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OPINION

Alpha seeks alpha

Alpha seeks alpha
August 23, 2016
Alpha seeks alpha

At the time I noted that "with the combined equity interest in the H20 shopping centre in Madrid, and the value of the UK freehold ground rents, equating to the market capitalisation of Alpha Real Trust, in effect we are getting a free ride on all its other investments worth 60p a share, virtually all of which are income producing". I can now reveal that the company's net asset value per share has increased from 137.9p to 141.7p a share in the first quarter of the new financial year to end June 2016. There were no direct property revaluations in the three month period, so this uplift only reflects positive exchange rate movements and earnings of 2p a share in the three-month period.

 

Foreign exchange movements

Bearing this in mind, the company used a closing exchange rate of £1=€1.206 to value its €39.7m equity interest in the wholly owned H20 shopping centre in Madrid at the end June 2016. This was after accounting for a €71.2m mortgage secured on the €110m property, the only debt Alpha has outstanding. The shopping complex comprises 118 retail units with a gross letting space of 51,825 sq metres, a multiplex cinema, a supermarket let to leading Spanish operator Mercadona, and restaurants.

Capital improvements made, record visitor numbers, high occupancy rates and a raft of new tenancies in the first half of 2016, are all highly supportive of the valuation. The investment accounts for a third of Alpha's portfolio by value, so it's worth noting that since the end of June sterling has fallen further against the euro to a cross rate of £1=€1.153. This adds £1.5m to Alpha Real Trust's last reported net asset value of £98.2m which, based on 69.3m shares in issue, boosts Alpha's book value per share of 141.7p by a further 2.2p.

I would also point out that the shopping centre is generating a thumping 19 per cent yield on cost. That's because the annual interest charge on €50m of the €71.2m loan is capped at 2.85 per cent, so there is a substantial cash surplus after interest payments and one that is accretive to both earnings and net asset value per share. The equity interest in the H20 shopping centre is now worth almost 50p a share.

And as I noted in my update last month the £18.9m investment in defensive ground rents which yield around 4 per cent are worth around 27p a share. This means that 77p of the current share price is backed by these two rock solid investments alone.

 

Portfolio with promise

It's not as if the company's other investments are of dubious quality. The main investments in Alpha's £99m portfolio are high-yielding equity in property worth £40.7m, including the H20 asset (41.1 per cent of the portfolio); high-yielding debt worth £20.1m (20.3 per cent); ground rent investments worth £18.9m (19.1 per cent); and residential investments in the private rented sector (PRS) valued at £6.4m (6.5 per cent). The cash flows from these assets support a quarterly dividend of 0.6p a share.

Two development sites that Alpha has acquired in central Leeds and Birmingham are of interest as these have planning permission for 431 residential units and potential for commercial development too. The plan here is to exploit the growth opportunities in the private rented sector (PRS). Strategically it makes sense to do so as the combination of rising occupier demand and an undersupply of accommodation is a supportive back drop and one where Alpha can create a portfolio capable of delivering a high-yielding return on equity. And as I highlighted in my article on Telford Homes yesterday ('London property trading play', 22 Aug 2016), PRS assets are attracting substantial institutional demand.

Alpha has options here as it could forward sell all or some of the developed units, or alternatively add value by constructing the development, funded with either debt or contractor finance, and subsequently holding the completed assets as investments. The company could also benefit from government support for borrowings secured against PRS assets under the PRS housing guarantee scheme. Design teams have been selected on both sites, and project designs are being reviewed to enhance the detailed planning consent.

The point is that the £6.4m in invested in these two PRS developments, and a host of other yielding investments worth a further £31m, are in the price for free. There is upside to these investments too.

 

Upside to Indian investment

For instance, there is potential for a windfall gain on Alpha's investment in the Galaxia project, a development site extending to 11.2 acres located in NOIDA, an established, well planned suburb of Delhi that benefits from new infrastructure projects and is one of the principal office micromarkets in India. That's because Alpha initiated arbitration proceedings against its joint venture development partner Logix Group in order to protect its Galaxia investment.

In January 2015, the Arbitral Tribunal, by a majority, decreed that Logix and its principals had breached the terms of the shareholders agreement and awarded Alpha a sum of £9.7m at current exchange rates, representing the return of its initial investment with interest, and costs. This sum accrues interest at an annual rate of 15 per cent until it's repaid by Logix so is now worth £12m. The Arbitral Tribunal also ruled that the company has no obligation or liability to fund the outstanding NOIDA lease rent under the shareholders agreement. Alpha is actively seeking full recovery of the sums awarded and has been awarded by the courts of India a charge over the private residence of the principals of Logix.

The Galaxia investment is held in Alpha's accounts at £5m, or less than half the £12.2m current value of the award made. If the company can recoup this sum, then it will add over 10p a share to the last reported net asset value of 141p a share.

 

High-yielding debt investments

The equity investment made in Active UK Real Estate, a company listed on the Channel Islands stock exchange (www.cisx.com) is of interest too. Alpha invested £3.2m for a 20.5 per cent stake in the company a year ago to increase its exposure to the high yielding UK commercial real estate sector. It's been successful as the shareholding has increased in value by almost 30 per cent to £4.1m. Active UK Real Estate continues to outperform its IPD benchmark, posting a return in excess of 11 per cent in the past 12 months.

Alpha also provides mezzanine finance of £7.1m to Active UK Real Estate on which it earns a 9 per cent annual coupon. This loan is due for repayment in November this year, so it's reassuring to know that based upon Active UK Real Estate's last portfolio valuation of £49m, and after factoring in bank finance and Alpha's loan, the company's loan-to-value ratio is well below 60 per cent. In aggregate, the equity interest in Active UK Real Estate and the mezzanine loan account for 11.2 per cent of Alpha's portfolio.

In addition, Alpha has a 19 per cent shareholding worth £2.3m in a small listed property company, Industrial Multi Property Trust (IMPT:155p). Alpha also provides IMPT with a subordinated five-year loan expiring in December 2018 and on which it earns an annual coupon of 15 per cent. IMPT's portfolio was valued at £85m at the end of June 2016 and it had external bank and mezzanine finance of £52m. So after factoring in Alpha's subordinated loan of £10.3m it has a loan-to-value ratio of 73 per cent.

IMPT's portfolio comprises a well-diversified portfolio of 52 multi-let properties offering 499 leasable units with a total floor area of 1.7m square feet, all of which are located in the UK with 86 per cent invested in light industrial property and the rest in offices. The properties offer attractively priced accommodation for local occupiers which explains why occupancy rates are 90 per cent. But with tenants favouring shorter term flexible leases the weighted average lease length is only 3.83 years to expiry and just over two years to the next tenant break. So with such a high cost of debt and short lease lengths, it's hardly a surprise that IMPT's shares are rated on a deep discount to net asset value of 263p.

It's worth noting then that the board of IMPT are planning to refinance the portfolio in the fourth quarter this year, but if a refinancing is not possible it will review alternative ways to improve shareholder value including a managed wind up of the company. Either way it's a positive situation for Alpha and there has also been unsolicited speculative bid interest in IMPT this summer. The equity and loan investment in IMPT accounts for 12.7 per cent of Alpha's portfolio.

The bottom line is that I feel there is a good chance that the high yield debt outstanding to both IMPT and Active UK Real Estate Fund will be redeemed before the end of this year. Indeed, there is an incentive for IMPT to refinance as it will escape the break fees that would otherwise be applicable on Alpha's facility. So, if this scenario plays out as I feel it will, Alpha will free up £17.4m of cash, or 25p a share, for investment and will still have upside potential from the equity stakes in both listed companies.

 

Anomalously priced

So, with Alpha's equity valued at £61m or 40 per cent below spot book value of £100m, and the quarterly payout offering an attractive 2.7 per cent dividend yield, the investment risk remains firmly skewed to the upside. Add to that potential for valuation uplifts, and I feel my 105p target price is not only conservative, but achievable.

Trading on a bid-offer spread of 87p to 88p, I continue to rate Alpha's shares a buy.