Not only are the shares modestly rated inline with the last reported adjusted book value of 43p, up from 35p in March 2015, but having carried out a number of property deals in Eastern Europe in the past few years the company has a high level of recurring revenue which underpins earnings for the new financial year and beyond. In fact, First Property's 11 directly held properties, of which eight are in Poland and three in Romania, are worth €198m (£157m) and generate an average yield of almost 10 per cent on their market value. That's well in excess of an average weighted borrowing cost of 2.96 per cent, so offering chunky profits to flow back to the company.
Indeed, these properties generated pre-tax profits (before accounting for central overheads) of £9.9m last financial year which represents quite a return on the £42m of equity held by First Property in the assets. Moreover, they are cash generative and produced free cash of £4.5m after accounting for tax, debt amortisation and capital expenditure. They are not highly geared either as loans secured on the properties equate to 73 per cent of their market value. Voids are minimal too as vacancy rates are only 2.4 per cent. An average unexpired lease term of 49 months may seem a touch on the low side until you factor in the quality of tenants. For good measure, the 11 directly held properties are held in special purpose vehicles and all borrowings are non-recourse so protecting First Property's shareholders.
Cashed up for more value accretive acquisitions
I would also flag up that First Property currently has £14m of free cash available to fund more high-yielding debt-funded deals in Eastern Europe so offering significant earnings upgrade potential. And that's even after analyst Chris Thomas at brokerage Arden Partners lifted his pre-tax profit forecast from £6.9m to £7.2m for the 12 months to end March 2017. This forecast is based entirely on the rental income on First Property's portfolio and the recurring fund management fees earned on the nine closed-end funds and joint venture investments it manages.
Excluding directly held properties, the company has £196m of funds under management of which £155m is in UK commercial property, £42m is in Poland and the balance is in Romania. It's not unreasonable to expect the company to pick up more mandates given its impressive track record: the investment performance of its funds under management in Poland and in Central Europe hold top spot against MSCI's Investment Property Databank (IPD) Central & Eastern Europe (CEE) Benchmark in the decade to 31 December 2015. MSCI's IPD CEE Benchmark comprised a total value of €8.12bn (£6.4bn) in 372 property assets invested by 19 fund managers across Poland, Czech Republic, Slovakia, Hungary, Romania and Bulgaria.
The outlook for Eastern European commercial property offers potential upside too. Ben Habib, chief executive of First Property, notes that while "capital values for prime property have increased, for good secondary property, of the sort we favour, values remain largely unchanged from their credit crunch lows, yielding some 2 per cent per year more than equivalent property in Western Europe". In other words, there are opportunities to pick up quality secondary property at attractive valuations and which offer potential for the yield gap with prime Polish property to narrow. Given that negative Euribor rates are boosting returns generated from debt funded property deals, then this attractive funding backdrop should stimulate investment demand and lead to a narrowing of the yield differential between prime and secondary market property. Industry experts predict that transaction volumes in 2016 are expected to exceed the €4bn recorded in 2015, which was the second highest year on record in Poland and the highest since the onset of the credit crunch.
The bottom line
Frankly, with the shares trading at book value, on 10 times EPS estimates of 4.6p, and offering a dividend yield of 3.3 per cent after the payout per share was lifted 11 per cent to 1.5p in last week's results, then the potential for further value creation is not being factored into the current valuation. Nor is the fact that 95 per cent of the current year £21.9m revenue forecast is recurring, so offering a high degree of certainty in those estimates.
The market is also failing to acknowledge the impressive track record of the company. Having first recommended buying at 18.5p in my 2011 Bargain Shares Portfolio, the company has paid out cumulative dividends of 5.75p a share excluding the final dividend of 1.115p just declared and which is payable in September. The total return of 174 per cent equates to a compound annual growth rate of 21 per cent since I initiated coverage, bang in line with the average annual total return First Property has posted since the onset of the credit crunch in April 2008.
There are not too many investments that can generate such a high sustainable return, nor have potential to continue to do so, irrespective of whether the UK stays or remains a part of the EU. So having last rated the shares a buy at 40p ahead of last week's full-year results ('First Property sell-off buying opportunity', 4 May 2016), I have no hesitation maintaining a buy recommendation at 45p and reiterating my 56p target. Buy.
