The two tenanted office buildings, located in Warsaw and the northern part of the Tri-City region in Poland, were purchased from the USS Fprop Managed Property Fund. First Property earns a management fee from this fund but its mandate is due to end in August when the fund winds itself up. As a result the company has been actively investing its own capital over the past 12 months in order to replace the anticipated lost income previously earned from USS Fprop.
Smart deal making
The latest deals look shrewd business. The two properties are held in special purpose vehicles (SPVs) and had borrowings of €75m (£59m), but this debt is non-recourse to the group so is ring fenced which mitigates risk. First Property paid a total consideration of €4.9m (£3.9m) to acquire these SPVs, but given the high debt funding and high property yields on the assets being acquired, then the two properties are expected to generate a profit before tax of £3m for First Property on an annualised basis. For the current financial year to end 31 March 2015, the contribution will be £840,000, so in effect in little over 15 months First Property will have recouped all of its equity investment.
The two deals follow on from five other property acquisitions since November 2013 which now means that First Property owns six direct property holdings, three of which are in Poland and the other three are in Romania. The company also has five properties in its Fprop Opportunities Polish-focused investment fund in which First Property owns a 76 per cent equity stake. In aggregate all these properties are valued at about €184m (£144m), or around 40 per cent of the total property managed by First Property, so the company has changed radically from the one in which I first recommended buying the shares at 18.5p in my 2011 Bargain Shares portfolio.
Indeed, by my reckoning First Property will have gross debt of around £120m at a group level following completion of these latest deals, compared to shareholders funds of £26.6m at the last balance sheet date, but it’s worth noting that all this debt is non-recourse as it all sits within the SPVs which own the properties. True, a debt to equity ratio of this magnitude would ordinarily raise alarm bells, but given the fact that the debt is ring fenced and the properties are generating strong cashflow and income, then I am comfortable with the unconventional nature of the group structure.
Attractive valuation
It’s also worth flagging up that the company’s ‘recurring’ profits have increased dramatically as a result of these six property deals. Analyst Chris Thomas at brokerage Arden Partners expects the company to now report pre-tax profits of £7m for the 12 months to 31 March 2015, a 10 per cent upgrade, and well ahead of the £6.6m profit reported last fiscal year when the company benefited from substantial one-off trading gains. On this basis expect EPS of 5.1p and a dividend per share of 1.19p, up from 1.12p. For the financial year to March 2016, Mr Thomas has raised his pre-tax profit estimate by more than half to £7.3m to produce EPS of 4.6p and to support a further rise in the payout to 1.26p a share. This means the shares are priced on a forward PE ratio of 7 and offer an attractive prospective dividend yield of 3.8 per cent.
The share price is also well supported by the underlying value of First Property's assets. As I have noted before the company values its property very conservatively, but once you adjust the last reported net asset value per share of £25.8m, or 22.8p a share, to factor in the current market valuations of all the investments First Property owns, then book value per share rises to about 29p on a marked-to-market basis. In my book a 10 per cent premium to net asset value is still an attractive entry point given the solid recurring revenue stream from First Property's portfolio and potential for the company to raise the dividend while paying down debt. It’s also worth considering the favourable macro back drop in Poland.
Positive economic back drop
Despite the headwinds in Eastern Europe and Ukraine, economic growth is expected to be around 3 per cent in Poland in 2014 with a similar rate of growth predicted in 2015. Since 2009, Poland has posted aggregate GDP growth of 16 per which compares very favourably to a contraction across the Eurozone in the order of 1.2 per cent over the same period. Inflation is close to zero in the country and the reference interest rate stands at 2 per cent, following a recent 0.5 per cent cut. Importantly, the Polish Zloty/euro exchange rate has been relatively stable at for a number of years.
Given the positive economic back drop, it’s hardly a surprise that occupational demand for commercial property has been on the rise, but so too has new supply across all property sectors. The rate of increase in supply is exceeding the rate of take-up and vacancy rates are forecast to rise, in particular for offices in Warsaw and regional shopping centres. However, this is not an issue for First Property. For instance, its multi-let shopping centre in Ostrowiec, in Southern Poland, which is owned by Fprop Opportunities, has an unexpired lease term of five years.
Moreover, the properties in Poland generate an aggregate annualised rate of return on equity in excess of 30 per cent per annum. And these high returns are attracting capital flows: investment demand is mainly from German, US and UK investors and for large prime properties. The transaction volume for 2014 is expected to exceed €3bn, similar to 2013, itself the highest volume since 2006.
It’s worth noting that First Property's income stream is also underpinned by management fee income on its UK Pension Property Portfolio Fund which generates a 6.3 per cent ungeared return on the £93m assets held. This is fully invested in 21 recessionary-resilient UK commercial properties whose capital values have risen during the course of last year as the market for secondary property recovers. Expect this trend to continue. The portfolio of properties, which was put together after the onset of the credit crunch, has voids of only one per cent and a weighted average unexpired lease term of over nine years.
The company also earns profits from its FProp PDR fund which was set up in October 2013 with a view to invest in office buildings in the UK with intention of converting them to residential use. The partnership, which is closed ended, has a life until May 2018 and First Property takes a 20 per cent slice of all the profits earned. At launch the company invested £2m for a 5 per cent equity stake in the £40m fund.
Target price
I last updated the investment case when the share price was 32p following the company’s bumper half-year results (‘Income stocks with capital upside’, 1 December 2014). The price subsequently hit my original target price of 35p in mid-December, but I still contend that my upgraded target price range of 38p to 40p outlined in that article is achievable. So on a bid-offer spread of 31p to 32p, I continue to rate First Property's shares a decent income buy with capital especially as the company has a further £10m of cash available for opportunistic and value accretive acquisitions.
Tender offer from Cenkos
The board of Cenkos Securities (CNKS: 192p) have clearly been listening to their shareholder base. Indeed, when I last updated the investment case when the price was 158p (‘Unravelling the Quindell fiasco’, 20 November 2014), I noted at the time:
“A single digit PE ratio and a high dividend yield represent value, so it will be interesting to see whether Cenkos’ board take advantage of their company’s depressed share price to undertake earnings enhancing share buy backs. They have done so before and it would send a very positive signal to shareholders to arrest the share price decline. Share buy backs were being considered at the time of the interim results in September and given the share price slump since then at the current level they would be significantly earnings accretive.”
And this is exactly what the company announced a few weeks later by appointing corporate advisers Smith & Williamson to make a tender offer for up to 5.7m shares, or 9 per cent of the issued share capital, at 188p each. If you tendered your shares then a cheque will be dispatched on 16 January with the proceeds. Moreover, shares in Cenkos have rallied strongly, hitting a high of 200p earlier this week, and making up some of the lost ground following the fall-out surrounding beleaguered insurance outsourcer Quindell (QPP: 79p), a client of Cenkos. Investor sentiment has clearly improved markedly.
By my reckoning after accounting for the payment of a 7p a share interim dividend, and the £10.7m spent on the tender offer, the company is now sitting on 48p a share of cash on its balance sheet based on a reduced share capital of 58m shares in issue. That’s the equivalent of 25 per cent of the current share price. Factoring in the payment of a 13p a share full-year dividend as analysts Mark Thomas and Martyn King at Edison Investment Research predict and the prospective dividend yield is pretty healthy at 7 per cent. Edison are holding their forecasts for 2015 at 'normal' revenues of £60m and pre-tax profits of £12.4m, a flat performance on 2014 once you strip out the bumper windfall Cenkos earned last year from the IPO of the AA (AA.: 348p).
However, with the earnings enhancing share buy-back factored in I would expect an upgrade in the order of 8 per cent to Edison’s previous EPS estimate of 17.8p for 2015. On this basis, this means that the 16p a share forecast dividend for 2015 would be covered 1.2 times. That may seem tight, but with the company’s balance sheet cash rich, Cenkos’ board have the flexibility of raising the payout again to reward loyal shareholders. They also have substantial shareholdings so it’s in their interests to maintain a progressive dividend policy.
So although Cenkos’ shares have recovered strongly since my last article, I would continue to hold the shares as a prospective yield of 8.6 per cent is attractive in my book, while a cash-adjusted PE ratio of 7 for fiscal 2015 is hardly exacting. In fact, Edison’s profit estimates look conservative given that the company continues to raise funds, and earn corporate broking fees for its clients: in the final quarter of 2014, Cenkos raised well over £300m in equity placings for eight corporate clients alone.
Please note that I first recommended buying Cenkos shares at 159p (‘Broking for success’, 20 May 2014), and subsequently updated the investment case after the company released forecast busting results last autumn when the price had risen to 250p (‘Broking for more success’, 18 September 2014).
Farm-out over for Global Energy
Shares in Aim-traded South American oil explorer and producer Global Energy Development (GED: 45p) have pulled back by 6 per cent this morning on news that Everest Hill Energy has decided to terminate its two farm-out agreements with the company given the depressed oil price.
Following the signing of the farm-out agreements early last year, Global Energy retained a 50 per cent interest in its Bolivar license area, located in the Middle Magdalena valley in Colombia, and had a fully carried interest on three wells. The portfolio contains 32.2m barrels (1P-proved), 55m barrels (2P-proved and probable), and 184m barrels (3P- proved, probable and possible) and Everest was fronting drilling costs of $24m (£15m). In addition, Global Energy had a free carry on its Bocachico license area in the Middle Magdalena Basin containing 11m barrels (1P-proved), and 40.4m barrels (2P-proved and probable). Both licences now return to Global Energy and I would expect the drilling programme to be put on hold in the current subdued oil price environment.
On a positive note, Global Energy recently completed the attractive disposal of it Llanos portfolio, a deal I commented on last month when the shares were around the current level (‘Undervalued and unloved oil plays’, 17 December 2014). That sale was based on an oil price well north of $90 a barrel, so it was a smart bit of business in hindsight. Moreover, the cash consideration of US$50m (£31.8m) represented a 35 per cent premium to the valuation analysts attributed to these assets. Having settled debt and interest payments, Global Energy now has net cash of $42m, or £28m at current exchange rates. To put this figure into some perspective, the company has a market value of just £16m based on 36.1m shares in issue.
Or put it another way, net funds now account for 77p per share, or 71 per cent more than Global Energy’s current share price! With such substantial cash backing I still maintain that the shares are a value buy ahead of an announcement from the company on the use of the cash windfall. Analyst Andrew McGeary at broking house Northland Capital has offered the same advice to his clients this morning.
■ Simon Thompson's 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 stockpicking'
