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OPINION

Homing in on a break-out

Homing in on a break-out
June 3, 2014
Homing in on a break-out
IC TIP: Buy at 46.5p

For good measure the share price is no longer extended above the 20-day moving average. In fact, both the 20-day and 200-day moving averages are now around the 46p level, offering strong support for an overdue break-out to the upside above the top of the current trading range. From a technical perspective, the 14-day relative strength indicator (RSI) is showing a reading in the mid fifties so is not overbought and offers scope for the share price to make further gains to the upside.

The fundamental case certainly supports a break-out to my 60p fair value target price. In the first half to end December 2013, the company increased operating profits by 26 per cent to £4m on revenues of £12.8m. Moreover, underpinned by a strong development pipeline and a record forward order book of reserved or contracted sales of £47.1m, analyst Duncan Hall at brokerage finnCap predicts revenues will surge from £31.1m in fiscal 2013 to £44.3m for the 12 months to end June 2014. On this basis, expect a 60 per cent rise in both pre-tax profits and EPS to £8.1m and 3.2p, respectively.

But that only tells part of the story as markets are forward looking and the 141 residential completions in the financial year just ending are already in the price. More important is the 270 forecast completions in the 2014/15 fiscal year, which are expected to boost revenues by a further 47 per cent to £65m, lift pre-tax profits to £10m and generate EPS of 3.9p. On this basis, Inland's shares are trading on a modest 12 times prospective earnings. In addition, finnCap are pencilling in a 85 per cent hike in the annual dividend to 0.5p at the forthcoming full-year results, rising to 0.7p a share next year. The respective dividend yields are 1.1 per cent, rising to 1.5 per cent.

A substantial land bank

But even this predicted bumper performance does not reveal the full impact on Inland of the current housing boom. That's because under the leadership of chief executive Stephen Wicks the company has built up a substantial land bank of 3,565 plots, up from 2,306 plots a year ago. Of these just under 1,000 plots are owned with planning consent (including those managed on behalf of the Drayton Garden Village (DGV) joint venture in West London); a further 843 plots are owned/contracted without consent; and around half the land bank are controlled or terms agreed without consent. There is clearly substantial value in this land bank especially as the land is held in the books at cost.

To put the potential value into some perspective, Inland has just exchanged contracts for the purchase of a site at Southampton and entered into options over two sites in Little Chalfont and Holmer Green, both of which are in Buckinghamshire. These three sites have the potential for 620 plots. The seven acre site at Southampton is the home of the former Meridian television studio, located to the east of the city centre and fronting the River Itchen. It was purchased from West Register, which is part of The Royal Bank of Scotland.

Inland plans to create a residential development on the site, comprising up to 350 residential units along with some commercial space, with a planning application anticipated to be submitted in the second half of this year. Consideration has been agreed in a phased manner, with an initial payment of approximately 7.5 per cent of the total paid on exchange of contracts. I understand that the initial payment was less than £500,000 to secure the site pre-planning, implying a total payment of around £6.7m for the Southampton site as a whole, or the equivalent of around £20,000 per plot. True, the company still needs to gain full residential planning permission on the site, but assuming this is achieved then Inland will make a substantial paper profit even before development work commences.

In addition, Inland intends to seek planning permission for up to 200 residential units at Little Chalfont and up to 90 residential units on the nine acre site at Holmer Green. The combined gross development value (GDV) of all three sites is around £115m. In terms of the profit potential, Inland generated a gross margin of 31 per cent on sales in the first half of the current financial year, so the likely gross profits on a GDV of £115m could be substantial. It also means that the company has the option of selling these sites with planning permission to major housebuilders in order to crystallise the gains in due course. It’s something Inland has been adept at doing as Mr Hall expects Inland will have sold around 250 plots in the year to end June 2014.

It's equally possible that Inland will keep these sites for itself since it has been enjoying a roaring success on its developments. Currently, the company is developing eight sites and 486 plots including DGV. Of particular note has been the site at Ashford Hospital (now known as West Plaza). Following strong interest from investors and homebuyers, two thirds of the 152 apartments have been contracted or reserved prior to any homes being completed. Projected revenue from this project alone is likely to be in excess of £31m.

Funded for growth

Importantly, Inland has a strong enough balance sheet to continue the roll-out of its development pipeline, thus underpinning the aforementioned bumper profit forecasts. At the end of December, the company had cash balances of £8.9m after factoring in inventory growth of £22m in the six month period. Factoring in the £10m issue of zero dividend preference shares, net debt was £14.7m or the equivalent of only 24 per cent of shareholder funds of £60.8m.

True, trade payables shot up from £3.5m to £17.5m in the six months to end December, but this reflects the increase in inventories from £44.7m to £66.9m in the same period. In any case, Inland also had trade and other receivables of £18.6m, mainly relating to DGV, which will convert into cash. The company has since placed a further 934,500 new zero dividend preference shares raising gross proceeds of £1.1m on a gross redemption yield of 5.57 per cent.

Conservative book value

Although Inland shares trade on a premium of 1.5 times reported book value of 30p a share, this is misleading. That's because the company has a further 2.66p a share of net profits (around £5.4m) embedded in its share from DGV, which can be added to this net asset value figure. In addition, Inland's assets are held at the lower of cost and net realisable value and are not subject to any re-valuation. Integral to the business model is the purchase of brownfield land without planning permission, which will have a significant uplift in value once planning permission is obtained.

For instance, Inland has secured a MoD site, the Defence School of Languages site at Wilton Park, Beaconsfield, encompassing 300 plots for mid/high-end housing. Beaconsfield is a very affluent part of southern England, and this looks an ideal development to replace the income from Drayton Gardens which will be fully developed next year. Inland continues to work closely with the planning authority on finalising the development brief for this project. The brief is expected to be adopted in the coming months, paving the way for a formal planning application to be submitted thereafter.

Therefore, as planning permission is gained on more sites, then Inland's book value per share becomes even more conservative. It's also worth flagging up that there is a natural gearing effect of rising house prices on profits embedded in the company's land bank. As a rule of thumb, every 10 per cent rise in land prices adds around 14p a share to Inland's net asset value based on around 200m shares in issue. That's a significant sum considering that the company's reported net asset value is 32.7p including the net profits set to flow through from DGV in the next year or so.

Or put it another way, a 10 per cent movement in land prices between now and the end of June 2015, combined with 1.84p a share of EPS earned in the past six months, and a further 3.9p a share forecast in the coming 12 months, implies that Inland's net asset value could easily rise to well over 50p by June 2015. And that's after accounting for total dividend payments of 1.2p a share.

So, Inland shares are realistically trading on a discount to 12-month forward book value, a valuation that could attract predatory interest from larger rivals unless the shares are re-rated. In the circumstances, I have no hesitation reiterating my buy advice with the shares priced on a bid-offer spread of 46p to 46.5p. Ahead of a likely chart break-out above the 51p resistance level, and offering 29 per cent share price upside to my year-end target price of 60p, the shares are well worth buying.

■ Simon Thompson's new book Stock Picking for Profit can be purchased online at www.ypdbooks.com, or by telephoning YPDBooks on 01904 431 213 and is being sold through no other source. It is priced at £14.99, plus £2.75 postage and packaging. Simon has published an article outlining the content: 'Secrets to successful stock-picking'