Currency in GBP
Last close As at 02/02/2023
GBP2.10
▲ 4.00 (1.94%)
Market capitalisation
GBP92m
Research: Real Estate
Palace Capital (PCA) has recently disclosed several positive developments covering the near completion of its non-core disposal programme, the commencement of capital redeployment into opportunities with more attractive return profiles and leasing progress at its attractive York development, completed earlier in FY22. A highly experienced new chairman has also been appointed.
Palace Capital |
Strategic progress underscores potential |
Company update |
Real estate |
24 January 2022 |
Share price performance
Business description
Next events
Analyst
Palace Capital is a research client of Edison Investment Research Limited |
Palace Capital (PCA) has recently disclosed several positive developments covering the near completion of its non-core disposal programme, the commencement of capital redeployment into opportunities with more attractive return profiles and leasing progress at its attractive York development, completed earlier in FY22. A highly experienced new chairman has also been appointed.
Year end |
Net rental income (£m) |
Adjusted PBT* (£m) |
Adjusted EPS* (p) |
EPRA NTA**/ |
DPS |
P/NAV |
Yield |
03/21 |
14.9 |
7.5 |
16.4 |
350 |
10.5 |
0.73 |
4.1 |
03/22e |
14.1 |
6.9 |
15.1 |
370 |
12.8 |
0.69 |
5.0 |
03/23e |
15.2 |
7.7 |
16.7 |
390 |
14.0 |
0.66 |
5.5 |
03/24e |
17.5 |
10.0 |
21.6 |
404 |
18.0 |
0.63 |
7.0 |
Note: Adjusted for revaluation gains, share-based payments and non-recurring items.
Positive developments on several fronts
The completed/agreed disposal of two properties in late December 2021 for a combined c £4.5m, ‘a significant premium to book value’, brings total transactions under PCA’s £30m non-core disposal programme to £28.2m. Redeployment of the disposal proceeds has commenced with the completed £10.25m acquisition of a fully let, good-quality office property in central Maidenhead, generating net income of £0.75m pa, reflecting an attractive yield of 6.83%. Combined with an additional £1.3m of annual income generated through active asset management, including lease renewals, rent reviews and new lettings, the new annualised income added to the portfolio rent roll since the start of FY22 now exceeds the income lost through the disposal programme by more than £1m pa. This includes the recently completed letting of 11.3m sq ft of grade A office space at Hudson Quarter (HQ) in York, at a headline rent of £26 per sq ft, subject to a short rent-free period. The new chairman, Steven Owen, also non-executive chairman of Primary Health Properties, brings strong financial and property sector experience to PCA.
Organic upside and capital redeployment
Organic income and capital growth potential within the existing portfolio is strong. H122 estimated rental value was £3.1m (18%) ahead of contracted rent, primarily recently refurbished/developed office assets, including Hudson Quarter, immediately available for letting. Further capital redeployment will add additional income and improve overall asset quality. Capital available for redeployment includes the remaining proceeds from the non-core disposal programme from sales of the Hudson Quarter residential apartments, which additionally generate trading gains. Our forecasts, for now unchanged, assume total capital redeployment of £50m (including Maidenhead), adding c £3m pa to rent roll.
Valuation: Not reflecting company growth targets
A c 5.0% prospective yield, with DPS fully covered by cash earnings and a c 30% discount to H122 EPRA NTA per share, is undemanding relative to peers and does not appear to reflect the potential for income and capital growth embedded in the existing portfolio or the opportunities for accretive new investment.
Highly experienced new chairman
Steven Owen has been appointed chairman with effect from 1 January 2022, replacing Stanley Davis, chairman since 2010 when he co-founded PCA in its current form along with CEO Neil Sinclair. Mr Davis had signalled his intention to retire at the end of October, but remained in place while the search for his successor was completed.
Steven Owen combines the financial skills of a chartered accountant with extensive experience of investment and development in commercial property in a listed company environment. He began his career with KPMG before moving into property with Brixton plc, where he spent 24 years. At Brixton he became finance director and then deputy chief executive. In 2014, he was appointed to the board of Primary Health Properties (PHP) and became non-executive chairman in 2018, overseeing significant corporate activity including its merger with MedicX Fund in 2019 and the internalisation of PHP’s management structure in January 2021.
Disposal programme nears completion
PCA has now almost completed its £30m disposal programme with the aggregate value of transactions completed or exchanged in FY22 year to date reaching £28.2m by end-December 2021 (end-Q322). Having grown the portfolio primarily through portfolio acquisition, non-core disposals have been a regular feature, enabling capital deployment to be optimised and supporting operational efficiency. Disposals are typically driven by completion of the business plan for the asset or where the risk-return balance favours disposal, in some cases generating an immediate saving on property operating costs. We expect the capital released by the current year disposals to be reinvested in better-quality assets by the end of FY23. Redeployment has commenced and, including disposal proceeds from the sale of Hudson Quarter residential assets,1 we forecast an aggregate c £50m of acquisitions (including Maidenhead) by end-FY23 at a blended c 6% net initial yield, adding c £3.0m to annualised contracted rents.
The Barclays development loan facility that had part-funded the Hudson Quarter was fully repaid by end-November 2021 and all proceeds from the remaining apartment sales will then be available for redeployment. Sales of residential apartments completed during H122 amounted to c £19.2m, generating trading profits of c £2.8m, and have continued since. We forecast that apartment sales will be completed by end-FY23, generating total sales proceeds of c £51.0m.
Of the 15 mature/non-core assets identified for disposal earlier in FY21, 12 have now been sold/exchanged. The two most recent transactions were:
■
The completed sale of Russell House in Walton-on-Thames in Surrey, a multi-let office and industrial building, for £2.625m. Since acquisition in 2014, PCA brought it to full occupancy and has increased rental income by 30%.
■
The now completed sale of Westminster House in Gerrards Cross, Buckingham, a multi-let office and residential building, for £1.9m.
For both assets, PCA has crystalised a significant but undisclosed uplift on both the acquisition prices and book values.
Redeployment underway
The £10.25m (before costs) acquisition of an office building in central Maidenhead marks the start of PCA’s capital redeployment plans. It is a good-quality building with an EPC2 rating of B and was recently refurbished. It is fully let, with the office space leased to Techtronic Industries EMEA, a strong tenant whose parent company is listed on the Hong Kong Stock Exchange. The lease term is 10 years, commencing on 1 August 2021, with a break option at the end of the fifth year. Including two small retail units on the ground floor, the total annual rent for the building is c £718k, reflected in the 6.83% net initial yield.
Energy performance certificate.
The acquisition is consistent with PCA’s focus on good-quality regional towns and city centres that are easily accessible and close to public transport, as well as the amenities that employees are keen to have near their place of work. Maidenhead is situated in the Thames Valley, between Reading and Slough. It is in an affluent area of the south east, well connected to the UK's motorway system and Heathrow Airport, making it an attractive location for international businesses looking for space close to London. Like many towns and cities outside of the capital, it has experienced a reduction in good-quality office space alongside rising demand.
Realising organic income potential
In addition to acquisitions, PCA has significant income potential within its current portfolio. At 30 September 2021 (H122), the externally estimated market rental value was £3.1m (or 18%) ahead of contracted rent roll of £16.9m. Void reduction/letting of vacant space in the office sector assets represented the single largest opportunity to increase portfolio income at £2.8m, primarily related to recently refurbished or developed assets, including the high-quality HQ office assets (£0.9m).3 Initially, 4,700 sq ft of office space, on the ground floor of one of the HQ residential buildings, was pre-let to Knights, a quoted law firm, at a record rent for York of £25 per sq ft, and the recently completed letting of 11,300 sq ft takes occupancy to c 41%. The new tenant is Great Rail Journeys, headquartered in York, which has leased the fourth and fifth floors, including the top floor terrace, on a 10-year lease (with a break option at the end of year six) at an average headline rent of £26/ sq ft subject to a short rent-free period. Great Rail Journeys has also taken 10 car parking spaces at an additional c £23k pa, indexed to inflation. Of the remaining 23,500 sq ft of office space, 10,400 sq ft is now currently under offer and completion would take total HQ office occupancy to c 67%.
HQ occupies a two-acre site in York, within the city walls and just a minute’s walk from York railway station, which is 105 minutes (non-stop) by rail from London. The scheme comprises three residential buildings and a commercial building. The 127 flats (c 95,000 sq ft of living space) are being sold and the commercial element, including 39,200 sq ft of grade A offices, will be retained for income. The office space is rated EPC ‘A’, BREEAM (a leading sustainability assessment) ‘excellent’, and WiredScore (digital connectivity certification) ‘platinum’.
Forecasts and Valuation
The recent positive developments in terms of leasing events and the continuing sale of assets at well above book value suggest the potential for FY22 income earnings and capital growth to be ahead of our forecasts, although we leave these unchanged pending further updates from the company.
Unlike REITs that focus wholly or predominantly on generating income returns, PCA’s total return model relies significantly on generating capital growth from the repositioning of value-add properties, as well as seeking an attractive level of income. Capital returns do not emerge with the same regularity as contracted rental income but are targeted to enhance overall return. Since its first major post-IPO transaction in H214, PCA has built a proven track record of acquiring properties where it can extract value by enhancing sustainable recurring income and generating capital growth through refurbishment and development opportunities. During this period and up to end-H122, it has generated cumulative accounting/EPRA NTA total returns of 118.0% or a compound annual average return of 10.2%. This is a good level of return despite the negative impact of COVID-19 on late FY20 and FY21.
Exhibit 1: NAV total return history
H214 |
FY15 |
FY16 |
FY17 |
FY18 |
FY19 |
FY20 |
FY21 |
H122 |
Cumulative return H114–H122 |
|
Opening EPRA NTA per share (p)* |
218 |
341 |
388 |
414 |
443 |
414 |
407 |
364 |
350 |
218 |
Closing EPRA NTA per share (p)* |
341 |
388 |
414 |
443 |
414 |
407 |
364 |
350 |
362 |
362 |
DPS paid (p) |
2.5 |
8.50 |
14.00 |
18.00 |
19.00 |
19.00 |
19.00 |
7.50 |
5.50 |
113 |
Income return (%) |
1.1% |
2.5% |
3.6% |
4.3% |
4.3% |
4.6% |
4.7% |
2.1% |
1.6% |
51.8% |
Capital return (%) |
56.6% |
13.5% |
6.9% |
6.9% |
-6.4% |
-1.8% |
-10.4% |
-4.1% |
3.6% |
66.1% |
NAV total return (%) |
57.8% |
16.0% |
10.5% |
11.2% |
-2.1% |
2.8% |
-5.8% |
-2.0% |
5.2% |
118.0% |
Average annual compound return |
10.2% |
Source: Palace Capital data, Edison Investment Research. Note: *Since FY20, EPRA net tangible assets per share and prior to FY20, the broadly equivalent EPRA net asset value per share.
Based on the minimum 3.25p quarterly DPS that PCA targets for the balance of FY22, the prospective yield is c 5.0%. We forecast FY22 DPS to be well covered by adjusted earnings and for DPS to increase further during FY23 and FY24. Meanwhile, the shares continue to trade at a significant discount of c 30% to H122 EPRA NTA per share of 362p.
In Exhibit 2, we show a summary performance and valuation comparison of PCA and a peer group of UK commercial real estate investment companies with a strong regional focus. For comparative purposes, the valuation data are based on last reported EPRA NTA/NAV and trailing 12-month DPS declared. On this basis, PCA trades at a clearly lower P/NTA than the group average and, despite its total return focus, its trailing dividend yield is only modestly below the average.
The Palace valuation continues to appear undemanding in view of:
■
the strong long-term track record of total return generation;
■
the significant income and capital return potential embedded within the existing portfolio; and
■
the opportunity to recycle capital accretively and/or maintain a somewhat lower gearing level than has historically been the case and/or return capital to shareholders if attractive investment opportunities fail to emerge.
Exhibit 2: Peer group valuation and performance comparison
Price |
Market cap (£m) |
P/NAV* |
Trailing yield (%)** |
Share price performance |
||||
One month |
Three months |
12 months |
From 12-month high |
|||||
Circle Property |
208 |
59 |
0.76 |
1.7 |
-2% |
1% |
17% |
-10% |
Custodian |
105 |
465 |
0.99 |
4.7 |
2% |
9% |
19% |
-2% |
Picton |
104 |
568 |
0.99 |
3.2 |
3% |
4% |
26% |
-2% |
Real Estate Investors |
39 |
70 |
0.68 |
9.6 |
1% |
-1% |
12% |
-9% |
Regional REIT |
91 |
470 |
0.92 |
6.9 |
-2% |
5% |
18% |
-5% |
Schroder REIT |
56 |
273 |
0.84 |
4.8 |
6% |
10% |
43% |
-1% |
UK Commercial Property REIT |
81 |
1056 |
0.90 |
3.4 |
8% |
9% |
25% |
-4% |
BMO Commercial Property Trust |
115 |
864 |
0.88 |
3.7 |
10% |
16% |
54% |
-1% |
BMO Real Estate Investments |
88 |
212 |
0.80 |
4.0 |
2% |
4% |
38% |
-2% |
Average |
0.86 |
4.7 |
3% |
6% |
28% |
-4% |
||
Palace Capital |
256 |
118 |
0.71 |
4.6 |
-2% |
5% |
33% |
-12% |
UK property sector index |
1,922 |
-2% |
3% |
22% |
-5% |
|||
UK equity market index |
4,217 |
1% |
3% |
11% |
-2% |
Source: Company data, Refinitiv. Note: Prices as at 21 January 2022. *Based on last reported EPRA NAV/NTA per share. **Based on trailing 12-month DPS declared.
Exhibit 3: Financial summary
Year end 31 March (£m) |
2018 |
2019 |
2020 |
2021 |
2022e |
2023e |
2024e |
PROFIT & LOSS |
|||||||
Rental & other income |
16.7 |
18.8 |
21.1 |
17.3 |
16.8 |
17.3 |
19.4 |
Movement in credit loss |
0.0 |
0.0 |
(0.9) |
0.0 |
0.0 |
0.0 |
|
Non-recoverable property costs |
(1.8) |
(2.3) |
(2.4) |
(1.5) |
(2.6) |
(2.1) |
(1.9) |
Net rental income |
14.9 |
16.4 |
18.8 |
14.9 |
14.1 |
15.2 |
17.5 |
Gross profit from trading properties |
4.1 |
3.2 |
0.0 |
||||
Dividend income from listed equity investments |
0.0 |
0.1 |
0.1 |
0.1 |
0.0 |
0.0 |
|
Administrative expenses including share-based payments |
(4.2) |
(4.1) |
(4.3) |
(4.3) |
(4.5) |
(4.6) |
(4.8) |
Operating Profit (before capital items) |
10.7 |
12.4 |
14.6 |
10.6 |
13.8 |
13.8 |
12.8 |
Realised & unrealised gains/(losses) on properties |
6.0 |
(1.0) |
(18.0) |
(13.1) |
3.9 |
4.4 |
3.9 |
Loss on revaluation of listed equity investments |
0.0 |
(0.2) |
(0.4) |
0.7 |
(0.1) |
0.0 |
0.0 |
Operating Profit |
16.7 |
11.1 |
(3.9) |
(1.8) |
17.6 |
18.2 |
16.7 |
Net finance expense |
(3.4) |
(4.7) |
(5.2) |
(3.8) |
(3.4) |
(3.3) |
(3.2) |
Profit Before Tax |
13.3 |
6.4 |
(9.1) |
(5.5) |
14.3 |
15.0 |
13.5 |
Taxation |
(0.8) |
(1.3) |
3.6 |
(0.0) |
0.0 |
0.0 |
0.0 |
Profit After Tax (FRS 3) |
12.5 |
5.2 |
(5.4) |
(5.5) |
14.3 |
15.0 |
13.5 |
EPRA adjustments: |
|||||||
Realised & unrealised gains/(losses) on properties |
(6.0) |
1.0 |
18.0 |
13.1 |
(3.9) |
(4.4) |
(3.9) |
Deferred tax charge |
(0.3) |
0.2 |
0.0 |
0.0 |
0.0 |
0.0 |
0.0 |
Other adjustments |
0.3 |
1.1 |
(1.8) |
(0.3) |
(4.0) |
(3.2) |
0.0 |
EPRA earnings |
6.5 |
7.6 |
10.8 |
7.2 |
6.4 |
7.3 |
9.6 |
Share-based payments |
0.2 |
0.3 |
0.1 |
0.3 |
0.4 |
0.4 |
0.4 |
Other adjustments |
0.7 |
0.0 |
(2.9) |
0.0 |
0.2 |
0.0 |
0.0 |
Adjusted earnings |
7.4 |
7.9 |
8.1 |
7.5 |
6.9 |
7.7 |
10.0 |
Tax adjustments |
1.1 |
1.0 |
(0.0) |
(0.0) |
0.0 |
0.0 |
0.0 |
Company adjusted PBT |
8.5 |
8.9 |
8.0 |
7.5 |
6.9 |
7.7 |
10.0 |
Average fully diluted number of shares outstanding (m) |
35.0 |
45.9 |
46.0 |
46.1 |
46.2 |
46.1 |
46.1 |
Basic EPS - FRS 3 (p) |
35.8 |
11.3 |
(11.8) |
(12.0) |
30.9 |
32.5 |
29.2 |
Fully diluted EPRA EPS (p) |
18.7 |
16.5 |
23.4 |
15.7 |
13.9 |
15.9 |
20.7 |
Fully diluted adjusted EPS (p) |
21.2 |
17.3 |
17.5 |
16.4 |
15.1 |
16.7 |
21.6 |
Dividend per share declared (p) |
19.0 |
19.0 |
12.0 |
10.5 |
12.8 |
14.0 |
18.0 |
Dividend cover by adjusted earnings (x) |
1.11 |
0.91 |
1.46 |
1.56 |
1.18 |
1.20 |
1.20 |
NTA total return |
-2.1% |
2.8% |
-5.8% |
-2.0% |
9.2% |
9.0% |
7.7% |
BALANCE SHEET |
|||||||
Fixed Assets |
254.0 |
261.1 |
251.7 |
239.3 |
213.8 |
273.3 |
282.2 |
Investment properties |
253.9 |
258.3 |
248.7 |
235.9 |
213.6 |
273.1 |
282.0 |
Other non-current assets |
0.1 |
2.7 |
3.0 |
3.5 |
0.1 |
0.2 |
0.2 |
Current Assets |
46.3 |
55.3 |
51.8 |
61.9 |
68.1 |
16.6 |
13.6 |
Trading properties |
0.0 |
14.4 |
27.6 |
42.7 |
18.5 |
(.0) |
(.0) |
Assets held for sale |
21.7 |
11.8 |
0.0 |
0.0 |
0.0 |
0.0 |
0.0 |
Cash |
19.0 |
22.9 |
14.9 |
9.4 |
39.8 |
6.8 |
3.9 |
Other current assets |
5.6 |
6.2 |
9.3 |
9.8 |
9.8 |
9.8 |
9.8 |
Current Liabilities |
(11.5) |
(16.0) |
(16.1) |
(34.9) |
(42.0) |
(42.2) |
(43.2) |
Creditors |
(8.8) |
(10.0) |
(14.1) |
(12.9) |
(11.1) |
(11.3) |
(12.3) |
Short term borrowings |
(2.7) |
(6.0) |
(1.8) |
(21.9) |
(30.8) |
(30.8) |
(30.8) |
Long Term Liabilities |
(105.5) |
(120.0) |
(121.1) |
(108.5) |
(72.8) |
(71.3) |
(69.8) |
Long term borrowings |
(97.2) |
(112.0) |
(117.5) |
(105.4) |
(70.0) |
(68.5) |
(67.0) |
Deferred tax & other long-term liabilities |
(8.3) |
(8.0) |
(3.5) |
(3.1) |
(2.7) |
(2.7) |
(2.7) |
Net Assets |
183.3 |
180.3 |
166.3 |
157.8 |
167.1 |
176.3 |
182.8 |
EPRA net assets |
0.0 |
0.0 |
167.9 |
161.3 |
171.3 |
180.5 |
187.0 |
Basic NAV/share (p) |
400 |
393 |
361 |
343 |
361 |
381 |
395 |
Diluted EPRA NAV/share (p) |
0 |
0 |
364 |
350 |
370 |
390 |
404 |
CASH FLOW |
|||||||
Operating Cash Flow |
9.9 |
11.9 |
15.7 |
11.3 |
37.3 |
33.0 |
14.2 |
Net Interest |
(2.7) |
(3.4) |
(3.7) |
(3.6) |
(3.2) |
(3.1) |
(3.0) |
Tax |
(0.4) |
(1.6) |
(2.2) |
(1.2) |
(0.0) |
0.0 |
0.0 |
Net cash from investing activities |
(67.7) |
(11.5) |
(10.1) |
(14.8) |
26.6 |
(53.0) |
(5.0) |
Ordinary dividends paid |
(6.7) |
(8.7) |
(8.7) |
(3.5) |
(5.4) |
(6.2) |
(7.4) |
Debt drawn/(repaid) |
8.2 |
18.0 |
1.4 |
7.6 |
(26.9) |
(1.7) |
(1.7) |
Proceeds from shares issued (net) |
67.7 |
(0.0) |
0.0 |
0.0 |
0.0 |
0.0 |
0.0 |
Other cash flow from financing activities |
(1.1) |
(0.1) |
(1.0) |
(0.3) |
(0.0) |
0.0 |
0.0 |
Net Cash Flow |
7.0 |
4.4 |
(8.5) |
(4.5) |
28.4 |
(31.0) |
(2.9) |
Opening cash |
10.9 |
18.0 |
22.4 |
13.9 |
9.4 |
37.8 |
6.8 |
Closing cash |
18.0 |
22.4 |
13.9 |
9.4 |
37.8 |
6.8 |
3.9 |
Restricted cash |
1.0 |
0.5 |
1.0 |
0.0 |
2.0 |
0.0 |
0.0 |
Closing balance sheet cash |
19.0 |
22.9 |
14.9 |
9.4 |
39.8 |
6.8 |
3.9 |
Closing balance sheet debt |
(99.8) |
(118.0) |
(119.4) |
(127.3) |
(100.9) |
(99.4) |
(97.9) |
Unamortised debt costs |
(1.6) |
(1.3) |
(1.4) |
(1.0) |
(0.6) |
(0.4) |
(0.2) |
Closing net (debt)/cash |
(82.4) |
(96.5) |
(105.8) |
(118.9) |
(61.6) |
(92.9) |
(94.2) |
Net LTV (excluding restricted cash & adjusted for unamortised debt costs) |
29.8% |
33.7% |
38.1% |
42.0% |
26.0% |
33.4% |
32.8% |
Source: Palace Capital historical data, Edison Investment Research forecasts
|
|
Research: Healthcare
Renaissance BioScience is a private bioengineering company developing proprietary yeast strains for use in the food and beverage, healthcare and agriculture industries. It has been successful in commercially licensing its ‘Generation 1’ technology, which comprises yeast strains for use in the food and beverage industry. The primary focus has now shifted to the development of its ‘Generation 2’ technology – yeast strains capable of producing and delivering RNAi – and aims to address challenges in the agriculture and biopharmaceutical industries. Early results indicate that its RNAi solutions could be low-cost, efficacious and non-toxic. As the company is a private entity, we have limited visibility on its financials. However, in November 2021, it successfully closed the balance of its US$5m convertible debenture, proceeds from which have been allocated to advance its RNAi platform.
Get access to the very latest content matched to your personal investment style.