Raven Property Group — Strong operational performance

The Russian economy returned to growth in 2017, with GDP increasing 1.5% and the official forecast for 2018 is that the rate of growth will have increased to 2.0%. The actual growth rate may have been stronger, with preliminary data indicating growth of 2.3%. The Bank of Russia’s benchmark interest rate has fallen a long way from the late 2014 high of 17%, but the decline has recently been interrupted by currency weakness and a desire to limit the inflationary impact of the VAT increase effective from the beginning of 2019. The benchmark rate is now 0.5% above its 2018 low, at 7.75%. Underlying inflation appears well controlled and despite the increase in VAT, policymakers expect the annual inflation rate to be between 5.0% and 5.5% by the end of the year and return to 4% in the first half of 2020. Supported by the stronger economy and structural growth dynamics, the warehouse market has continued to strengthen. Demand in Moscow and the Moscow region, where the majority of Raven’s assets are sited, increased to a record level in 2018. With take-up of 1.6m sqm and new supply of 918k sqm, the vacancy rate reduced to c 5% and prime market rents increased. From a range of c RUB3,600–4,000 per sqm for Grade A space at the beginning of the year, the bottom end of the range has moved closer to RUB3,800 with the top of range firming above RUB4,000. Demand was strongest from retail and distribution tenants, while e-commerce is an area of strong growth. 2019 also looks positive, with preliminary estimates of demand of c 1.4m sqm and supply of c 1.0m sqm, of which less than half is speculative development. The rise in construction costs, resulting from rouble weakness feeding through to the cost of specialist imported materials, and rising labour costs, is a positive discipline on developers; if they are to maintain margins, they must build less space or increase rents.

Against this more positive economic and market background, Raven’s warehouse occupancy improved considerably during the year and was 89% at end-FY18 (FY17: 81%), and has since reached 90%. Existing leases covering 253k sqm of gross lettable area (GLA) were renegotiated or extended and new lettings were 241k, including 11,800 sqm to Accord Post, 16,000 sqm to Mir Instrumenta, 16,200 sqm to Cotton Club, and 18,200 to Perspective, all in Moscow. Since year end, another 31,850 sqm of new lettings have completed, and letters of intent (LOIs) signed in respect of 79,800 sqm of vacant space and renewals and expansions. If the LOIs are signed, vacancy will reduce by a further 24,250 sqm.

Vacant space at end-FY18 totalled 206,000 sqm. In addition to the maturities shown at the bottom of Exhibit 1, there are 91,600 sqm in potential lease breaks in 2019 and 199,900 sqm in 2020.

At end-FY18, the share of warehouse GLA let on US dollar leases was down to 26% compared with 31% at end-FY17, while the share of rouble-denominated leases increased to 61% (end-FY17: 47%). Euro-denominated leases (3%) and vacant space (11%) accounted for the balance.

The average rental level of the legacy US dollar-denominated leases continues to be higher than the average, such that NOI exposure to the US dollar, calculated using year-end exchange rates, was 51% (FY17: 62%).

The average US dollar-denominated rental level at end-FY18 was US$148 per sqm (End-FY17: US$143 per sqm), with weighted average term to maturity of 2.1 years (end-FY17: 3.0 years). The average rental level on rouble-denominated leases was RUB4,900 (end-FY17: RUB5,200) per sqm, with a weighted average term to maturity of 4.5 years (end-FY17: 3.6 years). In US dollar terms, the rouble-denominated rents are around US$75 per sqm, but benefit from minimum annual indexation of 5.9% (FY17: 6.8%).

The reduced US dollar share in NOI exposure in the year is substantially due to the increase in rouble-denominated rents resulting from increased occupancy and the significant acquisition activity of the past two years. Acquisitions are a key element of the company’s strategy to mitigate the loss of income from legacy US dollar-denominated leases as these mature over the next two years. Raven says that it is continuing to see a number of new acquisition opportunities, but its current preference is to be selective, focusing on newly completed or recently let properties with the best long-term prospects for sustainable cash flow and value appreciation.

Two acquisitions of Grade A warehouse complexes were completed during the year, for an aggregate consideration of RUB5.3bn, adding 123,200 sqm of space (c 7% of the opening stock), with expected annualised income of RUB580m. That takes the total acquisition investment since April 2017 to RUB14.6bn. In September 2018, Raven completed the acquisition of a c 59k sqm Grade A warehouse complex, immediately adjacent to the c 195k sqm Sever logistics park in Moscow, which it acquired in November 2017. It was acquired 78% let, with an unexpired weighted average lease term of nine years and annual rent indexation of 6%. The current annualised lease income, before indexation, was c RUB230m at acquisition, rising to an expected c RUB270m when fully let. The initial consideration was c RUB2.5bn, with RUB160.0m deferred for six to eight months.

In December 2018 Raven closed the acquisition of a completed warehouse in Nizhny Novgorod, a city 400km east of Moscow, together with 21.5ha of adjacent land. The 64,375sqm warehouse complex was acquired fully let with a weighted average unexpired lease term (WAULT) of 8.4 years. Consideration for the acquisition was RUB2.8bn with expected annual income of c RUB350m, giving an initial yield of 13.7%.

Stripping out last year’s exceptional £16.4m gain from sales of legacy UK land assets, net rental and related income (NOI) was ahead of 2017, supported by acquisitions and occupancy growth. The reduction in NOI from the existing investment portfolio reflects the movement of the average rouble/sterling exchange rate over the year, from 75.2 roubles to the pound in 2017 to 83.7 in 2018. Underlying rouble-denominated income from the existing investment portfolio increased from RUB7.2bn to RUB7.7bn. The FY18 acquisitions will contribute for a full year in FY19, which we estimate will add c RUB380m to rental income (more than £4m at the year-end exchange rate).

Exhibit 5 shows a summary of the FY18 income statement, on a reported and underlying basis, as well as a comparison with FY17. The FY18 results (with an FY17 restatement) are reported for the first time in sterling rather than US dollars. Sterling has been and remains the functional currency of the group, but the presentation currency has switched from US dollars to sterling, matching the denomination of the equity capital and preference capital base, and in recognition of the declining significance of US dollars in terms of group revenues and borrowings. At the level of the investment property owning subsidiaries, the functional currencies are all now rouble, having previously included some US dollar denominations, and the group financial statements are translated into sterling at the group level at the appropriate rates.

The improved operational performance described above is obscured by the non-repeat of the £16.4m FY17 exceptional land sales gains as well as a negative swing year-on-year of £8.6m in unrealised foreign exchange movements. Adjusting for these two factors, on a comparable basis, the FY18 underlying profit before tax would have been £28.7m (actual £26.2m) compared with £33.4m in FY17 (actual £55.9m). Higher staff incentive payments in respect of the 2017 performance and a full year interest cost on the 2017 issue of convertible preference shares are the main factors contributing to the decline. In calculating underling earnings, the most significant adjustment to IFRS earnings is the movement in unrealised revaluation on property assets. In FY17 this was a positive £28.2m but in FY18 was a negative £121.0m. In roubles, the property valuation increased by 8%, reflecting an unchanged range of valuation yields of 11–12.5% on the year. The sterling loss reflects the movement in the period-end rouble/sterling exchange rate, from 77.9 at end-FY17 to 88.3 at end-FY18. Although market demand-supply dynamics have improved and rents are firming, the valuations have been set amid a slow year for the Russian commercial property investment market, with the volume of transactions falling by c 40%. Raven expects yields to be driven by interest rates and the strength of investor appetite for the time being, with the potential to adjust downwards if rents begin to grow, reflecting the potential for rental growth from under-rented leases expiring.

Given the change in presentational currency, it is difficult to make a direct comparison with our previously published forecasts in US dollars. However, we note that our FY18 adjusted PBT forecast of US$26.7m excluding forecast FX impacts was US$35.4mm, based on 88% year-end occupancy. Translated into sterling at the year average US$/sterling rate of 1.33 this is £26.6m compared with the FX adjusted £28.7m reported.

Period-end cash was £73.5m, providing resources for further accretive acquisitions.

Significant progress was made during the year in migrating the secured debt facilities out of US dollars and into roubles and euros, to better match the evolving income profile and de-risking cash flows. Raven has also invested £19m in rouble interest rate hedging, capping the rouble cost of debt at 8.25% for periods of five to seven years. Around 84% of the end-FY18 secured bank debt was hedged.

At end-FY18 US dollar debt had reduced to 34% of total secured debt excluding unamortised loan arrangement costs and accrued interest of £643m from 92% at end-FY17 (rouble debt 31% and euro debt 35%) and management expects that much of the remaining US dollar debt will be gone by the end of the current year. By using a blend of rouble and euro debt, Raven has limited the impact on the average cost of secured debt, which increased from 7.62% at end-FY17 to 7.69% at end-FY18. The average term to maturity was 4.0 years. The gross secured debt, making no allowance for cash, represented 54.7% of the investment portfolio value at end-FY18.

In addition to the secured debt, Raven is funded by sterling-denominated, fixed-rate, unsecured preference (£109.3m nominal value) and convertible preference shares (£99.6m nominal excluding own held shares). The capital structure makes basic NAV per share quite sensitive to movements in the portfolio value. The improvement in the Russian economy and warehouse market, if translated into further property valuation gains, not offset by FX moves, has the potential to be quite material. We estimate that a 1% increase in portfolio value would increase basic NAV per share by c 4%.

For an investor, the ordinary shares provide full exposure to distributions and NAV per share movements. For distributions, the convertible preference shares rank ahead of other share classes, and the cumulative 6.5% preferential dividend on the subscription amount of 100p represents a cash yield of 5.6% on the current price of 115.5p. They are redeemable by the company on 26 July 2026 at 1.35p, and can be converted into ordinary shares at the holder’s request at any time prior to redemption, currently at a rate of 1.617 (equivalent to c 71p per ordinary share at the current price), a premium of c 67%.

The (non-convertible) preference shares earn a cumulative 12% dividend on the fixed issue amount per share of 100p, ranking ahead of the ordinary shares. At a current price of 134p, the yield is 9.0%.