Self-storage market
Over 300 companies compete in the UK self-storage market, operating around 800 outlets and offering total rentable space of 28m sq ft, but the largest businesses - including the three quoted firms, Lok’n Store, Safestore and Big Yellow - have a dominant position, accounting for 45 per cent of the UK market.
Lok'n Store currently has 22 sites in southern England, including one managed store in Woking, offering total rentable space of 1.1m sq ft, which gives it a 4 per cent share. So the company not only has the scale to benefit from a housing market and economic recovery, but with a south of England bias, it has the right locations, too. And it is a recovery that now looks well under way.
Strong recovery
Since the housing market bottomed out in December 2008, research house Hardman and Co note that there has been growth in self-storage space in 11 of the last 15 months. This positive trend was clear to see in Lok'n Store's results in the six-month period to 31 January 2010 when occupancy levels averaged over 550,000 sq ft, a 10.2 per cent rise on the comparable period a year earlier. The company has also managed to push through price rises of around 2.8 per cent and there should be scope to push through more rent rises without affecting its competitiveness, as Lok'n Store's average price for storage of £18.09 per sq ft compares favourably with the sector average of £20.49 per sq ft.
Moreover, the company has been boosting margins by increasing ancillary revenues, which rose by almost 25 per cent in the first half, and this segment accounts for around 10 per cent of turnover. For example, 79 per cent of all new customers buy its insurance compared with 62 per cent of its existing customer base. Households account for 63 per cent of clients with corporate customers making up the balance and, helped by the strong positioning of its depots, around 45 per cent of new business comes from passing traffic alone. Another 21 per cent of new business is generated from referrals, which is testament to the quality of customer service Lok'n Store offers.
The net result of these positive trends was that Lok'n Store returned to profitability in the six months to end-January, posting pre-tax profits of £190,600. Cash profits were up 12 per cent to £1.45m and, with the benefit of strong cash generation, net borrowings were reduced from £24.9m at the end of July to £24.2m at the half year-end. Interest is charged at 1.25 per cent to 1.35 per cent above Libor on these lines of credit, which run until February 2012. So, with Bank of England base rate unlikely to change anytime soon, expect the net monthly finance charge to stay around £40,000 per month. Interest cover is looking far healthier, too, as operating profits covered finance charges 1.8 times. Not that the company has any issues with its finances as it retains £11.9m of undrawn facilities and is trading well within its banking covenants. And the board was confident enough in the outlook to declare an half-year payout of 0.33p, having paid a 1p a share dividend in the previous financial year.
Valuation
The upbeat news on trading prompted an earnings upgrade from Hardman and the broker now forecasts full-year pre-tax profits of £0.3m and EPS of 1.2p, rising to £0.55m and 2.2p in the 12 months to July 2011. However, the earnings recovery is only part of the story . Lok'n Store owns some valuable real estate including freehold property worth £57.6m, leasehold property valued at £9.98m and three sites under development with a carrying value of £10.8m. Sensibly, the company has taken a conservative stance on new developments, focusing instead on growing cash flow from the existing portfolio of stores by raising occupancy rates, revenues and keeping a tight rein on costs. In time, though, there will be value to be added by developing these sites.
But right now there is already ample untapped value in Lok'n Store's share price. First of all, adjusting for 1.14m shares held in treasury and 0.6m shares held in an Employee Benefit Trust, the company has 25m shares in issue. So, based on its last reported net asset value (NAV) of £37.1m at the end of January 2010, the shares trade on a 41 per cent discount to reported NAV of 148p a share. However, a quirk of IFRS accounting means that short leasehold property held under operating leases are included in the balance sheet at cost rather than at market valuations, which depresses the reported valuation by £4.9m or almost 20p a share. In other words, with the shares priced on a bid-offer spread of 85p to 90p, valuing the company at £22m, they are currently trading on a hefty 46 per cent discount to adjusted NAV of 168p.
That valuation looks anomalous to me especially as Lok'n Store is in recovery mode and is a geared play on the nascent economic and housing market recovery. In fact, even if the shares were trading 50 per cent higher at 135p, they would still be priced 20 per cent below adjusted NAV. That's my six-month price target and I rate the shares a strong buy.
