Moreover, given the significant yield gap between that on commercial property and government bonds, the attraction of a secure income stream supported by high-quality tenants is obvious. In fact, according to the Investment Property Databank (IPD), the yield gap between index-linked gilts and underlying property yields in the UK has never been wider. And with the chances of interest rate rises anytime soon virtually non-existent, and the odds of another round of quantitative easing from the Bank of England a distinct possibility, then the investment landscape remains highly supportive of commercial property.
Commercial property gains
This is good news if you followed my recommendation to buy shares in Daejan (DJAN: 4000p) in February ('Buy the breakout', 14 February 2013). To recap, the company is controlled by the Freshwater family who by my reckoning own over 70 per cent of the share capital through direct interests, beneficial holdings and shares held in trust. It is this substantial family holding that mainly explains why the share price was trading on such a hefty discount to book value when I spotted the valuation anomaly. This looked unwarranted, especially since Daejan has held a London listing as a property company for 55 years, during which time it has built up substantial commercial and residential property holdings worth just under £1bn in the UK and a further £260m in the US.
In fact, the discount to net asset value was so wide three months ago that investors were placing a modest £538m value on the company's equity of £884m. That equated to a massive 38 per cent share price discount to book value even though the company was carrying net borrowings of only £176m secured against properties, mainly located in London and New York, worth £1.27bn at the end of September 2012. The last reported balance sheet gearing is a minuscule 20 per cent of shareholders' funds so there are no financial concerns to warrant such a wide discount.
The key attraction for me is that three-quarters of Daejan's portfolio is located in the prosperous London, south-east of England and New York. In terms of the portfolio split, offices account for 20 per cent of the book (£209m in the UK and £36m in the US); retail property makes up 21 per cent (mainly £265m in the UK); and residential property accounts for a further £650m of assets, of which £426m is in the UK and £224m in the US. Industrial, leisure, care homes and land & development assets account for the balance of the £1.27bn portfolio.
So, given the strength of the London property market, it's hardly surprising that some of Daejan's properties have achieved bumper prices when sold. It's not surprising, either, that other investors have cottoned on to the fact that there is a good news story here, and one at a favourable price. In fact, shares in Daejan have risen more than 20 per cent in the past three months from my recommended buy-in price of 3,300p to a high of 4,045p at the end of April. As a result, the share price discount to net asset value of 5,425p has narrowed to 26 per cent. It also means that the shares have hit my target price of 4,000p.
But I have decided not to take profits on this holding. That's because I can see scope for a reasonable amount of net asset growth in the second half of the financial year, and beyond, not to mention valuation uplifts on developments. The company also paid a dividend of 75p a share, including a final of 50p a share in the previous financial year, so we are in line for at least a final payout of 50p a share when Daejan announces its final results in early July. My advice is to run your profits and await the financial results in eight weeks' time. They are unlikely to disappoint.
Booming London property profits
Last year I recommended buying shares in east London housebuilder Telford Homes (TEF) as a way to gain exposure to the capital's booming housing market. The investment didn't disappoint as the shares more than doubled by the time I advised banking profits earlier this year.
However, we maintained our exposure to the London and south-east property market through shares in Mountview Estates (MTVW), which I believed were worth buying earlier in the year ('Chart breakout for a solid income play', 11 February 2013). To recap, the company holds a portfolio of investments in three specific niche areas: regulated tenancies; ground rent units and life tenancies. The book value of regulated tenancies is around £274m, of which £149m of these investments are in London, and a further £73m in the south-east and home counties. Mountview owns more than 2,500 residential properties under regulated tenancies, which account for 90 per cent of the company's portfolio by value.
When the company last updated shareholders three months ago the board reported that trading in the third quarter to end-December had maintained the "same solid progress seen in the first six months of the financial year". Revenue and rental income had risen strongly and earnings were up by over 25 per cent, year on year. This follows on from first-half results to the end of September 2012, which revealed pre-tax profits up 22 per cent to £11.9m and EPS up 25 per cent to 245p. On a 12-month rolling basis, the company is generating EPS of around 500p, which easily covers the annual 165p-a-share dividend.
It doesn't take a genius to work out that difference of 335p a share between EPS and the annual dividend is boosting the company's net asset value, which is one reason why Mountview reported a 7 per cent increase in book value in the six months to end September 2012. Moreover, even if the company only puts in the same performance in the second half to end-March 2013, the book value will rise to around 6,200p.
The combination of a secure income stream, exposure to the London property market and a pretty conservative portfolio valuation is quite a compelling investment proposition. For instance, the core regulated tenancy portfolio is held at the lower of cost or net realisable value even though properties sold on vacant possession achieved three times their book value last year. This also explains why Mountview's shares have risen from around my buy-in price of 5,050p to above my target price of 5,600p. We have also pocketed a 50p-a-share interim dividend. As a result, the share price discount to historic book value has narrowed to 6 per cent, and the discount to my conservative estimate of prospective book value is currently around 10 per cent.
Still, with the company set to report full-year results at the end of June, and the prospect of a final dividend of 115p a share to come, I am going to run these healthy profits. From a chart perspective, there is little overhead resistance until well north of 6,000p and, with a bumper set of results set to be announced, then this could be just the catalyst to propel the share price above that level.
MORE FROM SIMON THOMPSON ONLINE...
My next article will appear online by 12pm on Thursday 2 May. I have also written two other online articles so far this week, both of which are on our homepage:
'Seasonal stock picking strategies', 30 April 2013
'Small-cap stock picks', 1 May 2013
■ My new book 'Stock Picking for Profit' will be published at the end of May and is being sold only through YPDBooks at £14.99, plus £2.75 postage and packaging. Pre-orders can be placed online at www.ypdbooks.com, or by telephoning YPDBooks on 01904 431 213.
