To recap, I advised buying shares three years ago in my 2011 Bargain share portfolio when the price was 18.5p and I have remained positive ever since. I have had good reason too because three annual payouts of 1.08p a share have provided a steady income stream and have helped to generate a 82 per cent total return on the holding.
Moreover, at the current offer price of 31.5p, the dividend yield is still attractive at around 3.6 per cent based on the recently raised payout of 1.12p for the financial year to March 2014. It’s not too late to bank the latest dividend as the final payout of 0.75p a share is payable on Thursday, 25 September and the shares go ex-dividend on Wednesday 20 August.
It’s also clear from the latest set of results that the dividend is safe. As expected the company delivered bumper pre-tax profits of £6.6m in the 12 months to March 2014, up from £3.5m in the prior financial year. The profit surge was mainly down to some very shrewd property investments. For instance, First Property achieved almost £3.9m of profit on an investment of £3.4m in only six months 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.
Exciting profit potential from new fund
These opportunistic property purchases augur well for the earnings potential from the partnership First Property formed last autumn with clients to invest in office buildings in the UK with a view to converting these to residential use. The closed-ended partnership, Fprop PDR, has a life until May 2018. Clients committed £39m to the venture and First Property invested £2m of the equity raised. To date, Fprop PDR has acquired seven properties with a total value of £22m and has one further property under offer at a purchase price of around £8m. Completed deals include two offices in Birmingham and Camberley, Surrey for a total consideration of just under £5m.
To give you some idea of the profit potential from the partnership over the coming years, instead of levying management fees for its services, First Property will be paid 20 per cent of the profits earned, subject to claw back in the event of losses. So based on a normal development margin of 25 per cent on costs, First Property's profit share could easily be several millions of pounds.
It was also clear from the results release that First Property is well on its way to replacing all the lost income from the mandate on its USS Fprop Managed Property Fund, which expires in August 2015. This fund was established eight years ago on behalf of The Universities Superannuation Scheme (USS) to invest in commercial property in the UK and central Europe. It currently generates £2m fees on an annual basis so is material to First Property’s earnings. However, assuming the company can meet its 15 per cent hurdle rate on invested capital, the current £11.3m free cash on the company’s balance sheet should easily generate the fee income needed to replace the £2m of ongoing earnings from the USS fund. Indeed, recent deals have achieved a hurdle rate way in excess of this.
Opportunistic property purchases
For instance, the company has purchased a multi-let shopping centre in Ostrowiec in Poland from USS which was previously managed by Fprop Opportunities, the company's 76 per cent-owned Polish-focused fund. 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 fact, the two new investments made by Fprop Opportunities during the year to March 2014 are expected to generate returns on equity in excess of 30 per cent and 50 per cent, respectively, miles ahead of that 15 per cent hurdle rate. The Fprop Opportunities fund runs until October 2020 and now accounts for £62m of First Property’s total assets under management of £341m.
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. The company has also made some shrewd investments of its own.
Blue Tower making sky high gains
First Property currently has one directly owned property holding, Blue Tower, an office tower in the central business district of Warsaw. The initial 28.3 per cent interest in Blue Tower was acquired in December 2008 for £8.3m and has surged in value to £11.7m since then. This investment accounts for almost £1m of First Property’s profit before tax and unallocated central overhead costs, equating to an annualised return on equity invested of 49 per cent. This highlights the very high returns achievable in the Polish commercial property market.
It’s hardly surprising then that First Property has deployed some of its spare cash to increase its investment in Blue Tower. At the end of last year, it acquired an additional 19.7 per cent interest in the property for €5.2m (£4.3m) funded by €1.7m in cash and a €3.5m bank loan. This will generate an additional €460,000 of earnings for the company, equating to an impressive pre-tax return of 27 per cent on equity.
That’s another reason why I am comfortable with the forecasts from analyst Chris Thomas at brokerage Arden Partners who expects First Property to report pre-tax profits of £4.5m and EPS of 2.7p in the financial year to March 2015. On this basis, the dividend of 1.12p is very secure. Not only that, but there is potential for an earnings beat since Mr Thomas hasn’t factored in any significant profits from Fprop PDR, leaving scope for the company to outperform conservative expectations. But even if First Property only hits current earnings forecasts, then the shares are hardly overpriced on a prospective PE ratio of 11.5 and are well underpinned by a yield of 3.6 per cent.
And let’s not forget that First Property's UK Pension Portfolio fund is a valuable and secure asset to manage. The fund is fully invested and has £90.5m of assets under management, or 26 per cent of the total, mainly focused in retail warehousing and properties in the retail sector. The fund is producing an ungeared return of 6.5 per cent and has a minuscule vacancy rate on a portfolio of 21 properties. These have a weighted average unexpired lease term of 10.2 years.
Marking assets to market value
Interestingly, First Property conservatively holds Blue Tower at cost in its accounts, which means that the company’s reported net asset value of £23.5m at the end of March, or 21p a share, massively understates its true worth. In fact, mark the Warsaw property to market value of £16.2m, or £3.4m above book value, and First Property's book value rises a further 3p to 24p a share.
It's worth flagging up that First Property values its interests in all the funds at cost too. If these were marked-to-market value the carrying value of these investments would be £16m, rather than the £10.6m stated in the company's latest accounts. The additional £5.4m equates to 5p a share, and means that when combined with the hidden value of the Blue Tower Property, the company's net asset value rises again to closer to 29p a share. Add to that figure the 1.6p a share of forecast post-tax earnings in the financial year to end March 2015 (after adjusting for dividend payments), and my model suggests that the shares are actually trading bang inline with March 2015 net asset value on a mark-to-market basis. This asset backing is not just reassuring, but given the profit potential from Fprop FDR, and scope for further deals in Poland to replace the lost income from the USS mandate, then there is upside on my net asset value forecast too.
It goes without saying that on a bid-offer spread of 29.5p to 30.5p, I rate First Property shares a decent income buy and my target price of 35p could yet prove conservative.
■ 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'
