Bargain shares updates

Shares in Aim-traded property developer and investor Terrace Hill (THG: 27.5p) have surged 78 per cent since early February when I recommended buying at 15.4p and have now hit my 27.5p target price. However, it's still realistic to expect further gains with the trading update at next month's full-year results likely to be very positive. That's partly because the company's risk profile has improved markedly since February, but also reflects the potential for more valuation uplifts in the coming year.

Much improved financial profile

Following a site sale and forward funding agreement for the company's 1,104 unit student accommodation scheme in Southampton, and the disposal of the majority of its remaining residential assets, Terrace Hill's balance sheet gearing was slashed to only 29 per cent at the end of March. The weighted average interest rate on the company's debt is 3.3 per cent, with maturity extending out to 21 months after factoring in loans where the expected terms have been agreed, but not yet documented. So, not only is the loan-to-value ratio comfortable, but the cost of these short-dated lines of credit is attractive. There is scope for further debt reductions, too, as Terrace Hill bought out a joint-venture partner to take ownership of 47 residential assets worth £5.3m, all of which will be sold off on a piecemeal basis.

The obvious implication of this debt reduction programme is to significantly improve the financial risk profile on the company's short-dated borrowings, which was the major reason the shares had been trading on a huge discount to net asset value at the start of this year. But even after the re-rating the share price discount to book value has potential to narrow further, especially as the company has been growing its net assets. In fact, Terrace Hill's net asset value was 29.2p a share at the end of March, up from 28.3p in September 2012, and analysts at brokerage Oriel Securities predict that it hit 31p a share at end-September 2013. On that basis, the shares are trading on a 11 per cent discount to book value.

Sound prospects

In my view, such a discount fails to acknowledge the potential for value creation in Terrace Hill’s remaining commercial property developments, including its food store developments. Since the March half year-end, the company has completed three new food stores comprising 189,265 sq ft of aggregate floor area at Sunderland, Sedgefield and Skelton. Importantly, all were pre-let and forward funded for a total capital value of £64m. This type of funding agreement is sensible as it mitigates financial risk.

In terms of the pipeline, two food stores at Herne Bay, Kent and Middlesbrough, Teesside (totalling 225,000 sq ft) are in the planning process, and a number of others are under contract or are being reviewed. In fact, only last week, Terrace Hill acquired a 5.3 acre site in North Yorkshire to develop a 15,500 sq ft food store. Subject to planning approval, the supermarket will open by Easter 2015.

The company also has a number of other interesting non-foodstore developments including a major one at Howick Place in London's Victoria which has now completed and the majority of the 25,300 sq ft of residential units have been let or sold. There has been a good level of occupier interest in the 135,000 sq ft of office space there, so it will be interesting to see what the latest occupancy rates are at next months results. Terrace Hill is also the development manager of a 29,000 sq ft office and retail development at Conduit Place, Mayfair. Given that capital and rental values in central London continue to rise, expect good news in the results from both of these schemes.

Favourable technical set-up

Having taken out my 27.5p target price, which coincides with the February 2011 high, I now feel that a re-rating of the shares to book value and beyond is not an unrealistic possibility. The 14-day relative strength index (RSI) is not overbought, so offering scope for a continuation of the uptrend, and the share price is not over-extended above its short-term 20-day moving average around 27p either.

Trading on a bid-offer spread of 26.5p to 27.5p, in my view Terrace Hill's shares are still worth buying ahead of the results and I have upgraded my balance sheet derived target price to 32p. The time frame for this trade is three months.

How Simon Thompson's 2013 Bargain Shares Portfolio has performed

On solid foundations

Shares in Inland (INL: 50p) have hit both a six-year high and also my upgraded 50p target price. It also means the share price has risen by 109 per cent since I included the shares in my 2013 Bargain share portfolio.

At the current price the company has a market value of £100m, or around 1.5 times price-to-book value once you factor in the 5p a share of future net profits embedded in its Drayton Gardens residential joint venture in West London. That’s not expensive compared with other listed housebuilders, some of which are valued on two times book value or above.

And with brokerage finnCap expecting pre-tax profits to rise a further 40 per cent to £7m in the current financial year to June 2014, before hitting £9m in 2014-15, the prospective earnings multiple is set to drop from a forward PE ratio of 18 to only 14. That may seem punchy for a housebuilder, but these profit estimates look on the conservative side to me even after factoring in a 25 per cent rise in forecast revenues to £38.8m in the 12 months to June 2014, rising to £59.6m the year after.

Those figures are certainly achievable once you factor in that Inland is on course to ramp up output to 140 residential completions in the current financial year, rising to 235 homes in 2014-15. However, given the strong south east of England bias of the company’s developments, and the strong momentum in the housing market in the region, I see ample scope for these revenue estimates to be beaten as house prices rise. And that would mean earnings upgrades.

I am not being widely optimistic either because the tailwind of the government's Help to Buy mortgage guarantee scheme, the Bank of England's Funding for Lending operations and the benign monetary policy of the Bank of England means that borrowers can realistically expect the low interest rate environment to stay for the next couple of years at least. This can only boost the confidence of homebuyers, support transaction levels and drive house prices higher given the supply-demand imbalance in the market. And if that was not attractive enough, Inland is operating in a sweet spot by targeting the £160,000 to £400,000 range of selling prices, so it is best-placed to reap the greatest upside.

Geared play on property prices

Moreover, as house prices rise, as seems even more likely now given the concerted and blatant efforts of the current government to make the feel-good factor from higher property prices a vote winner come the next general election in May 2015, then land prices will too. That's further good news for Inland because it has a 2,306 plot land bank, located in the London periphery/South East, with average unit sales prices ranging between £160,000 and £330,000. There is also substantial latent value in inventory as planning approval is secured. A rapidly increasing land bank also ensures Inland offers a geared exposure to upward house price movements.

For instance, analyst Duncan Hall calculates that "as a ready reckoner, a 10 per cent house price movement on a £250,000 property could ultimately add £12,000 to a plot value. Across 2,300 plots this equates to £27.6m, or 13.7p a share to net asset value."

In other words, even if property prices rise modestly over the next 18 months, Inland shares are probably only trading inline with their book value as of June 2015 once you mark the land bank to market value. And if house prices rise at a faster rate, then this would have quite a dramatic effect on the value of Inland’s land bank and in turn its net asset value.

In the circumstances, and ahead of what is likely to be a positive update on trading at the annual meeting on Wednesday, 27 November, and with the favourable first quarter period for house builders just round the corner, I have decided to upgrade my fair value target from 50p to 60p. Trading on a bid offer spread of 49p to 50p, I continue to rate Inland shares a buy.

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