In double quick time the shares re-rated from my recommended buy-in price of 44.5p to the middle of my fair value target range of between 60p to 65p. However, as I pointed out in my market outlook column last week, investors have been more inclined to trade shares this year and book short-term profits rather than adopt a buy-and-hold investment strategy. In turn, this has created additional volatility in the shares I recommend as traders’ bank gains. This has clearly been the case with London & Associated Properties.
That said, the investment case remains intact and if anything is stronger now than when I made that original buy recommendation six months ago. I last updated my view at the end of April when the price was 47.5p (‘Property for the shopping list’, 28 April 2014), since when the company has made some important announcements, the most important of which is a £45m bank financing with Santander and Europa Capital Mezzanine. This refinances London & Associated Properties’ entire Royal Bank of Scotland loan and releases funds for new acquisitions.
The new debt package has a five-year term, is fully hedged and has a current blended interest cost of 4.79 per cent. To put this into some perspective, London & Associated Properties' average weighted cost of capital was 7.48 per cent in 2013. In addition, the company has extended its debt maturity profile with £45m of its £60m credit lines now repayable in July 2019 and a further £10m not due until August 2022.
As part of the refinancing arrangements, the company has also exited the last of its interest rate hedging arrangements: a 20 year swap for £20m with a seven-year call option in favour of the bank, taken out in December 2007, at a rate of 4.685 per cent. The final cost of exiting this hedge was £10.7m, around £1.1m higher than the £9.6m liability stated on the company’s balance sheet at the end of 2013.
However, it was still well worth doing because with the benefit of a clean balance sheet, London & Associated Properties' is far better positioned to take advantage of market opportunities both for direct investment and joint venture asset management. Adjust for the aforementioned hit on exiting that final interest rate swap arrangement and I estimate that the company has a pro-forma EPRA net asset value of £53.5m, or 63.5p a share. That’s well over 50 per cent above the current market value of £34.5m, a harsh valuation given that the board have de-geared the balance sheet and are well placed to take advantage of acquisition opportunities using cheaper funding lines.
In fact, by my reckoning net borrowings have plunged from £132m at the end of 2012, to only £38m post completion of the sale of the King Edward shopping centre in Windsor earlier this year. In other words, net debt now equates to 71 per cent of my estimate of EPRA shareholders funds which means London & Associated Properties' has around £22m of spare funds to invest in new property deals.
Solid property portfolio and asset management businesses
It’s also worth noting that voids on the company's remaining properties are minuscule and the weighted average unexpired lease term is around eight years. This makes the hefty 35 per cent share price discount to pro-forma EPRA net asset value even harder to justify.
To recap, the portfolio includes the Orchard Shopping Centre in Sheffield; Kings Square, West Bromwich; the Langney Shopping Centre, Eastbourne, owned in joint venture with Columbus Capital Management; and Brixton Market, in South London.
Tenant demand at Orchard Square continues to be strong. Three leases expired last year and two tenants, Waterstones and Clarks shoes, subsequently agreed new leases at rental levels close to the peaks achieved during the last decade. The company has also received a number of offers from retailers on the vacant former USC unit which fronts on to Fargate. The unit has since been split to maximise returns and most of the ground floor is now under offer to a national retailer. The board are confident the new leases will exceed the previous rent of £200,000 on the vacant space, highlighting the strength of tenant demand.
And as I have previously noted, Brixton Markets continues to go from strength to strength. In fact, there are currently around 160 retailers on the waiting list for any available space in London & Associated Properties two indoor markets. These are let on 25 year leases to InShops, a subsidiary of Groupe Geraud, who also operate 200 markets across Europe. Gross revenue has increased by a quarter in the past three years alone and London & Associated Properties is sharing the upside as it receives half of the higher rental income in line with a profit share agreement.
In my view, the share price discount to book value is even harder to justify when you consider that the company also generates significant income by offering a full asset management service through London and Associated Management Services (LAMS). Clients include Lloyds Bank and NAMA, the state-owned 'bad bank' in the Republic of Ireland.
Furthermore, at the end of last year LAMS set up a joint venture with American private equity fund Oaktree Capital Management to acquire three shopping centres: the Vancouver Quarter centre in Kings Lynn; the Rushes in Loughborough; and the Kingsgate in Dunfermline. LAMS invested £2.2m in the joint venture. All are being managed by LAMS, so providing a useful source of management fee income.
Undervalued
True, the shares have drifted below my last recommended buy-in price of 47.5p, and are now marginally below my original buy-in price of 44p, but with a series of property disposals transforming London & Associated Properties’ balance sheet, and occupancy levels robust, I see little reason why the shares should be valued 35 per cent below EPRA net asset value.
The recent retirement of finance director Robert Corry certainly doesn’t justify such a hefty discount either. Mr Corry was with the company 22 years and having overseen the successful refinancing, this was a sensible time to call it a day.
In my opinion, London & Associated Properties’ shares continue to rate a value buy on a bid-offer spread of 38p to 41p, and I am maintaining my fair value target price of between 60p to 65p. Please note that the company will announce its half year results at the end of August and is scheduled to release a second interim management statement on 17 November.
■ Simon Thompson's new 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 £2.75 postage and packaging. Simon has published an article outlining the content: 'Secrets to successful stock-picking'
