The UK-listed property sector cannot, as a whole, boast a long-term record of value creation - the 2009 round of rescue rights issues put paid to that. But there are a few exceptions, the largest of which is Derwent London (DLN). The only real-estate investment trust to have grown in value since its pre-crisis peak, Derwent redevelops offices in gentrifying pockets of London like Fitzrovia and Shoreditch. This highly profitable business model should outlast current fears about the 'tapering' of today's ultra-loose monetary policy, which have depressed its share price since the spring.
- Booming London office market
- Exposure to geographical sweet spots
- Major development programme
- Superb track record
- Rising interest rates could sap valuation growth
- Shares trade at premium to book value
Derwent has been helped in its rapid recovery from the 2008 crash by the remarkable flexibility of the London economy. Office employment in central and inner London has already returned to within spitting distance of its previous peak of just under 1.2m. True, some 6,000 jobs have been lost in financial and professional services, and a further 12,000 in the public sector. Yet these have been partly replaced by 11,000 new jobs in technology, media and telecoms.
This reshaping of the London employment market has been a huge, somewhat unexpected, boon for Derwent because firms in these sectors tend to eschew the corporate City and West End cores in favour of the trendier fringe areas where its portfolio is concentrated. Its style of building - unlike most developers, Derwent can claim to manufacture a distinctive brand of office, heavy on exposed concrete, airy atria and design detail - also appeals to creative types.
The company's record of attracting tenants bears this out. Its first-half results were dominated by a major leasing deal with Publicis. The French advertising giant, which currently houses its subsidiary Saatchi & Saatchi in a 1960s Derwent building on Charlotte Street, Fitzrovia, agreed to rent two of the company's current developments, one at 40 Chancery Lane and the other next to the new Farringdon Crossrail station. Having paid £4.3m a year for Charlotte St, Publicis will now shell out £8.8m a year for a minimum of 18 years. Charlotte St will in turn become a major refurbishment project for Derwent - the capital expenditure more than justified by the higher rents now achievable in Fitzrovia.
DERWENT LONDON (DLN) | ||||
|---|---|---|---|---|
| ORD PRICE: | 2,287p | MARKET VALUE: | £2.3bn | |
| TOUCH: | 2,286-2,289p | 12-MONTH HIGH: | 2,550p | LOW: 1,904p |
| FWD DIVIDEND YIELD: | 1.6% | TRADING PROP: | £11.2m | |
| DISCOUNT TO FWD NAV: | -3% | |||
| INVESTMENT PROP: | £2.89bn | NET DEBT: | 44% | |
| Year to 31 Dec | Net asset value (p) | Pre-tax profit (£m) | Earnings per share (p) | Dividend per share (p) |
|---|---|---|---|---|
| 2010 | 1,432 | 356 | 342 | 29.0 |
| 2011 | 1,636 | 233 | 225 | 31.4 |
| 2012 | 1,824 | 228 | 223 | 33.7 |
| 2013* | 2,156 | 393 | 378 | 35.9 |
| 2014* | 2,356 | 249 | 237 | 37.0 |
| % change | +9 | -37 | -37 | +3 |
Normal market size: 1,000 Matched bargain trading Beta: 1.0 *Investec Securities forecasts | ||||
The Publicis deal helped boost the valuation of Derwent's development portfolio by a quarter during the half. This drove adjusted book value 8.9 per cent higher to 2,054p - a growth rate most property companies would struggle to achieve in a whole year. It is high even by Derwent's standards, but not outrageously so - the company has posted double-digit book-value growth each year since 2010. Broker Investec believes adjusted book value will reach a minimum of 2,206p by December, rising to 2,406p at the end of 2014.
So what could knock Derwent off its roll? One threat weighing on the whole sector is the prospect of rising bond yields. Because the appeal of property as an investment is the yield premium it offers over bonds, rising rates will make it relatively less attractive. This is particularly true of London offices, which offer a tighter yield premium over bonds. Derwent's shares have consequently fallen from an all-time high of 2,550p in May.
Yet any normalisation in the interest-rate environment should be accompanied by improvements in the economy, which will translate into rental growth. Rents for new West-End offices are currently at £97.50 per square foot, according to broker Jones Lang LaSalle - still well below the 2007 peak of just over £115. Companies remain cautious about taking on big commitments, and office take-up last year was considerably lower than 2004-08 levels. This is not a market near its peak.
