Industrial estates are underrated. They may not be pretty, but, over the years, they have been a better investment than shops, and far better than offices. That's because they command a generous rental income, which compounds over time. They're also quick and cheap to build, which lessens the risk that huge numbers will flood onto the market all at once, precipitating a crash.
- Fat dividend yield
- Big discount to NAV
- Resilient operating performance
- Low-risk development portfolio
- Exposed to eurozone
- Operating in a tenants' market
This is why it makes sense to buy shares in Segro, Europe's largest industrial landlord. The company churns out generous dividends that, thanks to lettings activity and a fairly low-risk development pipeline, should grow. And the shares are lowly rated. Since hitting a post-crash high of 395p in late 2009, the price has sunk to 230p. That's 40 per cent below the company's forecast asset value for the year end generates a big fat dividend yield of 6.5 per cent.
Of course, the share-price performance reflects valid fears. The most topical is that the eurozone, and possibly the UK, will fall back into recession. Demand for warehouse space is economically sensitive, and Segro owns estates across France, Germany, the Benelux states and Poland worth 30 per cent of its total portfolio. Moreover, vacancy rates across most of its portfolio are high - 10.2 per cent at the end of September. That suggests it's a tenants' market, which could put pressure on rents.
SEGRO (SGRO) | ||||
|---|---|---|---|---|
| ORD PRICE: | 230p | MARKET VALUE: | £1.71bn | |
| TOUCH: | 229-230p | 12M HIGH / LOW | 334p | 208p |
| DIVIDEND YIELD: | 6.5% | TRADING STOCK: | £303m | |
| DISCOUNT TO NAV: | 40% | |||
| INVEST PROPERTIES: | £4.6bn | NET DEBT: | 85% | |
| Year to 31 Dec | Net asset value (p) | Pre-tax profit (£m) | Earnings per share (p) | Dividend per share (p) |
|---|---|---|---|---|
| 2007 | 690 | -247 | -53.6 | 23.0 |
| 2008 | 462 | -939 | -215.9 | 13.7 |
| 2009 | 354 | -248 | -41.3 | 14.0 |
| 2010 | 366 | 197 | 28.5 | 14.3 |
| 2011* | 387 | 138 | 18.8 | 14.9 |
| % change | – | – | – | +4 |
NMS: 14,000 Matched bargain trading BETA: 1.0 *Peel Hunt estimates (NAV, profits and earnings not comparable with prior years) | ||||
That said, vacancy rates have fallen steadily for over a year now, and Segro signed 92 leases in the third quarter, which in time will generate £11.3m of rent annually. It has worked particularly hard on its Brixton portfolio, which it bought in 2009. In June 2010 the Brixton vacancy rate was 21.5 per cent; at the latest count it was just 13.4 per cent.
Many of the new lettings are short-term; filling empty space is a higher priority than securing the perfect tenant. But Segro is not taking a haircut on rents. In the first nine months of 2011, on average new lettings were negotiated at 2.7 per cent above so-called 'estimated rental values' (market rates estimated by surveyors as the basis for property valuations last December). This suggests Segro can continue to grow its rent roll and dividends by letting out further space. That's not something that other large real-estate investment trusts, which typically own top-notch London properties with low voids, can claim.
The other way property companies can increase their rental income is through development, and Segro is a promising example. It has 22 projects contracted or under construction, worth about £19m in rental income for capital spending of £174m – a yield of 10.9 per cent. Nor is much of that income speculative – 76 per cent is covered by 'pre-let' agreements with companies that have, in effect, ordered tailor-made distribution warehouses from Segro. Even if no further tenants are found, the yield on cost is over 8 per cent.
Admittedly, there was evidence in the latest trading update that the balance of power is shifting to tenants. Rents agreed in the third quarter were on average lower than those agreed in the first half in both Europe and the UK. That's perhaps not surprising given the economic news. Alan Carter, an analyst at broker Evolution Securities, says "there are tenants out there, but you have to be very competitive on rent", and expects the company's net asset value to dip slightly in the second half.
