In the circumstances, it may seem remarkable that Dragon’s operations have proved so resilient. It may also seem remarkable that the company’s share price has held up so well too. This is largely because investors are looking beyond the political turbulence and tensions with Russia and instead focusing on the cash generative nature of the company’s developments and the solid asset backing they provide.
For instance, following the disposal of Dragon’s stake in Henryland, the owner of six retail schemes in different regions of Ukraine, the company has just reported it had a cash pile of $20.7m at the end of June 2014, or the equivalent of £12.6m. Based on 109m shares in issue, that sum equates to 11.5p per Dragon share. Moreover, the balance of the sale proceeds from that sale ($3.7m) is expected later this year. The company has no debt.
Substantial value in assets on the balance sheet
Dragon also owns a 12.5 per cent stake in London-listed Arricano (AIM: ARO - $2.42), one of the leading real-estate developers in Ukraine specialising in operating shopping centres, which listed its shares on Aim at the end of 2013. In Arricano’s half year results the company reported a 97 per cent occupancy rate with only 14 of its 440 tenants vacating in the first half this year.
Given that all rents are linked to the US Dollar, and the country’s currency, Hryvnia, collapsed by 20 per cent against the greenback in the first half, to maintain tenancy levels was impressive to say the least. But that also reflects the board’s sensible decision to share some of the currency risk with its retail tenants by fixing the foreign exchange rate in March and then gradually levelling prices over the course of this year. That way it has given retailers time to adapt, especially those selling foreign goods and which are more exposed to exchange rate movements. Overseas retail tenants include Fiba (Marks and Spencer), New Yorker, Benetton, Topshop and Auchan.
I also feel that investors have taken the view that with a loan-to-value ratio of 25 per cent, and loan maturity between 2018 and 2020, then Arricano is financed to trade its way through the current turmoil. That’s not to say that the crisis has not had a financial impact: a foreign exchange loss of $90m partly offset by a revaluation gain of $44.7m and meant $45m was wiped off the company’s net asset value. Arricano’s investment portfolio now has a carrying value of $247m, down from $287m at the start of the year.
That said, Arricano’s net asset value of $187m, or $1.81 per share is very conservative. That’s because the company owns a 49.97 per cent stake in Skymall, one of the largest shopping centres in Kyiv with 68,000 square metres of space. This is in the books at cost of $20.7m even though the company has exercised a call option to buy-out the remaining 50.03 per cent interest for $51.4m.
The market value of the whole shopping centre was just shy of $180m at the end of June 2014, implying a $108m uplift to the company’s net asset value once the deal goes through. True, legal wrangle have complicated matters. But following a London Court of International Arbitration hearing last month, which ruled that Arricano has legitimately exercised its call option, the company intends to proceed as soon as practicably possible with the acquisition. This valuable investment helps explains why Arricano’s share price has held up so well and at $2.42, is trading a third above reported net asset value of $1.81 a share at the end of June 2014.
It was Dragon’s interest in Arricano which sparked my interest a year ago. That’s because the 12.5 per cent shareholding is worth $31m, or £19.1m. So once you factor in Dragon’s cash pile of £12.6m, then cash and the stake in Arricano are worth a combined £31.7m, or 29p per Dragon share. This not only mitigates risk, but means that we are getting a free ride on virtually all the company’s other assets which have a carrying value of $100m, less Dragon’s total liabilities of around $19.5m. That nets out at about £50m, or 46p per Dragon share at current exchange rates.
A free ride
And there is clearly value in Dragon’s eight other projects, half of which are cash generative.
For instance, having attracted a partner who agreed to share some of the development costs in exchange for $5m worth of premises at Dragon’s Obolon project in an upmarket district of Kiev, the company sold 28 apartments in the first half this year. This means that 70 units have sold to date, or 43 per cent of the residential space for sale. Completion is due next summer. The one hectare development is in the books for $28.9m, or 16p a share.
Rivierra Villas, a cottage community near Kiev, has promise too. To date 18 land plots have been sold, and the first of four streets has been completed. Currently, five homes are available for sale. Dragon owns a 59.6 per cent interest in the 10 hectare development which is in its accounts for $9.7m, or 5.5p a share.
In addition, Dragon is developing a 14 hectare North American-style cottage development at Greenhills. Located six miles outside Kiev, the project encompasses 178 land plots of which 41 have been sold. The development is in the books for $11.9m, or 6.7p a share.
In other words, around $50m of the $81m worth of ‘free’ assets not in Dragon’s share price are accounted for by these three residential developments. A land bank of 502 hectares worth $31.8m accounts for the majority of the remaining assets held. Around 20 hectares of this land has been rezoned for commercial and residential development and all the infrastructure should be in place by the spring of next year. True, realising value could take time, but even so the land has to have some value.
Estimating fair value
As I noted in my last update (‘Dragon shows signs of life’, 9 June 2014), the stake in Aricanno and net cash on the balance sheet mitigates risk even after factoring in the geopolitical situation in the region. Moreover, with the company not dependent on external bank funding, and committed to realising value from its assets and making distributions to shareholders, then there is scope for the share price discount to book value to narrow in time.
So although Dragon’s share price has fallen from a summer high of 41p and is below my advised buy in price of 34p, I still believe they are worth holding onto for medium-term upside to my fair value target of 57p.
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