It’s a company I have followed very closely and successfully too, having first recommended buying at 18.5p in my 2011 Bargain Shares Portfolio. Since then the board has paid out aggregate dividends of 5.75p a share excluding the final dividend of 1.115p payable in September (ex-dividend date of 1 September 2016). The total return of 172 per cent on an offer-to-bid basis and including dividends equates to a compound annual growth rate of 20 per cent since I commenced coverage, in line with the average annual total return First Property has posted since the onset of the credit crunch in April 2008. I firmly expect this positive trend to continue.
As regular readers of my columns will be aware I have made a concerted effort to exploit special situations post the EU Referendum, and specifically ones where there is a strong currency headwind to benefit both a company’s profits and the sterling value of assets held overseas (‘Brexit winners’, 1 Aug 2016). First Property is one such beneficiary.
That’s because the board under the shrewd leadership of chief executive Ben Habib has executed a number of property deals in Eastern Europe over the past few years, so not only does the company have a high level of recurring revenue to underpin earnings, but with sterling falling heavily its 11 directly held properties, of which eight are located in Poland and three in Romania, are now worth a lot more in sterling terms than they were a couple of months ago.
Impact on balance sheet valuations and profits
These properties were valued at €197.9m on an open market basis by CBRE and BNP Paribas in First Property’s last set of annual accounts for the 12 months to end March 2016. The company had borrowings of €144.8m secured on these assets, so net of this debt equity in the properties is around €53.1m. And because sterling has plunged from £1:€1.261 to £1:€1.157 since the end of March, the sterling value of equity tied up in these 11 directly held assets is now worth £45.9m, or £3.8m more than at the end of March. To put this sum into perspective, and based on 116m shares in issue, this adds 3.3p a share to First Property’s last reported adjusted net asset value of 43p a share.
Furthermore, these 11 directly held properties generate an average yield of 9.97 per cent on their market value of $197.9m. That bumper return is more than three times higher than the average weighted borrowing cost of 2.96 per cent on the €144m of loans secured on the properties, so First Property is generating around €13.5m of pre-tax profit pre-central overheads on its overseas investments. The point being that those profits were translated into sterling at an average exchange rate of £1:€1.363 in last year’s accounts to give a figure just shy of £10m.
However, the average sterling:euro exchange rate in the 19 weeks since the end of March has fallen to £1:€1.232, and if sterling stays at the current level of £1:€1.157 for the remainder of First Property’s financial year then this will bring the average rate down to £1:€1.188. Importantly, both the Polish Zloty and the Romanian New Leu have held steady against the euro since the end of March. In other words, the pre-tax profit of €13.5m earned from the 11 directly held properties in Poland and Romania could be worth almost £1.5m more to the company this year due to the fall in sterling.
That’s a chunky sum in relation to the pre-tax profit estimate of £7.2m which analyst Chris Thomas at brokerage Arden Partners believes First Property will make in the 12 months to end March 2017. This forecast was made before sterling’s plunge and 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. Indeed, around 95 per cent of the current year £21.9m revenue forecast is recurring.
Or put it another way, not only is First Property benefiting from an increase in the sterling value of its portfolio following the plunge in sterling, but if sterling trades at the current level between now and the end of March then analysts will really have no option but to upgrade their pre-tax profit estimates by around 20 per cent. And there appears little downside risk to the profits earned from First Property’s 11 directly held properties as voids are minimal at only 2.4 per cent, and the tenant quality is high which mitigates an average unexpired lease term of four years.
I would also flag up that First Property has £14m of free cash available to fund more high-yielding debt-funded deals in Eastern Europe so offering earnings upgrade potential. The outlook for Eastern European commercial property is favourable as 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 boost investment demand and lead to a narrowing of the yield differential between prime and secondary market property.
For good measure, economists predict the Polish economy will grow at 3.5 per cent this year, accelerating to 3.7 per cent in 2017, maintaining its status as one of the fastest growing economies in Europe. The market back drop is equally favourable in Romania as rent levels are stable, occupier demand for commercial property is improving and the economy is expected to grow at north of 4 per cent this year.
The bottom line
So, with First Property’s shares trading at book value after factoring in the currency gains on its directly held properties in Poland and Romania, and with potential for current year EPS estimates of 4.6p to be increased by around 20 per cent if sterling fails to regain its losses against the euro between now and the end of March 2017, then there are obvious catalysts for a higher share price. A trading update at the forthcoming annual meeting on Thursday, 22 September is likely to do just that.
Furthermore, in the current zero interest rate policy environment First Property's share price is well supported by an attractive income for shareholders which Arden believes will be raised from 1.5p to 1.55p a share in the current financial year, implying a dividend yield of 3.3 per cent.
Needless to say, I am maintaining my positive stance (‘Head east for profits’, 13 Jun 2016), so much so that I now rate First Property’s shares a strong buy on a bid-offer spread of 44.5p to 46p ahead of next month's annual meeting. My initial target price is 56p.
