For instance, interim results from East London housebuilder Telford Homes (TEF:319p) a few weeks ago revealed the company now has £700m of forward sales, up by more than a fifth since April, and a better than expected launch of its new City North development in Finsbury Park, North London post the half-year end. Forward sales now account for half the £1.4bn sales pipeline of over 4,000 homes, so offering substance to the board’s target of delivering a 50 per cent plus hike in annual pre-tax profits to more than £50m by March 2019, and doubling the size of the business over the next five years.
To do so the company will clearly have to maintain sales momentum so it’s interesting to note that Telford raked in over £43m of sales by selling a fifth of the 355 units at the City North development at an off-plan launch over just three weekends in November, highlighting the point that there is strong demand for new build property in the Capital even if house price growth has moderated this year, and at the super prime end gone into reverse. It also means that over £110m of open market revenue has been secured at the development even though it will not complete until 2020. The average sales price equates to £860 per sq ft, right at the top end of the company’s targeted £500 to £900 per sq ft range for properties in London.
Moreover, Telford has not needed to discount prices below anticipated levels at any of its developments in London. This reinforces my view that a combination of high rental returns on Telford Homes’ developments and its focus on the affordable end of the London housing market is both underpinning demand from both domestic buyers, and also foreign investors taking advantage of sterling’s sharp falls this year.
It’s important too that the company is well funded given the scale of its developments. Net debt of £32.7m represents a gearing ratio of 17 per cent of Telford’s net assets of £188m, and the company has £125m of available headroom on a new credit facility which runs to March 2019 and will help fund future site acquisitions and construction costs on existing developments. I would also flag up that the company has already offloaded around 300 homes in its pipeline with a development value of £130m to M&G Real Estate, and a subsidiary of L&Q, one of the UK's leading housing associations and one of London's largest residential developers. These deals reflect increasing institutional demand for high-quality, well-located developments to be 'built for rent'.
There is decent financial upside from PRS sales because assuming Telford achieves close to its target operating margin of 15 per cent, it will earn material profits on the £130m of revenue generated from the two schemes. Profits will be recognised earlier because under contract accounting standards it is based on a percentage build basis rather than on legal completion of the schemes. Furthermore, Telford has no debt finance on its PRS developments, has recouped its land costs and is fully carried on funding, so will generate a higher return on capital employed that on a normal housing development.
True, half year profits declined, but this was purely a timing issue and virtually all the compamny’s budgeted sales have been pre-sold for the current financial year. Indeed, since the end of September more than 100 units have completed and analyst Gavin Jago believes the company is bang on track to increase revenue by 20 per cent to £291m in the 12 months to end March 2017 and deliver pre-tax profits of £33m and EPS of 35p. Analysts Mark Hughes and Hannah Crowe at Equity Development have similar forecasts, having initiated coverage in the past few months. On this basis, expect the full-year dividend per share to be raised by 10 per cent to 15.7p, implying that the shares are rated on a modest 9 times earnings estimates and offer a prospective dividend yield of almost 5 per cent. A price-to-book value of 1.3 times is hardly exacting either.
So, having initiated coverage on the shares at 289p ('London property trading play', 22 Aug 2016), and reiterated that advice at 284p in the autumn (‘Value plays’, 18 Oct 2016), I feel that there is material short-term upside at the current price of 319p. In fact, a return to the pre-Brexit summer highs around 381p is a definite possibility in my view, so much so that I have edged up my price target from 370p to 380p to coincide with the pre-Brexit summer highs at the start of June. Strong buy.
Inland Homes valuation anomaly
Shares in Inland (INL:58.5p), the specialist housebuilder and brownfield land developer, have proved volatile this year, albeit they are trading just shy of the 60p level at which I last advised buying (‘Riding small cap bumper gains', 24 Oct 2016), and are up 154 per cent since I initiated coverage at 23p in my 2013 Bargain share portfolio ('How the 2013 Bargain shares fared, 7 Feb 2014).
The trading update at this month’s annual meeting is worth noting as the company’s housebuilding programme is clearly building momentum with a record 394 homes now under construction across 12 sites, of which 54 units have been reserved since the start of the new financial year. This includes 12 units sold at the off-plan launch of the 54 unit Meridian scheme in Southampton which has consent for 351 homes to be constructed in four phases.
Inland’s land bank currently stands at 7,220 plots, up from 6,681 plots at the end of June, of which 1,415 plots have a planning consent or a resolution to grant planning consent including 239 units at Inland’s Lily's Walk scheme in High Wycombe, Buckinghamshire. Lily's Walk is a prime 3.5 acre site in the centre of High Wycombe, located directly opposite the Eden Shopping Centre, and is being developed in joint venture with CPC Group. In addition, Inland has pre-application discussions ongoing regarding 1,802 plots, and planning applications awaiting determination for 1,746 residential units, with applications for a further 470 residential units set to be submitted shortly.
True, the timing of land sales can make Inland’s profits lumpy, and the company has guided towards a more profitable second half due to the timing of land sales and completions on the housebuilding side. However, with the shares trading a thumping 42 per cent below the June 2017 EPRA net asset value estimate of 100p based on forecasts from analyst John Cahill at broking house Stifel, then volatility of earnings due to the lumpy nature of land sales is already fully embedded in the modest valuation. In any case, Mr Cahill expects Inland’s underlying diluted EPS to rise from 5.4p to 6.8p in the 12 months to end June 2017 to underpin a 15 per cent hike in the payout per share to 1.5p. On this basis, the shares are trading on a modest 10.5 times historic earnings, and on just 9 times current year forecasts. A 2.6 per cent prospective dividend yield is attractive too.
Importantly, these estimates look achievable in my view as they are based on Inland realising a gross profit of £16.3m by offloading £44m worth of land to housebuilders which equates to about £88,000 per plot, and completing 240 private residential sales itself to generate gross profits of £12m based on a profit margin of 20 per cent. On this basis, Inland’s recurring pre-tax profits rises from £14.9m to £17m on revenue of £123m. I see the company’s focus on the affluent south east of England property market as a major positive given the chronic housing shortage and the pressures being put on housing stock from net migration into this part of the country.
The bottom line is that with newsflow positive, and the company lowly rated, I feel the 20 per cent share price derating from the last summer's highs is way overdone and continue to rate the shares a value buy as I feel that the extent of the housing market slowdown embedded in the current valuation is being massively overplayed. Buy.
Urban&Civic conservatively valued
There has been some modest director share buying at Urban&Civic (UANC:215p), a listed property group specialising in strategic residential land developments in key growth areas of the UK. It’s easy to understand why as the company has just reported a 5 per cent increase in EPRA net asset value per share to 284p in the 12 months to end September 2016, and reported positive valuation uplifts on land holdings at its key developments.
In particular, unserviced residential EPRA values per plot rose by a third to £24,500 at the company’s 1,432 acre freehold site at Alconbury Weald, incorporating Cambridgeshire's Enterprise Zone with permission for 5,000 homes; and jumped by 16 per cent to £15,000 per plot at the 1,170 acre site in Rugby where permission has been granted for 6,200 new homes. Importantly, there have been major sales too as over the past 12 months almost 1,000 plots have been contracted at the two sites including license arrangements with listed housebuilders for 386 plots.
Analyst Miranda Cockburn of broking house Stifel points out that “the important point about these commitments is that the minimum annual drawdown arrangements are above the latest valuations (in Urban&Civic’s accounts) plus the allocated cost of servicing (the land) giving further evidence that the book valuations are conservative.” Furthermore, Miss Cockburn adds that “the annualised aggregate value of minimum payments in the five contracts signed (at Rugby and Alconbury) exceeds £10m and will be receivable for an average of five years.” In other words, the company has been successfully monetising the value in these two major developments.
Indeed, although not significant in monetary terms, the first house sale at Alconbury generated a £64,000 profit. After adding back the company’s allocated land cost of £14,000 and taking into account previously recognised EPRA adjustment of £7,000, this produces an unserviced plot value of £71,000 per private plot, well above the appraised blended plot value of £24,500 calculated by CBRE Limited, an independent firm of chartered surveyors, which was used in Urban&Civic’s latest accounts. And that’s significant because CBRE have conservatively valued the two developments at Rugby and Alconbury at £105m and £197m, respectively, so these account for three quarters of the company’s net asset value of £410m.
Or put it another way, these valuations now look very conservative, a sentiment shared by the directors who note that “the difference between the larger site valuation of Alconbury and Rugby, as included in the EPRA valuation, and current land parcel sales to housebuilders is around £91m, or 60p per share.” They add that “our licence model ought to produce higher figures again than parcel sales to housebuilders.” I concur with that view and would add that given the affluent south eastern geographic and demographic bias to these developments, the board look justified in their belief that the likely proceeds from land parcel sales could be “better than two times Urban&Civic’s EPRA September 2016 plot values, even on completely flat house price assumptions.”
True, the shares have performed badly this year, having been sold down from 286.5p ('Hot property, 7 Jan 2016), and are below the 274p level at which I initiated coverage at in October last year (‘Plotting a break-out’, 15 Oct 2015). The general sell down of shares in housebuilders post EU Referendum clearly has been a factor, but this should not negate from the fact that there are sound fundamentals supporting Urban&Civic’s development programme including a chronic housing shortage in the south of England and a desperate need to build more new homes. These factors are unlikely to change anytime soon, as is the rude financial health of the listed housebuilders, key buyers of the company’s land parcels.
The 10 per cent hike in Urban&Civic’s dividend per share to 2.9p is a pretty strong sign of the board’s confidence and I would not discount another similar percentage rise in the payout in the current financial year either as analysts at Stifel forecast. Trading on a 25 per cent discount to EPRA NAV of 284p, and more than a third below current year EPRA NAV estimates of 324p and 332p, respectively, based on the latest numbers from analysts at Stifel and JP Morgan Cazenove, I rate the shares a clear buy.
Property play to pay
There has been a fair amount of newsflow surrounding Local Shopping REIT (LSR:28.25p), a small cap retail sector-focused property investment company that’s in the process of selling down its portfolio with a view to returning the cash proceeds to shareholders. Given the shares are trading a third below book value, and there is a plan in place to sell down the portfolio, I feel there is value on offer here which is why I suggested buying the shares earlier this year at 26.5p (‘Shopping for a property bargain’, 23 Aug 2016).
I am not the only one who sees investment upside as the company has attracted the attention of Aim-traded marine seismic equipment provider Thalassa (THAL:45p), a cash rich small cap minnow with a market capitalisation of £10m and one that has built up a 23.48 per cent shareholding in Local Shopping REIT. Thalassa requisitioned a general meeting which was held earlier this month in order to remove two directors from Local Shopping REIT’s board and to appoint amongst others Duncan Soukup, chairman of Thalassa, to the board. However, the directors of Local Shopping REIT had the backing of the company’s major shareholders who clearly supported their view that “Mr Soukup and Thalassa are attempting to gain control via the back door. To what purpose remains unclear, but the board do not believe it is likely to be in the interests of shareholders, other than Thalassa”. Thalassa was forced to back down.
This spat has led to some volatility in Local Shopping REIT’s share price, but what is clear to me is that if the board can deliver on their new investment strategy, and one which was for all to see in the company’s results last week, then there is a very good chance that shareholders will reap decent share price gains over the coming 12 months. The plan is to sell a total of 125 of the company’s smaller and more challenging properties between now and the end of 2017 to raise around £20m, mainly through property auctions. Since the start of October, the company has sold 22 of these properties realising a total of £2m and at a modest premium to book value, having sold 27 properties worth £5m in the financial year to end September 2016.
Having just negotiated an extension to its £43.5m banking facility with HSBC until the end of 2019, and at a favourable rate of 2 per cent above LIBOR, the company is under no pressure to have a fire sale of its £75m property portfolio. At the end of September 2016, the company’s net debt was £39.5m to give a comfortable loan to value ratio of 52 per cent. So, the planned sell down of properties will not only enable the company to significantly deleverage its balance sheet, but means that it will be in a position of financial strength to market the sale of its ‘core’ portfolio of 200 remaining properties, worth £55m at current valuations, as a single lot to interested buyers at the start of 2018. This would be the precursor to a windup and liquidation of the company.
Bearing this in mind, I still feel that if Local Shopping REIT’s board can achieve sale prices around current valuations, and the portfolio is being valued on an equivalent yield of almost 9.5 per cent, then my liquidation value of £30m, or 36p a share, is a very realistic target. I have arrived at this figure after deducting all net borrowings secured on the portfolio, after factoring in retained net profits earned by the company between now and the start of 2018, after accounting for all professional fees, and conservatively adjusting for some slippage on the sale prices realised. To put my liquidation value of 36p a share into some perspective, it’s 27.5 per cent above Local Shopping REIT’s current share price of 28.25p, but 16 per cent below the last reported net asset value of 43p a share at the end of September 2016.
Given this financial return could be achieved within the next 18 months, it’s still a favourable one on a risk:reward basis. Trading on a bid-offer spread of 26.5p to 28.25p, valuing the equity at £23.5m, I rate shares in Local Shopping REIT a medium-term buy.
Finally, I published an indepth article to small cap investing on Friday last week.
