In what has been described as a golden age for small- and medium-sized enterprises (SMEs), Workspace (WKP) has carved out a niche by providing them with flexible office space at affordable prices in locations close to central London and with good transport links. What's more, its 4,000 tenants compare with an estimated 190,000 London SMEs, so there is plenty of potential for growth.
- Strong development pipeline
- Valuation upgrades likely
- Solid growth in rental income
- Strong demand for quality office space
- Modest dividend payout
- Vulnerable to economic shocks
When Workspace releases full-year results on 3 June, it is expected to report that net asset value (NAV) has almost doubled over two years thanks to a cocktail of profitable property development, portfolio expansion, fast-rising rents and rapid property price increases. Workspace attracts new tenants in a number of ways, and its latest venture is known as Club Workspace. Members can use designated space within each centre, with internet access and meeting facilities, and many subsequently opt to rent space on a permanent basis. And Workspace doesn't lose out as a result of offering such facilities because most of the communal areas are converted from space that was previously unused, such as basements.
There are attractions for a small company to take office space. Average rent per sq ft is just £17.76; so a typical 500 sq ft office would cost less than £750 a month, although centres in more attractive locations within the portfolio may attract up to £80 per sq ft.
Workspace adds to rental income through rent-boosting refurbishments and by adding new space. The targeted internal rate of return is 10 per cent, but this is often exceeded because rents have been higher than originally expected. And the short-lease model means rents stay very close to market rates, which is great when demand is high. Total rent roll in the third quarter to the end of 2014 rose by 5.1 per cent to £64.4m and by 10.5 per cent in the first nine months of the year. Rental income has also been boosted by a steady improvement in occupancy rates which stood at 92.6 per cent at the end of last year. And rent per sq ft in the first nine months rose by nearly 12 per cent.
Always on the lookout for new premises, Workspace recently acquired three sites in central London for £61m, funded by a successful share placing last November that raised £96.5m at 660p. It has 11 redevelopment projects on site and nine refurbishments. Total upgrades of properties are usually completed within two years. Upgrading also enhances property values. An example is the Metal Box Factory, situated between London Bridge and Waterloo, which cost £16m to refurbish. Assuming 90 per cent occupancy, broker Panmure Gordon estimates rent will have jumped from £1m pre-refurbishment to around £3.5m.
| WORKSPACE (WKP) | ||||
|---|---|---|---|---|
| ORD PRICE: | 861p | MARKET VALUE: | £1.39bn | |
| TOUCH: | 861-862p | 12-MONTH HIGH: | 916p | LOW: 542p |
| FORWARD DIVIDEND YIELD: | 1.5% | TRADING PROPERTIES: | nil | |
| FORECAST PREMIUM TO NAV: | 14% | NET DEBT: | 37% | |
| INVESTMENT PROPERTIES: | £1.2bn | |||
| Year to 31 Mar | Net asset value (p) | Pre-tax profit (£m) | Earnings per share (p)* | Dividend per share (p) |
|---|---|---|---|---|
| 2012 | 308 | 49 | 11.9 | 8.8 |
| 2013 | 348 | 76 | 12.2 | 9.7 |
| 2014 | 496 | 253 | 13.9 | 10.6 |
| 2015* | 690 | 318 | 16.5 | 11.7 |
| 2016* | 753 | 123 | 18.6 | 12.9 |
| % change | +9 | -61 | +13 | +10 |
Normal market size: 1,500 Matched bargain trading Beta: 0.95 *Panmure Gordon forecasts, adjusted EPS figures | ||||
While significant value is being created from redeveloping properties, Workspace does not take on major development risk. It seeks planning consent for sites within the portfolio, typically carving out a new business centre but leaving room for some residential and retail development. Once planning is received, Workspace sells the asset to a hungry housebuilder, but with a contract to hand back the completed business centre at the end.
Financing looks solid. In the downturn, over-gearing and a fall in property values exacerbated by the short duration of the leases exerted pressure on the group's bank loans, and prompted a deeply discounted rights issue to shore up the balance sheet. Times have changed, and the loan-to-value ratio is now a more comfortable 27 per cent. What's more, around three-quarters of debt is now either fixed or hedged, with a current cost of 5.3 per cent, and with interest payments 2.3 times covered by operating cash flow. Another economic shock could dent occupancy rates, but the group is now well-placed to weather any storm.
The shares may not immediately scream value priced at a 14 per cent premium to next year's forecast NAV. However, substantial growth is being achieved and Workspace's short leases and development pipeline make it one of the most exciting ways to play the hot London SME rental market. Panmure Gordon expects the company to deliver a compound annual NAV growth rate of 19 per cent out to 2017, which we thinks easily justifies the premium the shares currently trade at. Indeed, a premium rating is nothing unusual for shares in Workspace and the valuation could still improve from here as the good times roll on. The policy of increasing the dividend by 10 per cent each year is also a plus, although the forecast yield is still only 1.5 per cent for next year.
