A speedy resolution to the crisis is the best solution, albeit one that you would not bet upon with any degree of confidence. In the meantime, risk aversion has increased sharply for Russian stocks listed on overseas markets as all companies have been dragged down. However, this has thrown up some value opportunities as I highlighted yesterday (‘Undervalued Russian value play’, 10 March 2014) in my article on Aim-traded investment company Aurora Russia (AURR: 23.5p).
Another company that offers clear value is property company Raven Russia (RUS: 76p), an old favourite of mine and one large enough (market capitalisation of £565m) to be on the reserve list as a constituent of the FTSE 250 index. I first recommended buying the shares at 69.3p a year ago ('A major buy signal beckons', 11 Mar 2013), since when we have banked some decent dividends distributed through a tender offer process. And there have been capital gains too as the shares hit a multi-year high of 86.5p at the start of the year, prior to the sell-off prompted by events in Ukraine. That high was just shy of my 90p fair value target set when I updated the investment case three months ago (‘Cash in on a Russian property play’, 26 November 2013).
It is understandable that some investors have been banking profits, unnerved by the geo-political risk, but what can not be in any doubt is the strong operational progress being made by Raven Russia. Demand in the warehouse and logistics market in Moscow remains as strong as ever due to an under-supply of property and vacancy rates are below 1 per cent. As a result, demand in Raven Russia's portfolio is robust. In yesterday’s full-year results announcement, Raven Russia confirmed that 97 per cent of its 1.4m square metres portfolio of Grade 'A' warehouses in Moscow, St Petersburg, Rostov-on-Don and Novosibirsk is let out. In aggregate, this space currently generates an annualised net operating income (NOI) of $192m (£115m), including pre-lets.
Visibility on how the rent roll will grow is pretty good too. For instance, Raven Russia has signed a 15-year lease with Dixy, the large Russian supermarket operator, for 39,284 square metres of new-build space at the next phase of the company's Noginsk project in Moscow. Construction starts shortly and the building is due to be delivered in the first quarter of 2015. The build cost is around $48m and total income of $8.5m a year is expected. The 17.7 per cent rental yield on the property, which is well above the 11 per cent prime yield in Moscow, reflects a higher rental rate due to the specification of the building. As a result, the potential annualised NOI around $207m across Raven Russia's portfolio, a level likely to be achieved by the end of 2015.
It should increase further because Raven Russia can add between 50,000 and 100,000 square metres of new space each year simply by building on existing land holdings. Assuming a rental of $130 per square metre, every 100,000 square metres of new space adds $13m to NOI given that fixed overheads are already covered. It’s worth extrapolating this as analyst Ian Wild at brokerage N+1 Singer has done, noting that Raven Russia owns permitted land with "the potential to expand its Moscow portfolio by 38 per cent providing an additional $48m of NOI and significant earnings enhancement post financing costs."
It’s also reassuring that sales in the owner occupier logistics property market are very supportive of further growth in Raven Russia’s portfolio. Indeed, according to commercial property experts, over 300,000 square metres of space was sold in Moscow last year at an estimated price range of between $1250 and $1300 per square metre.
But as I pointed out the geo-political back drop introduces added risk to an investment despite the strong fundamentals underpinning the operation. It therefore pays to drill down to see how Raven Russia’s board have de-risked their business.
Sound funding
Firstly, it is comforting to know that the board are maintaining a high level of free cash. Cash on the balance sheet is currently $229m, up from $201m at the December year-end. To put this into some perspective, Raven Russia has gross borrowings of $815m on its $1.75bn investment and development portfolio with an average term to maturity of 4.7 years and a weighted average cost of 7.24 per cent per year. Importantly, only $37m of this debt pile is scheduled for renewals in the next 12 months.
Indeed, according to analyst Conor Fahy at broking house Equity Development , over half Raven Russia’s debts have maturity dates of between three to eight years, and a further fifth have maturity dates of between eight to 10 years. Also, the $75m of annual finance costs on loans this year is well covered by annual NOI of $198m according to brokerage N+1 Singer, while the free cash can be redeployed to invest in new projects. In addition, less than 60,000 square metres of the portfolio is due for renewal/break clauses in the next year.
That said, clearly if the Russian crisis escalates there is potential for contagion in the Russian banking crisis and this would make obtaining funding lines harder for all property companies. It would undoubtedly have implications on investment demand for Russian property and negatively impact property valuations. And if the EU and the US decide to impose sanctions against Russia, there would also be an economic impact, the most obvious implication of which would be to subdue rental demand if Russian companies become more cautious.
It’s worth pointing out too that retailers account for 30 per cent of Raven Russia's clients so is a key sector for the company’s warehouses. It’s therefore worth bearing in mind the impact of a weak Rouble on consumer demand and the level of rents that can be achieved. That’s because although Raven Russia’s rental income is received in Roubles, it is pegged to the US dollar which has been appreciating against the Russian currency all this year. So in effect the exchange rate risk is being passed onto tenants. Clearly, this is good news for Raven Russia as the company is using its tenants to hedge the currency risk, but the flipside is that sustained Rouble weakness will ultimately impact tenants and demand for space.
For now though retail sales remain strong and "it’s business as usual" according to Raven Russia’s chairman Richard Jewson. Still, it’s worth acknowledging these risk factors when considering the investment merits of the company. On that score the positives outweigh the negatives in my view.
Highly-profitable portfolio
For starters, with demand strong in an under-supplied market, and property developers generating bumper rents for prime space in Moscow, then Raven Russia's profits have been rising sharply.
Last year, Raven Russia’s underlying pre-tax profit doubled to $69.9m and net cash generated from operations surged from $130m to $192m. True, fully diluted book value per share only edged up by 1¢ to 126¢, or 75p a share, but this reflects the conversion of an expensive preference share issue into equity. That made sense because by converting the preference shares to ordinaries, Raven Russia no longer needs to hold such high reserves of cash ($181m or 14.2p per share pro forma according to analysts at Equity Development) to cover the preference dividend, so freeing up cash for further investment.
Furthermore, with NOI rising, then analysts at N+1 Singer predict Raven Russia will be able to lift recurring EPS by 10 per cent to 11.2¢ this year which would easily cover a dividend of 5.5p a share through a tender offer process. The board have just declared a 5p payout for 2013, a 33 per cent rise on the previous year. On this basis, the historic yield is 6.7 per cent, rising to 7.2 per cent this year.
In turn with profits rising, N+1 Singer forecast an 8 per cent increase in book value per share to 135¢ by the December year-end, rising to 147¢ a year later. That’s the equivalent of 81p a share at current exchange rates, increasing to 88p a share in December 2015.
Target price
In my opinion, not only do Raven Russia shares offer an enticing prospective yield of 7.2 per cent for 2014, but they are trading on an unwarranted forward discount to book value even though we can realistically expect further valuation uplifts as new space comes on stream and the remaining low levels of vacant space is let out. Needless to say I continue to rate the shares a buy on a bid-offer spread of 75p to 76p and maintain a 90p a share fair value target price, albeit it is now only likely to be achieved once the Ukranian crisis resolves itself and the elevated risk premium embedded in Raven Russia share price normalises.
Please note that I am currently working my way through a large number of announcements from companies on my watchlist and which I plan to update. These include: LMS Capital (LMS), BP Marsh Partners (BPM), Eros (NYSE: EROS), First Property (FPO), Trading Emissions (TRE), Polo Resources (POL), Global Energy Development (GED) and Pure Wafer (PUR).
