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OPINION

Shares with hidden value

Shares with hidden value
August 12, 2013
Shares with hidden value
IC TIP: Buy at 22.5p

I last wrote about the company in November when the price was around 18p. Since then, we have picked up an interim dividend of 0.33p a share, and we are in line for a final payout of 0.75p a share on 27 September. The ex-dividend date is 28 August, so there is still time to buy the shares ahead of that payout. Combined, this gives an annual dividend of 1.08p, so at the current price of 22.5p the shares still offer a decent yield of 4.8 per cent. The payout is also well covered by EPS of 2.2p last year, so looks very safe - especially as currency adjustments understate the true EPS figure by quite some margin. Importantly, the investment case remains attractive enough to warrant buying at these levels.

 

Shrewd management team

To recap, the company is run by a shrewd management team led by chief executive Ben Habib, who made the smart decision to exit UK commercial real estate before the bubble burst and turn the company's attention to Poland, the only country in the European Union that didn't fall into recession during the financial crisis. It proved a sound decision as First Property benefited from the upside on two directly held office properties in Warsaw, one of which has now been sold, as well as the significant funds flowing into the eastern European property market. Investors have done well, too, as First Property's investment performance is ranked number one versus Investment Property Databank's (IPD) Central eastern European universe over the past seven years to 31 December 2012.

However, the eurozone financial and economic crisis clearly changed the dynamics of the eastern European property investment market, which prompted Fprop Opportunities, the company's 76 per cent-owned Polish-focused fund, to make the sensible decision to suspend purchases of properties last year. In fact, there was only one property purchase made by the six closed-end funds managed by First Property in the financial year to end-March 2013.

In aggregate, these funds have £353m assets under management, of which 71 per cent of the properties are located in Poland, and a further 26 per cent in the UK. Still, the Polish commercial property market is starting to improve and Mr Habib expects a number of Polish deals to complete over the next few months, which will produce some positive newsflow.

Equally promising is last month's news that First Property splashed out £3.4m of the £13m cash balance held on its balance sheet buying seven largely vacant offices, one in Bracknell in the Thames Valley and the others in Old Woking, Surrey, which it plans to convert into housing. This looks a sensible deal, priced at only £62 per sq ft, since the company is exploiting the oversupply of offices in the regions in order to sell these properties as residential units into what is a buoyant housing market. The move also puts to good use the company's cash, especially as its UK Pension Portfolio fund is now fully invested and has £90m of assets under management, mainly retail warehousing and properties in the retail sector. That fund is producing an ungeared return of 6.45 per cent and has a minuscule vacancy rate of 0.6 per cent. This produces useful fee income as does First Properties' USS Fprop Managed Property Fund, which has £224m of property under management in Poland. The fee income from these funds aside, there is value in First Property's balance sheet.

 

Hidden value in the balance sheet

First Property has one remaining directly owned property holding, Blue Tower, an office tower in the central business district of Warsaw, in which it has a 28 per cent interest. It has proved a shrewd investment, rising by 52 per cent in value from $12.9m (£8.3m) in December 2008 to $19.5m at the end of March this year. The property contributed pre-tax profits of £962,000 last financial year to the company, or around a quarter of group profits.

Interestingly, First Property conservatively holds Blue Tower at cost in its accounts, which means that the net asset value of the company - £18.5m at the end of March, or 14.4p a share - understates its true worth. In fact, mark the Warsaw property to market value and First Property's net asset value rises a further 3.3p to 17.7p a share. Not that the company is looking to sell the property.

In fact, Mr Habib is looking to increase the company's interest as, and when, the opportunity arises, which is a clear indication of the improved outlook for the Polish property market since the dark times last year when it was being shunned by investors. As Mr Habib rightly points out: "Poland's faster rate of economic growth and the higher yields available in its investment property market, should result in Polish commercial property continuing to deliver attractive rates of return." The economic backdrop is certainly supportive as GDP is expected to be around 1.2 per cent this year, before picking up again in 2014 to over 2 per cent, according to economists. That would leave Poland at the top of EU member countries. Interest rates in Poland are also likely to remain low for some time yet.

It's also worth noting that First Property values its interests in all the funds at cost. However, if these were marked to market value the carrying value of these investments would be over £11m, rather than the £8m stated in the company's latest accounts. The additional £3m equates to 2.3p a share, and means that when combined with the hidden value of the Blue Tower Property, the company's net asset value is actually around 20p a share, rather than the 14.4p stated in the accounts. In other words, the current share price is 90 per cent backed by property assets and investments, which leaves a highly profitable fund management business virtually in the price for nothing.

 

Anomalous valuation

This valuation is even more anomalous when you consider that the only reason the company's pre-tax profits fell from £3.97m to £3.54m last financial year was the weaker euro, which wiped £228,000 off the bottom line, whereas in the prior year the company benefited from a £213,000 currency gain. Adjust for these and even though the eastern European property market was subdued, and transaction activity was minuscule, First Property still managed to maintain underlying profits. That's reassuring for income investors because the combination of management fee income and net rents on directly held properties means the substantial dividend is safe even when activity is low.

It also explains why First Property's shares have performed relatively well, rising by 25 per cent since last autumn when I last highlighted the investment case. The chart set-up is also positive and the share price looks on its way to target the 24.8p high that capped progress in the summer of 2008 and 2011. A move above this level would be very significant and would open up the possibility of a return to the 2000 high of 29.5p.

Trading on 10 times earnings and yielding almost 5 per cent, I continue to rate First Property a decent medium-term buy on a bid-offer spread of 21p to 22.5p. My medium-term target price is 27.5p.

 

Land ahoy

I have been in the fortunate position for the best part of 18 months of being able to report updates on a continuous stream of profitable investments. Hopefully, many of you will have followed some of these and will have benefited, too.

One of the winners is Aim-traded investment company Crystal Amber (CRS: 139p). Shares in the company have rocketed in the past eight months and are now 43 per cent ahead of my buy-in price of 97.25p ('Small-caps to buy now', 3 December 2012). That's a 2 per cent premium to end-July 2013 net asset value and represents a major re-rating of the shares as they were trading on a deep 17 per cent discount to book value in early December. This is partly down to the strong performance of the company's investment fund, but is also down to a share buyback programme that has resulted in the company buying back almost 8 per cent of its share capital to narrow the share price discount. It has clearly worked and at this level the shares are more a play on general market moves given that the discount to net asset value has completely disappeared.

The hefty gains made in Crystal Amber are just as well because one of the other shares I recommended at the time, Aim-traded Plymouth marina and property company Sutton Harbour (SUH: 26p), have endured a turbulent passage. Crystal Amber still has 8 per cent of its net asset value invested in Sutton Harbour so it is a major holding for the company, too. The good news is that Sutton Harbour's share price now looks set fair and could be making waves if the recent run of upbeat news continues.

 

Positive developments

In fact, in the past few weeks the company has reported a number of positive developments, including the reopening of the Heritage Trail, new lettings and the opening of a real food kitchen. In my opinion, these can only raise interest in and the profile of the company's Sutton Harbour site and are clearly positive for attracting new business from the service sector in the Plymouth area. It will also help give chartered surveyors confidence in the underlying value of the company's property assets when the company next reports results.

That's important because it was an incredibly cautious valuation of the company's property by a new firm of surveyors, DTZ, that sent the shares tumbling earlier this year. The surveyors used a bumper net initial yield of 8.64 per cent to value Sutton Harbour's properties at the end of September, and applied a 9.12 per cent yield at the end of March in the full-year revaluation. As a result, the company's net asset value has fallen from 43p to 38p a share, reflecting a £6.2m valuation decline, or around 12 per cent.

Importantly, this cautious valuation does not reflect any marked change in marina occupancy rates, which is good news as the company's King Point Marina, in the Millbay regeneration area of Plymouth, completes next month. King Point has a 171-berth capacity for vessels between five and 25 metres in length.

Understandably, investors have been spooked by the property downgrade. But even if we accept DTZ's conservative valuation, Sutton Harbour's shares, at 26p, are still trading a hefty 32 per cent below book value of 38p - and that's assuming the aforementioned 5p a share of value has been lost forever, which is hardly realistic.

 

Extreme undervaluation

If anything, the undervaluation is even more extreme now than six months ago after local government secretary Eric Pickles dismissed a planning appeal last week by developer Wharfside Regeneration for a £150m mixed-use scheme for Plymouth's Derriford Hospital site.

Sutton Harbour Holdings has already outlined its own proposal to develop the 113-acre former Plymouth Airport site, also in Derriford. The dismissal of the Wharfside appeal effectively supports a report published earlier in the year by planning inspector David Nicholson, which ruled that the scheme could stifle investment in a district centre for Derriford and suppress economic growth. Moreover, it adds further weight to the indicative plans Sutton produced to develop the former Plymouth Airport site. The local council has stated that it wants to create a sustainable mixed-use urban centre at the heart of the North of Plymouth. Sutton Harbour's plans encompass a business park, education facilities, new district centre, commercial and retail units, hotel and housing. The former Plymouth airport site is in Sutton Harbour's books at only £11.5m, or around £100,000 per acre, a bargain price if the development gets the go ahead.

That site offers long-term upside to Sutton Harbour shares, while the improving property market and potential to add value through selected developments offers scope for the share price discount to narrow in the medium term. Other investors have clearly noted these announcements too as Sutton Harbour shares, which have oscillated in the 20p-26.75p range since April, are now rising back towards the top of the range. If the run of good news continues, a breakout could be on the cards. Trading on a bid-offer spread of 24.5p to 26p, I rate the shares a medium-term value buy.

 

Finally, my next article will appear on our website on Wednesday 14 August. Please note that I published three articles last week: 'Secrets to successful stock picking'; 'Taking profits'. and Get ready for lift off.