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OPINION

Hot Property

Hot Property
July 27, 2015
Hot Property

It's hardly a surprise then that shares in the largest UK real-estate companies have mirrored this stellar progress: the FTSE 350 real estate index has risen by two-thirds in the past three years alone, including a 12.5 per cent gain in the year to date. In fact, investor appetite has been so strong that shares in many companies are now trading at premiums to even their forecast book values.

That's not to say that there isn't value to be found if you're prepared to put in the leg work. Indeed, in the past couple of years I have been reaping sizeable gains on holdings in a host of commercial property plays including FTSE 250 constituent Daejan (DJAN: 6,540p), Aim-traded property vulture fund Conygar (CIC: 180p) and Leeds-based family-owned shopping centre owner Town Centre Securities (TCSC: 308p). For good measure, I have identified another retail-sector-focused property play where the investment risk looks heavily skewed to the upside, FTSE Small Cap constituent Capital & Regional (CAL 60.25p).

 

Positive retail trends

The primary reason why the company appeals to me right now is that the business offers strong exposure to a benign environment for consumer spending and one that is clearly benefiting retailers at Capital & Regional's six wholly owned Mall shopping centres, in particular. The list of blue-chip tenants is a veritable who's who of the UK retail sector: M&S, Next, H&M, Debenhams, Boots, Topshop and WH Smith are just some of the occupiers of the company’s 900 retail outlets which attract 1.7m shopping visits each week.

The company has had no problem attracting new tenants either: occupancy levels rose by 110 basis points to 96.1 per cent last year, no doubt helped by the 2.2 per cent increase in retailers’ sales across the portfolio, and a 0.9 per cent rise in footfall which easily outperformed both benchmarks. These positive trends are likely to continue for a number of reasons too.

Firstly, wage growth is massively outstripping inflation so with interest rates, both fixed rates and variable, at record lows, this is putting extra disposable income in the pocket of consumers. In fact, real wage growth accelerated to 3.2 per cent in the second quarter this year, the highest level since the autumn of 2007.

Secondly, having taken 100 per cent control of its portfolio of six shopping centres by buying out minorities last year, part funded through an equity raise at 47p, the estate is now undergoing a £65m five-year investment programme, the majority of which will be completed this year and next. The strategy here is to tap into the strong retail demand for high quality space, and specifically from fashion retailers looking to take new space where refurbishments and reconfigurations have made it attractive and affordable.

London and south east focus key to income and asset growth

It’s not just demand for retail space that Capital & Regional is exploiting either as the company generates a fifth of its £65m gross rental income from non-retail activities, and specifically from leisure operators. For instance, at its Wood Green 530,000 sq ft shopping centre in North London, the company has agreed to build and lease out a new 35-room budget hotel to Travelodge, and EasyGym and a 16,000 sq ft supermarket. The combined capital expenditure is £7.6m and return on the investment is expected to be in excess of 10 per cent.

The refurbishment and development of Capital & Regional’s 260,000 sq ft Walthamstow centre in East London is bearing fruit too. Completion of new TK Maxx and Sports Direct outlets will complete in the fourth quarter, refurbishment of the centre has now completed and a planning application will be submitted in the coming weeks for 100,000 sq ft of new retail space, and more than 200 homes. Subject to planning consent being approved, construction work on the extension will commence in the first half next year.

The fact that all bar one of Capital & Regional’s shopping centres are located in the London and the South East – it also owns centres in Luton, Camberley and Maidstone – is bullish too given the demographic changes being seen in London and the ripple effect out to the regions. This can only be positive for footfall and retails sales at its shopping centres.

Moreover, there is a strong long-term trend here as analysts at Deloitte’s calculate that UK retail sales increased by 88 per cent between 1995 and 2014, and predict a further 20 per cent uplift by 2019 underpinned by population growth, higher employment and an improving economy.

Valuation uplifts

So with Capital & Regional’s centres in the right locations, then prospects for future income growth from the 3.2m sq ft wholly owned Mall portfolio look well supported especially as the company’s development programme guarantees a minimum return on investment.

These strong dynamics continue to generate strong investor interest across the sector: there was £5.7bn of shopping centre transactions in 2014, a quarter higher than 2013, and the highest level since 2006, according to commercial agents Strutt & Parker. In turn, this is resulting in yield compression as investors pay increasing prices to gain a slice of the action.

Indeed, reflecting a mix of yield compression and growth in income, Capital & Regional’s UK shopping centre valuations increased by 9.3 per cent last year and in this month's trading update the company revealed that its Mall Portfolio increased in value from £745m to £791m in the first half of 2015, driven largely by a reduction in the net initial yield from 6.27 per cent to 5.95 per cent.

It’s worth noting that Capital & Regional also has a 20 per cent interest in a joint venture with Oaktree Capital Management in the 900,000 sq ft Kingfisher shopping centre in Redditch, and a 50 per cent stake in the Buttermarket centre in Ipswich which is earmarked for a £12m investment. There is scope for valuation uplifts here too.

The first half valuation gain, and upside from new lettings and the refurbishment programmes, virtually guarantees a bumper set of half year results on Wednesday, 12 August. In fact, the aforementioned £42m uplift alone, after factoring in capital expenditure incurred of £4.5m, lifts the company’s net asset value per share by 10 per cent to 66p. This means that the shares are trading on at least a 9 per cent discount to spot book value per share, an anomalous rating for the hot retail sector. In my view, a year-end target net asset value per share of 70p is not an unreasonable expectation.

Well funded for dividend growth

The story gets even better when you consider that Capital & Regional only has pro-forma net debt of £336m on its balance sheet, after adjusting for disposals since the December year-end, representing a loan-to-value ratio of 43 per cent on its portfolio, excluding investments held in joint ventures. These borrowings are funded through a five-year debt facility fixed at an attractive interest rate of 3.36 per cent.

This means that pro-forma annual net rental income of £41.5m covers interest costs more than three times over and still leaves almost £23m available for shareholder dividends from the contribution from its Mall portfolio of shopping centres.

That's a chunky sum worth noting as based on 700m shares in issue, the board of Capital & Regional have stated their intention to pay a dividend of 2.9p a share this year at a cost of £20.3m, representing 90 per cent of the contribution from the Mall portfolio. The company became a real estate investment trust earlier this year with a view to offering a substantial income stream to its shareholders. On this basis, the shares offer an attractive dividend yield of almost 5 per cent.

Share price break-out imminent

If the investment case was not appealing enough then the share price is tantalising close to signal a triple top point & figure break-out. A close at 61p or above, taking out the 60p resistance level which has acted as a ceiling to share price progress in both May and June this year, would be evidence that the next leg of the re-rating is underway.

It’s a chart break-out that not only looks likely to me, but one I am willing to bet on it being the real deal too. The technical set-up is certainly supportive: the 14-day relative strength indicator (RSI) has a reading in the mid-60s, so is not in too overbought territory, and the moving average convergence divergence (MACD) momentum oscillator is positive and above its signal line having issued a buy signal earlier this month. A rally above the 60p resistance level should have legs.

So having considered the fundamental case to invest, technical set-up and anticipated positive news flow in a fortnight’s time when Capital & Regional releases results, I rate the shares a strong buy on a bid-offer spread of 60p to 60.25p. I have a year-end target price of 70p, inline with the recently upgarded target of brokerage Numis Securities. Offering a total potential return of 18 per cent including dividend income over the next five months, I rate the shares a strong buy.

MORE FROM SIMON THOMPSON...

At the end of April, I published an article with all of the share recommendations I have made this year. Since then I have published articles on the following companies:

Marwyn Value Investors: Buy at 220p, target price 260p ('Exploiting a value play', 5 May 2015)

Pure Wafer: Buy at 113p, target 140p to 150p; Paragon: Run profits at 440p, but buy on a confirmed breakout above the 445p and new target of 500p;600 Group: Buy at 16.5p, target 24p; Fairpoint: Buy at 127p, target 190p; AB Dynamics: Buy at 207p, target 230p ('Repeat buy signals', 11 May 2015)

Globo: Buy at 56p, target 69.5p; Greenko: Hold at 70p; Pittards: Buy at 128p ('Breakout looms for mobile wonder', 12 May 2015)

Macau Property Opportunities: Buy at 214p; Dragon-Ukrainian Properties & Development: Hold at 28p; Raven Russia: Hold at 53p ('Overseas property plays', 13 May 2015)

Trakm8: Run profits at 135p; Redde: Buy at 120.75p, target 140p; STM: Run profits at 45p, but conditional buy on close of 48p and new target of 60p ('Smashing target prices', 14 May 2015)

Bilby: Buy at 75p, target 100p ('Buy to build' growth play, 18 May 2015)

Bioquell: Buy at 148p, target 170p to 185p; Somero Enterprises: Buy at 140p, target 185p;KBC Advanced Technologies: Buy at 109.5p, target 165p; Inspired Capital: Hold at 14.25p ('Three value plays', 19 May 2015)

Renew Holdings: Buy at 315p, target range 350p to 375p; Manx Telecom: Buy at 198p, target 210p ('Renewing old acquaintances', 20 May 2015)

Marwyn Value Investors: Buy at 228p, target 260p;Charlemagne Capital: Hold at 13.5p; Bloomsbury Publishing: Hold at 178p ('Lights, camera, action', 21 May 2015)

Anite: Buy at 91.5p, target 110p ('Testing a breakout', 26 May 2015)

Character Group: Buy at 415p, target 525p ('Playtime', 1 Jun 2015)

Tristel: Run profits at 96p; Pure Wafer: Buy at 123p, target range 140p to 150p; Crystal Amber: Buy at 153p ('Hitting target prices', 2 Jun 2015)

B.P. Marsh &Partners: Buy at 150p, target range 170p to 180p; Moss Bros: Buy at 110p, target range 120p to 130p; SeaEnergy: Sell at 15p ('Exploiting a valuation anomaly', 3 Jun 2015)

Globo: Buy at 59p, target 69.5p; London & Associated Properties: Buy at 38.5p; Greenko: Hold at 44p ('Catalysts for share price moves', 4 Jun 2015)

Burford Capital: Buy at 148p, target 190p ('Legal eagles', 8 Jun 2015)

Market strategy ('Financial Market Watch', 9 Jun 2015)

Software Radio Technology: Buy at 29.5p, target 40p to 43p; Tristel: Run profits at 92p; Creston: Buy at 136p, target 150p; Sanderson: Buy at 69p, target range 80p to 85p ('Blue sky potential', 10 June 2015)

1pm: Buy at 67p, target 80p; Vislink: Buy at 58p, target 70p ('Small-cap growth stocks', 11 Jun 2015)

Elegant Hotels: Buy at 105p, target 135p to 140p ('Checking into an elegant investment', 15 Jun 2015)

First Property: Run profits at 45p; AB Dynamics: Run profits at 225p and target 250p; Inspired Capital: Sit tight at 20p (Bargain shares updates', 16 Jun 2015)

Trakm8: Run profits at 159p, new target 180p; Anite: Sit tight at 126.75p; Trifast: Run profits at 129p, target 140p; Record: Buy at 37p ('Small cap wonders', 17 Jun 2015)

Inland: Run profits at 71p, target 80p; KBC Advanced Technologies: Buy at 110p, target 165p; Caretech: Buy at 237p, target 300p ('Riding an earnings upgrade cycle', 18 Jun 2015)

Ensor: Buy at 97p, minimum target 125p ('Building up for a takeover', 22 Jun 2015)

GLI Finance: Buy at 54p, target 80p; Pittards: Buy at 128p; Netplay TV: Buy at 9.5p ('A triple play of small cap picks', 23 Jun 2015)

Bilby: Run profits at 97p; Safestyle: Run profits at 220p; Epwin: Run profits at 134p ('Soaring small caps', 24 Jun 2015)

Faroe Petroleum: Buy at 86p, target 100p; Greenko: Hold at 65p; Communisis: Buy at 48p ('A slick investment', 25 Jun 2015)

Mountview Estates: Buy at 12,250p; Inland: Run profits at 71p, conservative price target ('Running bumper profits', 29 Jun 2015)

Redde: Run profits at 138p, target range 150p to 155p; Trakm8: Buy at 175p, target 200p; Cohort: Buy at 312p, target 365p; Burford Capital: Buy at 175p, target 190p; Flowtech Fluidpower: Buy at 135p, target 155p ('Riding earnings upgrade cycles', 7 Jul 2015)

Crystal Amber: Buy at 161p; Stanley Gibbons: Buy at 258p; Somero Enterprises: Buy at 150p, target 185p; Globo: Buy at 49p, target 69.5p ('A quartet of small-cap buys', 8 Jul 2015)

H&T: Buy at 200p; STM: Buy at 47p, target 60p; Stadium: Buy at 113p, target 140p ('Exploiting upgrades', 9 Jul 2015)

Cambria Automobiles: Buy at 57.5p, target 75p ('Driving a re-rating', 13 Jul 2015)

Walker Crips: Buy at 47p, target 60p;600 Group: Buy at 18p, target 24p;Henry Boot: Buy at 235p, target 260p ('A trio of small cap value plays', 14 Jul 2015)

Bilby: Buy at 90p, target 120p; 32Red: Buy at 67.5p, ('Exploiting a valuation anomaly', 20 July 2015)target 90p; Marwyn Value Investors: Buy at 244p, target 275p (‘Acquisitions drive earnings upgrades’, 15 July 2015)

Vislink: Buy at 53p, target 70p ('Awarding success', 16 July 2015)

SPARK Ventures: Buy at 4.5p (‘Exploiting a valuation anomaly’, 20 July 2015)

W.H. Ireland: Run profits at 120p, target 140p; Safestyle: Run profits at 235p; Charlemagne Capital: Sell at 11p (‘Cash rich small-caps’, 21 July 2015)

Amino Technologies: Buy at 150p, targte 180p; Arbuthnot Banking: Buy at 1,530p; Globo|: Buy at 49p, target 69.5p ('Primed for major re-ratings', 22 July 2015)

SPARK Ventures: Buy at 4.5p; Entu: Buy at 115p, target 165p ('Cashed-up for gains', 23 July 2015)

■ Simon Thompson's 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 £2.95 postage and packaging. Simon has published an article outlining the content: 'Secrets to successful stockpicking'