Raven Property Group — Strongly growing NAV

The growth in the Russian economy that began in 2017 continues, albeit at a moderate pace, and inflation is well controlled, leaving room for further interest rate reductions. After a strong finish to 2018, taking annual GDP growth to 2.9%, the economy has slowed and official forecasts are for 1.2% growth in 2019. Following a pick-up in early 2019 as VAT was increased, inflation has been moderating for several months to an annual rate of 4.6% in July. The Russian Economic Development Ministry recently lowered its 2019 inflation forecast to 3.8% and 3.0% in 2020. Interest rates have been cut twice this year, each time by 25bp, and are now at 7.25%, which appears to indicate room for further reductions, especially in view of the more stable rouble and modest economic growth rate.

Warehouse demand in Moscow and the Moscow region, where the majority of Raven’s assets are sited, increased to a record level of 1.6m sqm in 2018 and after a strong first half-year, JLL forecasts further growth to 1.7m sqm in the current year. JLL expects demand to continue to outstrip supply, even though completions of new space are expected to increase (to c 1.4m sqm from c 0.9m sqm in 2018). Vacancy has fallen to 3.9% and is expected to fall further by year end, supporting growth in market rents. Raven indicates that prime Moscow rents have increased to c RUB4,100 per sqm at the top end from RUB4,000 at the beginning of the year. Prime yields remain high in absolute terms and compared with other European markets at 10.75% to 12.25%.

The H119 results reflect the steadily improving market conditions, reinforced by positive currency movements, particularly the strength of the rouble versus sterling. Income benefited from higher average occupancy (90% in H119 compared with 84% in H118), property valuations improved in rouble terms, and significantly more so in sterling terms, driving a significant increase in NAV per share to 67p compared with 48p at end-FY18. Currency mismatch risk was further reduced as borrowings adapt to the increasing share of rouble-denominated rents (now more than two-thirds by area).

Exhibit 1 shows a summary of the H119 income statement, on a reported and underlying basis, as well as a comparison with H118. Sterling is both the functional and presentational currency of the holding company, although at the level of the investment property-owning subsidiaries, the functional currencies are all rouble. During the half-year period, the rouble strengthened against sterling from 88.4 at 31 December 2018 to 79.9 at 30 June 2019. The average rate in H119 was still lower at 84.5 compared with 81.8 in H118.

The key features of the income statement were:

At the end of H119, Raven’s investment property portfolio was independently valued at just over £1.3bn. The portfolio composition was not materially changed in the period, although the two Grade A warehouse complexes acquired late in FY18 contributed fully to the income statement for the first time. Of the gross lettable area (GLA) of just over 1.9m sqm, Grade A warehouse space represented 98%, the majority of which (69%) was located in the Moscow region. Warehouse tenants were split two-thirds large local corporates and one-third international across a broad range of sectors,

Warehouse occupancy averaged 90% through H119 compared with an average 84% in H118. It was 89% at the end of the period, a similar level to end-FY18, and is currently again at 90% with a further 2% of space subject to letters of intent (LOIs).

During H119 and H219 to date, Raven has continued to make good leasing progress. In H119, leases covering 92k sqm of warehouse space were renegotiated or extended, new leases covering 116k sqm were completed, and 120k sqm of space was vacated, leaving period-end occupancy at a similar level to end-FY18. Coming into H219, leases covering 140k sqm were due to mature by year end with an additional 71k sqm of potential lease breaks. It is Raven’s expectation that c 47k sqm of maturing tenants and c 5k sqm of breaks will vacate by year end, and of the balance it has already renegotiated or extended c 32k sqm of the maturing leases. It has also completed letting c 20k sqm of vacant space, and has LOIs covering an additional c 39k sqm of vacant space and 109k sqm of currently let space.

Rouble-denominated leases now two-thirds of total GLA

By end-H119, the share of rouble-denominated leases had increased to 67% of warehouse GLA (end-FY18: 61%), while the share of US dollar-denominated leases had fallen to 19% (end-FY18: 26%). Euro-denominated leases (3%) and vacant space (11%) accounted for the balance.

Positively, the average rouble rent was RUB5,118 per sqm, up from RUB4,900 at end-FY19, and benefiting from indexation (an average 5.9% pa), with an average term to maturity of 4.2 years. However, the rental level of the legacy US dollar-denominated leases, at $147 per sqm (end-FY18: $148) or c RUB9,300 per sqm using the end-H119 exchange rates, remains significantly higher and will continue to act as drag on income over the next two to three years as leases mature. The average maturity of the remaining US dollar leases is 2.2 years.

Given the high and increasing share of rouble-denominated rents in the total, the sensitivity of the income statement (reported in sterling) to fluctuations in the value of the rouble has increased. However, as we note below, this has been accompanied by continuing progress in moving secured debt facilities from the US dollar and into a rouble/euro blend that better matches the changing income profile.

Property values increased in both rouble and sterling terms during H119. The external property valuation undertaken by JLL as at 31 May 2019 as part of the process to prepare the shareholder circular in respect of the share repurchase showed a 1.1% increase in the rouble value of the investment property portfolio since end-FY18, supported by increasing estimated rental values (ERVs) with prime valuation yields remaining at a relatively high 10.75–11.25%. The recovery in the rouble versus sterling from end-2018 lows has had a significant, additional positive impact on reported property values and NAV. Unrealised gains on the investment portfolio were £18.2m in H119 and, reflecting the balance sheet structure, with significant preferred capital and redeemable convertible preferred funding, NAV per share increased significantly to 67p from 48p at end-FY18.

Exhibit 5 shows our forecasts in detail on an underlying basis (the IFRS reported basis can be seen in Exhibit 8). Our last published forecasts pre-date the company’s change of presentational currency to sterling (from US dollars) and so cannot be directly compared.

Our forecasts are based on a rouble exchange rate of 80 versus sterling, similar to the current rate. Our key assumptions for property NOI include:

We have not allowed for any further acquisitions in our forecasts. Although the recently completed share repurchase reduces the flexibility for acquisitions from existing resources, given the high yields available we would anticipate that management would consider alternative funding options should attractive opportunities present themselves.

Secured debt facilities amounted to £683m at end-H119, up slightly from £649m at end-FY18. The increase included £35m borrowing to gear the assets acquired in late 2018. Loan amortisation was £12.4m. The average cost of debt was 7.4%, with the majority hedged or fixed. Including unamortised loan arrangement fees but netting off cash of £83.0m, the loan to value ratio (LTV) reduced to 51.3% in the period, driven by increasing investment property values in sterling. The average maturity of the debt was 3.6 years at end-H119, slightly down from 4.0 years at end-FY18. Debt maturities by the end of 2019 amount to £46m and £205m by end 2021. Management is currently engaged in extending £122m of facilities, including the near-term maturities

The transition of secured debt facilities towards a rouble/euro blend, better matching the revenue base, continued to make progress and the company expects to hold no US dollar-denominated debt by the end of the current year. By the end of H119, US dollar-denominated debt had fallen to 11% of the total compared with 34% at end-FY18 and 92% at end-FY17. Management expects its current refinancing plans to lead to the conversion of a further 8% of debt into roubles and the transition to rouble borrowing will likely accelerate if Russian borrowing rates reduce further.

The repurchase by the company of 89.1m ordinary shares (14.8% of the outstanding) from funds managed by Woodford Investment Management (72.1m/12%) and Invesco Asset Management (17.0m/2.8%) was completed on 21 August following approval at the EGM. The shares were acquired using the company’s existing cash resources for 36p per share, a significant discount to net asset value, and were immediately cancelled. Applied to the end-FY19 balance sheet, the effect would be to lift NAV per share of 67p to a pro forma 72p. In addition to being materially enhancing to NAV per share, the repurchase removes the perceived stock overhang from the market and we would expect the combination of the two to have a positive impact on share price performance.

Exhibit 7 provides an update on the capital structure and ownership following the repurchase and also the earlier market placing of Woodford Investment Management holdings in convertible and irredeemable preference shares among a wide range of institutional investors.

In addition to the secured debt, Raven is funded by sterling-denominated, fixed-rate, unsecured preference (£99.8m nominal value) and convertible redeemable preference shares (£213.9m nominal excluding own held shares), providing a range of options for investment in the company.

Investors in the ordinary shares are fully exposed to share distributions and NAV movements, and would benefit from a closing of the unusually wide discount of almost 50% to NAV. The capital structure makes basic NAV per share quite sensitive to movements in the portfolio value, as was the case in H119. In addition to the large discount to NAV, our forecast level of distributions represents a 7.5% yield.

The (non-convertible) preference shares earn a cumulative 12% dividend on the fixed issue amount per share of 100p and rank ahead of the ordinary shares. At a price of 133p, the yield is 9.0%.

Finally, the convertible redeemable preference shares rank ahead of the other share classes for distributions, and the cumulative 6.5% preferential dividend on the subscription amount of 100p represents a cash yield of 5.9% on the current price of 110p plus a premium on redemption. 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 1.553 (equivalent to c 71p per ordinary share at the current price).