I have good reason to because shares in the company have risen by 25 per cent since I advised buying them at 198p at this time last year ('A high yield play in the north', 18 Feb 2013). As a result they have hit my target price range of 250p to 255p, so I need to decide whether to run with the holding.
Bearing this in mind, one of the key attractions for me when I recommended buying the shares a year ago was a solid and pretty decent dividend. I have not been disappointed on that front because we subsequently banked a half-year payout of 3.1p a share last summer and a final payout of 7.34p last month. Combined, that gives a rolling annual dividend of 10.44p a share, covered by underlying EPS of 13.7p, to produce a current yield of 4.1 per cent.
It’s a dividend that’s safe too because the Ziff family, which controls almost 80 per cent of the shares, have a vested interest in adopting a progressive dividend policy. True, the limited free float means that some investors may be disinclined to invest due to the reduced liquidity. However, the interests of chairman and chief executive Edward Ziff, who controls 47.8 per cent of the issued share capital, and his brother, Michael, who owns a further 31.1 per cent, are clearly aligned with outside investors since the payout has more than doubled in the past decade. That’s because Town Centre Securities is a real-estate investment trust, so is obliged to pay out 90 per cent of the profits of the property rental business, after certain deductions, to shareholders as a Property Income Distribution. That virtually guarantees that the 10.44p a share dividend is safe. Moreover, there is capital growth coming through too.
A geared play on the regional property market
As I anticipated when I last updated the investment case in November (‘Time to make friends up north, 25 November 2013), the company is now generating valuation gains once again from its investment portfolio. In fact, in the latest six-month period to end December 2013, Town Centre booked a £8.2m net valuation gain on its £291m investment property portfolio. This partly reflects a yield compression as the initial yield on the portfolio contracted by 40 basis points to 6.8 per cent in the six month period. It also reflects a £3m investment in the estate which meant that on a like-for-like basis the valuation actually increased by 4 per cent. In addition, the company owns £7.8m of properties held for resale and a development portfolio that’s in the books for £13.7m.
It’s fair to say that the valuation gains are partly down to improved investor sentiment towards UK regional property, a trend that’s likely to continue as investors, playing the UK economic recovery, are now more comfortable seeking out better yielding assets outside of the hot London market. It’s also reasonable to assume that Town Centre’s high yielding portfolio will continue to benefit from this improvement in sentiment and investor demand for regional real estate.
To recap, the company was formed by businessman and philanthropist Israel Arnold Ziff in 1959, and quickly built a reputation for pushing the boundaries with landmark developments. Town Centre is widely acknowledged as a pioneer of the mixed-use property scheme and its investment portfolio now compromises an estate of over 900,000 sq ft of retail space and 360,000 sq ft of prime office space in the UK.
These properties include major retail developments, Merrion Centre in Leeds and Urban Exchange in Manchester. Occupancy rates are very healthy at 98 per cent across the book and tenant quality remains high with 99 per cent of rents collected within five days of the quarter end. Lettings have been pretty good too, with 60 transactions completed in the second half of last year including a number at the Merrion Way retail and leisure development in Leeds which is now 70 per cent let. Other developments in the pipeline include a 600,000 sq ft mixed use development and 128-bedroom hotel at Whitehall Riverside, Leeds. The site has now received planning permission from Leeds City Council to incorporate three eight-story office buildings.
There is also planning consent in place for a 500 space car park which would provide some additional income for the company’s substantial car park business. This operation already generates annual revenues of £5m and £2.5m of underlying pre-tax profits. Combined with rental income of £18m on the investment portfolio and total rents of £23m are highly supportive of the valuation. It also means that once you factor in the effect of gearing, then any further contraction of yields could have a major positive impact on the company’s book value per share.
Understanding how gearing impacts net asset value
To illustrate how the balance sheet gearing effect works in practise it’s important to understand how Town Centre’s funds its £311m property portfolio.
The company currently has borrowings of £158m, including £106m relating to a debenture that runs until 2031 and carries a coupon of 5.375 per cent. Town Centre also has a revolving credit facility of £90m, with three banks, which are not due for renewal until December 2015 and September 2016, so there are no pressing debt issues. In fact, the company has £35m headroom on its facilities to fund further deals. So, with cash on its balance sheet minimal at £2.5m, then in effect the properties have a loan-to-value ratio of around 50 per cent. This means that equity shareholders funds of £150m are roughly half the value of the portfolio.
As a result every £1m increase in the book value of the portfolio adds roughly 1.9p a share to net asset value. This explains why in the second half last year the company’s net asset value rose from 267p to 283p a share on the back of that aforementioned £8.2m valuation gain.
It also explains why analyst Miranda Cockburn at brokerage Oriel Securities has upgraded her June 2014 net asset value forecast from 280p to 290p a share in order to factor in improving investor demand in the regional property market.
But if the initial yield on the company’s portfolio was to contract by a further 40 basis points to 6.4 per cent, for instance, then Town Centre’s net asset value per share would be nearer to 300p. Moreover, that’s without factoring in any gains on trading property or developments which is why I believe that Oriel’s forecasts could be looking quite conservative in a few months time.
It’s worth pointing out that although Town Centre has net debt of around £155m, or 103 per cent of shareholder funds, net rental income of £18.5m covered the £7.7m finance charge on these borrowings more than twice over. That left ample surplus cash available to pay out £3.9m in dividends to shareholders and cover £4.2m of administrative costs to run the company.
Target price
Factoring in the dividend support for the shares with the real possibility of further yield contraction, and the accentuated impact on Town Centre’s book value due to the gearing effect, then it’s only sensible to continue to play the upside with the shares trading 22 per cent below what looks like a very conservative June 2014 net asset value estimate.
Trading on a bid-offer spread of 250p to 255p, I continue to rate Town Centre Securities shares a buy ahead of a pre-close trading statement in mid-May. I have also upgraded my fair value target to 290p.
Finally, shares in broking house WH Ireland (WHI: 113p) have soared 20 per cent this morning to 113p and are closing in on my fair value estimate of 120p. To recap, I advised buying shares in the company no fewer than four times between mid-February and early August at prices ranging from 61p to 65p. I last updated the investment case when the price was 90p a couple of months back (‘Broking for more success’, 19 December 2013).
However, with the company due to report full-year results on Wednesday, 26 February, and the risk to earnings to the upside, as buyers this morning clearly believe, then I would continue to run these bumper profits. I will of course update my view once I have analysed the forthcoming announcement later this week.
