a function of market capitalisation and free float) as well as the depressed level of trailing DPS; although disposals have reduced gearing and balance sheet risk, they will also reduce earnings and dividend paying capacity. Nevertheless, management’s intention is to maintain a solid footing on which to continue the successful long-standing strategy of active management and redevelopment to drive income and capital growth. The management team is strongly aligned with shareholders and is committed to restoring dividends as soon as is practicable. Although the UK economic outlook remains uncertain, we note TCS’s focus on better performing regional markets (Leeds and Manchester) that should continue to benefit from government initiatives to rebalance economic activity away from London.

The commercial property market is cyclical, historically exhibiting substantial swings in valuation through cycles, the impact of which on shareholder equity/NAV may be amplified by gearing. Income returns are significantly more stable, but still fluctuate according to tenant demand and rent terms. Aside from its general economic impact, the pandemic has created near-term uncertainty in terms of non-payment of rents, increased risk of tenant failure, and a slower lettings market while the longer-term implications for tenant demand and lease structures is far from clear. From a sector viewpoint we also highlight the increased risks and uncertainties that attach to development activity, including planning consents, timing, construction risks and the long lead times to completion and eventual occupation. In particular we note: