From my perspective, I always maintain a watchlist of companies and ascertain fair value for these companies so that I can exploit buying opportunities as and when markets go through correction phases. I also keep a close eye on companies that are showing relative strength during these down periods for the simple fact that it is an indicator that their bull-runs are very strong indeed.
With this in mind, shares in one of the companies on my watchlist, Aim-traded property fund manager First Property Group (FPO: 30.5p) have hit an 18-year high and also my 30p target price. It’s therefore a good time to revisit the investment case and ascertain whether the current relative strength is an indicator of further gains to come.
On solid foundations
To recap, I advised buying shares in First Property Group three years ago in my 2011 Bargain share portfolio when the price was 18.5p and I have been positive ever since. Having locked into a 5.8 per cent dividend yield at the time, an annual payout of 1.08p a share has provided a steady income stream and even at the current price of 29.5p, the yield is still attractive at around 3.5 per cent. Importantly, that payout was well covered by EPS of 2.3p in the 12 months to March 2013, and with EPS set to double to 4.7p in the financial year to March 2014, the final dividend of 0.75p is safe, too.
One of the reasons the company has been attracting more attention is down to its move into residential property which has been generating bumper profits. For instance, First Property achieved almost £3.9m of profit on an investment of £3.4m in little over six months last year by acquiring office properties in Woking and Bracknell in the Thames corridor, subsequently gaining planning permission for change to residential use and then selling them on.
This highlights the entrepreneurial skill of chief executive Ben Habib and his management team. It also augurs rather well for the earnings potential from the partnership First Property formed with clients to invest in office buildings in the UK with a view to converting these to residential use. The partnership, Fprop PDR, which is closed ended, has a life until May 2018. Clients have committed £39m to the venture and First Property has invested a further £2m of the equity raised. The company will manage the partnership, but will not levy any fees for its services. Instead it will be paid 20 per cent of the profits earned, subject to claw back in the event of losses. In today's trading statement ahead of results on 3 June, First Property revealed that so far two offices in Birmingham and Camberley, Surrey have been purchased for a total consideration of just shy of £5m, another three worth £9m are are in the process of being purchased and I understand additional properties worth £8m are currently under offer.
True, it would be unreasonable to expect the fund to generate anything like the bumper returns First Property achieved last year on its Thames corridor properties, but it doesn't need to in order to generate bumper returns. In fact, at a more normal development margin of 25 per cent on costs, First Property's profit share could be substantial.
Scope for earnings upgrades
I also like the fact that there is obvious scope for earnings upgrades as the year progresses. Buoyed by those bumper gains, analyst Chris Thomas at Arden Partners predicts that First Property will have made full-year pre-tax profits of £6.5m and EPS of 2.6p in the financial year to March 2014, up from £3.5m and 2.3p, respectively, in the prior year. For the current financial year to March 2015, Mr Thomas expects pre-tax profits of £4.5m and EPS of 2.7p, but this doesn't factor in any significant profits from Fprop PDR, leaving scope for the company to beat expectations.
Moreover, factoring in the proceeds from property sales, I estimate cash on First Property's balance sheet is now around £13m, around half of which is held by Fprop Opportunities, the company's 76 per cent-owned Polish-focused fund. This means that First Property has the funds available to build up a replacement income stream through its UK residential activities and property acquisitions in Poland to replace the income earned on its USS Fprop Managed Property Fund, which expires in August 2015. Assuming the company can meet its 15 per cent hurdle rate on invested capital, the cash pile should easily generate the fee income needed to replace the £2m of ongoing earnings from the USS fund.
For instance, a few months ago it purchased from USS a multi-let shopping centre in Ostrowiec in Poland which Fprop Opportunities has been managing. Fprop Opportunities acquired the special purpose vehicle that owns the shopping centre for €4.27m (£3.5m) in cash and took on €17.2m of external borrowings. The centre generates a net operating income of €2.1m, implying a healthy 9.5 per cent yield, which means net of interest costs the centre will make a €1.3m annual contribution to First Property's profits.
In my view, this was a low risk way of replacing some of the lost income from USS as well as gaining exposure to an attractive property market on a medium-term basis. In fact, the performance of First Property's funds under management in Poland and in Central Europe are ranked top in the Investment Property Databank (IPD) universe over the past eight years for the region.
Furthermore, with further earnings enhancing purchases more than likely, not only are earnings upgrades realistic as the year progresses, but the dividend is easily covered by recurring income from investment properties even after factoring in the loss of the USS mandate in 2015. For instance, First Property's UK Pension Portfolio fund is fully invested and has £88.5m of assets under management, mainly retail warehousing and properties in the retail sector. That fund is producing an ungeared return of 6.3 per cent and has a minuscule vacancy rate of 0.6 per cent on a portfolio of 21 properties. These have a weighted average unexpired lease term of 10.2 years. In addition, Fprop Opportunities has £21.4m of assets under management consisting of two investments that are generating annual rates of return on equity in excess of 25 per cent.
So although First Property's share price has hit my fair value target price of 30p, I still believe that there is scope for the rerating to continue given they only trade on 11 times current year EPS estimates of 2.7p, and offer a solid 3.5 per cent dividend yield. Add to that scope for upgrades to earnings from Fprop PDR and additional property acquisitions in Poland, and it's reasonable to expect the shares to make further headway. On a bid-offer spread of 29.5p to 30.5p, I rate First Property shares a decent income buy and have upgraded my target price to 35p.
A land of opportunity
It's decision time if you followed my advice to buy shares in London-listed property developer Macau Property Opportunities (MPO: 245p), the closed-end investment fund. Following a sensational set of full-year results when the company lifted underlying net asset value per share by a quarter to $4.95, or 299p, the board are making a 21.1p a share capital distribution to shareholders, equating to a £17.5m cash return.
Following approval at this month's EGM, shareholders on the register at close of trading on Monday, 14 April 2014 will receive one new 'B' share for every ordinary share held. Capital will then be returned through redemption of the 'B' shares, the payment of a dividend in respect of the 'B' shares or a combination of both. The payments will be made on 29 April and you have until 1pm on 14 April to choose which option to take.
The choice is simple: if you wish the capital return to be treated as income for UK tax purposes then opt for the dividend option; alternatively if you wish the return to be treated as capital for UK tax purposes then opt for the redemption of the 'B' shares. You can of course opt for a combination of the two. There is a safety net as the default option is a capital redemption of the 'B' shares, so only if you wish to take the dividend option for all or part of your holding do you need to fill out the dividend declaration form.
The bumper cash return is further good news if you bought the shares at 177p ('Far eastern delight', 6 September 2013). I last updated the company post results when the price had risen to an all-time high of 240p (‘Land of opportunity’, 5 March 2014). Adjusting for the cash return my new target range is 254p to 269p, and I continue to rate the shares a buy.
A crystal clear investment
First Property and Macau Property are not the only companies that have been smashing through my target prices. Shares in double glazing company Safestyle UK (SFE: 200p) have now hit my 200p target and are up around 50 per cent since I initiated coverage just before Christmas ('Window of opportunity', 23 December 2013).
Boasting a 7.85 per cent market share of the replacement window market, and having undertaken installed 250,000 frames last year, the company is the largest retailer and make of uPVC windows and doors for the UK homeowner replacement market. It has also been growing strongly, having increased its market share for nine consecutive years.
Moreover, with volumes up seven per cent last year and average unit prices 5.5 per cent ahead, this fuelled a 13 per cent increase in full-year revenues to £125m, or £2823 per order. Part of the reason for this outperformance of rivals is down to the fact that the company is the lowest cost national retailer and maker of uPVC windows and doors, so has a cost advantage over smaller firms. It also has the advantage of being able to target market its audience in a more focused and cost efficient way given its greater scale.
Sensibly Safestyle has also been expanding into the affluent south and south east market which has been benefiting the most from the property boom and the ongoing UK economic recovery. The strategy is clearly working as margins remain robust and with volumes and prices on the rise, analysts expect another year of double digit profit growth. Post results, Toby Thorington at Edison upgraded his current year EPS estimates by 9 per cent and ratcheted up his 2015 numbers by a hefty 17 per cent. On this basis, expect current year EPS of 15.7p, rising to 17.4p in 2015. Furthermore, with the benefit of a cash-rich balance sheet and robust cash generation, the 5.5p a share final payout (ex-dividend of 18 June), is forecast to rise to 8.7p in 2014 and 9.7p in 2015.
So although Safestyle shares have performed very well, a prospective PE ratio of 13 doesn't seem that steep for a business in an earnings' upgrade cycle and one where the share price is well supported by a 4.2 per cent prospective dividend yield. As a result I am upgrading my fair value target price to 230p, or the equivalent of 13 times 2015 EPS estimates. On a bid offer spread of 197p to 200p, the shares rate a buy.
Please note that I am working my way through a long list of companies on my watchlist that have reported results or made announcements recently. These include: IQE (IQE), Pure Wafer (PUR), LMS Capital (LMS), Communisis (CMS), Eros (EROS), Inland (INL), Sutton Harbour (SUH), Netplay TV (NPT), API (API) and Record (REC).
