However, I have noted a series of announcements concerning two particular property companies operating in the region and I am convinced there is a potentially lucrative trading opportunity to exploit here. It's rather complex, so there's lots of detail to get to grips with, but if I am right then shares in Aim-traded Dragon-Ukrainian Properties & Development (DUPD: 34.5p) are seriously undervalued.
Value in shareholdings
That's because Arricano (AIM:ARO - $2.33), one of the leading real-estate developers in Ukraine specialising in operating shopping centres, has just listed on the Aim market, raising gross proceeds of $24m (£15.2m) through a private placing of 10.3m shares at a price of US$2.33 each. These funds will be used to continue the development of Arricano's existing portfolio of operating assets and to fund future short-term working capital requirements.
In addition, the company has acquired four development properties, funded by issuing 28.3m shares (worth $66m), and one other property in a deal with deferred consideration of not more than $20m in cash. On admission, the company had a market value of $241m, or £152m.
Arricano is of great interest to me because adjusted for the following share issue, post flotation Dragon-Ukrainian Properties now owns a 12.51 per cent stake in the company worth $30.1m, or £19m. That is slightly less than the carrying value of the stake (around $32.7m at the end of 2012) in Dragon-Ukrainian Properties last set of accounts. But what it does mean is that the combined value of the shareholding in Aricanno, and the $21.7m net cash on the company's balance sheet, worth £13.7m at current exchange rates, is almost worth as much as Dragon-Ukrainian Properties own market value of £38.3m. That in effect gives us a virtual free ride on assets worth almost £87m on its balance sheet.
Moreover, there is definite substance behind Aricanno. The company's five shopping centres in Ukraine have 160,000 sq. m gross letting area and are located in the capital Kyiv (Sky Mall and M26/RayON shopping centres), Kryvyi Rih (SEC Sun Gallery), Zaporizhzhia (SC City Mall) and Simferopol (SC South Gallery). All of these properties were developed and have been operated by Arricano and, with the exception of the Sky Mall property that is co-owned with a joint venture partner, all are managed by Arricano's property management team.
Retail tenants include many of the international brands that are present in the Ukrainian market, whether through direct ownership or regional franchises, as well as leading national brands. Overseas retailers include Fiba (Marks and Spencer), New Yorker, Benetton and Topshop.
Importantly, a key driver in each of the above projects has been securing strong anchor tenants to drive footfall and entice other tenants to sign leases. At present, Auchan, a leading international hypermarket brand, is the anchor tenant in three out of the Aricanno's five shopping centres. Furshet, a leading Ukrainian supermarket chain of which Auchan is a shareholder, is the anchor tenant at the fourth project and the RayON shopping centre in Kyiv is anchored by a supermarket, Silpo, the main brand of leading Ukrainian retailer Fozzy Group.
As a result of low vacancy rates - RayON was 93 per cent let at the end of 2012, even though the centre only opened that year and vacancy rates are generally around 3 per cent - there is relatively low downside risk for both occupancy rates and rent levels. It also explains why Aricanno's net asset value rose from $115m to almost $135m last year. Adjust for the above $90m capital raise and Aricanno's net assets are now closer to $225m by my reckoning, so the company is being valued on 1.07 times book value. That doesn’t seem unreasonable for an operation with development upside as new centres are rolled out.
Chronic undervaluation of Dragon-Ukrainian Properties
What the flotation of Aricanno also highlights is the chronic undervaluation of Dragon-Ukrainian Properties. The company had net assets of $198m, or £125m at the end of last year, of which £19m represents the shareholding in Aricanno. Strip out this amount and the aforementioned £13.7m cash pile on Dragon-Ukrainian Properties balance sheet from the company's market value of £38.3m and, in effect, assets worth £92.3m are being attributed a value of only £5.6m.
Now, I am under no illusion that these assets should be trading at anything other than a deep discount to book value given the risks associated with investment in the region and lack of funding post the financial crisis for development of property. In fact, Dragon-Ukrainian Properties latest annual report and accounts reveals that the company took a $11.9m write-down on trading property and land last year.
Even so, these assets clearly have some value and should not be trading on a 94 per cent discount to their underlying value, which is currently the case. For instance, following a number of complex transactions, Dragon-Ukrainian Properties now owns a 62 per cent holding in Henryland, an operator of three shopping centres with 50,000 sq metres of gross letting space and which is also developing another three centres to double its size. To date Dragon-Ukrainian Properties has received $2.6m of dividends from Henryland, including $1.1m in January this year.
The company originally acquired a 38 per cent shareholding in Henryland in July 2007 and the carrying value of the asset was in the books at $11.1m at the end of last year, or almost $3m less than the total investment made. Since then the company has boosted its stake to 62 per cent in deals valuing Henryland at $27.3m, and Dragon-Ukrainian Properties stake at $16.9m, or £10.7m. The investment in Henryland accounts for almost 10p a share of Dragon-Ukrainian Properties net asset value of 114p. Clearly, this stake is worth more than the derisory £640,000 implied in Dragon's current share price after adjusting for cash on the balance sheet and the stake in Aricanno. The $1.1m dividends paid in January alone exceeds this sum.
Value in residential assets
It's also worth noting that Dragon-Ukrainian Properties has interests in the following residential schemes: Riviera Villas, an upmarket development in Kyiv, in which the company has invested $18.3m for a 59.6 per cent stake; Green Hills, a North American cottage style community in Kyiv suburbs in which it has invested $23m; and Obolon Residential Towers, a business-class residential complex with office and retail premises on the central square of the upmarket Obolon district in Kyiv and where construction works have recently started. Dragon-Ukrainian Properties has invested $24.6m for a 98 per cent stake in the development. The fourth scheme is in Sadok Vyshnevy, a wholly owned development of 38 apartments in which the company has invested $12.8m.
In other words, Dragon-Ukrainian Properties market valuation implies the $78.7m investment in these four residential developments is in effect being valued at less than $5m, or £3m, after adjusting for cash on the balance sheet and the stake in Aricanno! Clearly, that is a ridiculous valuation when you consider that the total residential sales for Greenhills and Riveira Villas doubled last year and at the end of May stood at $12.1m. This can only increase with the start of sales and marketing of the Obolon project. In turn, this not only improves the cash generative capacity of these developments, but mitigates risk too as the value in the assets is turned into cash.
True, residential prices in Kyiv are still 40 per cent below their 2008 peak levels so there is a long way to go before Dragon-Ukrainian Properties reaps the full benefits of its investments. That said, transactions are moving in the right direction - up 87 per cent year-on-year in 2012 - and residential prices rose by 4 per cent and 7 per cent respectively last year in the secondary and primary markets in Kyiv.
Value in land assets
By my reckoning, over two-thirds of Dragon-Ukrainian Properties' net asset value of $198m is accounted for by the four residential schemes, the shareholding in Henryland, the stake in Aricanno and the cash pile on its own balance sheet. The remaining investments mainly include land holdings of 483 hectares which were acquired for $125m in 2008. Following revaluations these land holdings were valued by surveyors CB Richard Ellis at $57m at the end of last year. Of the plots, around 20 hectares has been rezoned for construction use and the remainder, though currently registered for agricultural use, are in the process of being rezoned for residential use.
Clearly, some discount has to be applied to the land values, but by my calculations Dragon-Ukrainian Properties market valuation - after adjusting for cash on the balance sheet and the stake in Aricanno - implies the $57m carrying value of the 1,210 acres of land is in effect being valued at only $3.4m. That’s the princely sum of £2.2m, or less than £2,000 per acre which is a ludicrous valuation.
Assessing risk
It's worth noting, too, that four of Dragon-Ukrainian Properties' 10 projects are now self-funding and cash-generative. Moreover, the company is clearly targeting cashflow generation from its development and operating assets and still has that cash pile on its balance sheet, unlike other highly encumbered and overly indebted property companies that used lines of credit to fund their acquisitions. As a result, the company is not a forced seller of any of its assets.
That's an important point to note with the share price trading on a huge 70 per cent discount to net asset value. Or put it another way, the company can afford to realise value from its investments as and when market conditions are right.
In my view, a 50 per cent share price discount to net asset value of 114p is a far more reasonable valuation for this type of company. And that is hardly an aggressive rating once you consider that, after adjusting for cash on the balance sheet and the stake in Aricanno, then this implies the $146m carrying value of its remaining investments would still only be valued at $46m!
Clearly, if I am right there is a huge amount of share price upside here with Dragon-Ukrainian Properties currently trading on a bid offer spread of 32.25p to 34.5p. In fact, if my target is reached this implies a hefty 63 per cent potential upside.
Positive technical set-up
Interestingly, the technical set-up supports an overdue rerating. The share price has been trading in a tight range between 28.5p and 35p all this year and is now at the top of the range. Importantly, with the 14-day RSI showing a reading of 60, the shares are not yet in overbought territory. So a continuation of the uptrend and a chart break-out from this trading range is the most likely outcome.
It is also one that could easily see the share price swiftly move into the 38p to 41p trading range, a band that provided stiff resistance between November 2011 and the early months of last year. However, if this band can be breached then there is no resistance whatsoever until my fundamental based target price of 57p. This coincides with a major support level dating back to March through to June 2011 which finally gave way that summer. I would expect most resistance to be encountered there.
Needless to say, with Dragon-Ukrainian Properties shares trading on huge 70 per cent discount to book value, and the flotation of Aricanno highlighting the value in the company, I rate the shares a strong buy. My six month target price is 57p.
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