Weathering the Russian storm
Shares in Raven Russia (RUS: 53p), a Russian warehouse developer and investor, are largely unchanged since my update just before Christmas (‘Lessons to learn from 2014’, 15 December 2014), although it’s hardly been plain sailing given the macroeconomic and geopolitical situation in Russia.
However, there is no doubt in my mind that Raven Russia is a quality company and its business is well underpinned by a supply:demand imbalance of Grade 'A' warehouses in Moscow, St Petersburg, Rostov-on-Don and Novosibirsk. It is well funded, too, with free cash of $247m (£158m) on its balance sheet at the end of 2014, a sum equivalent to 21p a share, and ample credit lines in place.
In fact, the company successfully refinanced $275m of credit lines last year to cut the borrowing cost on its $1.6bn investment portfolio by 20 basis points to 7 per cent and maintain an average weighted term to maturity on this debt of 4.8 years. The annual interest charge of $68m on gross borrowings of $892m is covered more than three times over by annualised net operating income of $199m including pre-lets ($185m on a fully contracted basis) on a portfolio of 1.4m square metres of warehouse space. Voids are 6 per cent, including new space which was launched at the end of last year, and about half of the tenants are multi-nationals. The surplus income from this rental stream underpins the board’s policy of buying back shares through a tender offer twice a year in lieu of dividends. Last year’s distribution equated to 6p a share, or 11 per cent of the current share price.
Of course, the turmoil in Russia has impacted the value of Raven Russia’s properties which were downvalued by $133m at the end of last year. As a result, net asset value per share fell from 126 cents to 106 cents, albeit this was better than many analysts had predicted. At current exchange rates, net asset value equates to 68p a share.
Rent protection
Importantly, lease breaks and expiries this year only account for $17m of that bumper rent roll on 140,000 square metres of space, or 1 per cent of the total portfolio. Renewal terms have already been agreed on 75,000 square metres of space. The company has US dollar-pegged lease contracts with its tenants so has largely been insulated from the devaluation of the rouble. However, Raven Russia has entered dialogue with certain domestic tenants facing early maturity on their leases with a view to possibly accepting rouble rents with annual Russian inflationary indexation.
True, if the rouble plunges against the US dollar again then this would undermine the capital value of properties with rouble denominated rents, but the flip side is that with Russian inflation rate running at over 16 per cent, then the rent increases in local currencies will act as a hedge against currency weakness. And of course it’s better to have a property occupied and generating income than letting a good tenant leave. Plus, in the event of the rouble recovering its lost ground against the US dollar, then there would be a currency gain on the value of properties with tenants paying rents in local currency.
It goes without saying that the geopolitical situation remains uncertain, but a 22 per cent share price discount to spot net asset value of 68p a share, based on a sterling US dollar cross rate of £1:US$1:56, coupled with a 11 per cent dividend yield is attractive. Priced on a bid-offer spread of 52.5p to 53p, the shares are still worth holding.
Foreign cash returns
Maintaining the overseas theme, Aim-traded Dragon Ukrainian Properties & Development (DUPD: 28p), an owner and developer of shopping centres and residential properties in Ukraine, has sold the rights to develop the second phase of its Obolon project to an unrelated party in return for a cash payment of $5m which will be made in four equal quarterly instalments this year.
The second phase of the Obolon project comprises the second residential tower of 118 apartments as well as 1,925 square metres of commercial space. The company has sold 118 apartments of the 160 apartments in the first phase of the project to date, and also 2,230 of commercial space. It looks a sensible deal to me as it frees up more cash for the debt free company and is in line with the policy of selling off assets with a view to return surplus cash to shareholders.
By my reckoning after adjusting for the $6m cash returned to shareholders in January - a sum equivalent to 3.6p per share – and after factoring in the final cash payment of $3.7m received from the disposal of Dragon’s interests in the Henryland shopping centres, the company’s pro-forma cash pile is likely to be around $16m at next month’s half-year end after accounting for operating expenses. This equates to £10.2m at current exchange rates, or the equivalent of 9.2p per Dragon share.
Moreover, Dragon also owns a 12.5 per cent stake in London-listed and Aim-traded Arricano Real Estate (Aim: ARO - $2.25), a leading real-estate developer in Ukraine specialising in operating shopping centres. This holding is worth £19.6m, or 17p per Dragon share. In other words, cash on the balance sheet and the stake in Arricano equate to Dragon's market value of £30m which gives a free ride on Dragon’s other assets which had a carrying value of $100m, less total liabilities of $19.5m, at the last balance sheet date. Of course, there are likely to be write-downs to the value of these assets due to the sharp appreciation of the US dollar against the Hryvnia since Dragon last reported its financial results. But even taking this into consideration, the shares should not be trading on a 67 per cent discount to historic book value of 84p after adjusting for the cash return in January.
This substantial asset backing helps explain why the shares have held up despite the problems in Ukraine. In fact, after factoring in the payment of that 3.5p a share dividend, Dragon’s share price is up 20 per cent since I last updated the investment case (‘A tinci gain worth taking’, 6 January 2015), albeit it is still 10 per cent adrift of my original buy recommendation (‘Super sleuthing’, 16 September 2013). I would continue to hold the shares, trading on a bid-offer spread of 26p to 28p, for news of further cash returns.
Far eastern value play
Shares in London-listed property developer and closed-end investment fund Macau Property Opportunities (MPO: 214p) have drifted 9 per cent since my last investment column on the company (‘Wired up for gains’, 11 November 2014), but are still 33 per cent ahead of my recommended buy in price of 177p when I initiated coverage ('Far Eastern delight', 6 September 2013) after taking into account the cash return of 21p-a-share in April last year.
This subdued performance in the past six months largely reflects a softening of Macau’s property market in the wake of China's anti-graft and anti-money laundering campaign, and the government’s attempts to curb the double-digit rise in property values in the Chinese equivalent of Las Vegas. Macau is now in a transition phase with the dynamics of its gaming industry shifting away from VIP high rollers towards the higher margin mass market, and a planned, longer term rebalancing of the economy towards a greater diversity of commercial activity. As a result, analysts predict that gaming revenue in the former Portuguese territory will be flat this year at around $44bn (£28bn), following 2.6 per cent contraction in 2014.
That said, visitor numbers to Macau still increased to a record high of 31.5m in 2014, representing a 7.5 per cent year-on-year increase, and the visitor mix is expected to improve with the opening of several new five-star hotels, which will be part of the upcoming gaming resorts in Cotai. Over the next three years, six new casino resorts will open, boosting the number of hotel rooms in the territory from 29,000 to 42,500 - still 110,000 fewer than in Las Vegas. Some 35,000 new foreign workers, or almost 10 per cent of Macau's working population, will be needed to staff these resorts. This is highly supportive of both the residential property market, and demand for commercial space too given the ongoing growth in visitor numbers.
Indeed, the new phase of casino developments will be heavily geared towards China's growing middle class - the key to sustainable future growth in the territory. This in turn is expected to drive mass-market gaming, which is significantly more profitable and less volatile than the VIP segment upon which Macau had been too dependent and is the ongoing target of China’s anti-graft campaign.
Given this back drop it’s worth noting that housing starts remain low, supply is tight, and volumes in the residential market are expected to rise by around 5 per cent this year to around 8,000 transactions, albeit that is a third less than in 2013 and a far cry from the peak of 17,000. Still, this represents a stabilisation of market activity and should help support Macau Property's property valuations following a 2 per cent decline in the second half of 2014. It’s worth pointing out though that after factoring in the weakness of sterling against the greenback, the company’s reporting currency, adjusted net asset value per share actually rose from 286p to 302p in the six month period.
Cashed up for opportunistic buys and share buy-backs
I would also flag up that the company has been doing some smart deals to release cash for future opportunistic acquisitions including refinancing its Fountainside niche residential development. This asset is in the books for $78m, or around 14 per cent of the portfolio’s total value. A new $28.4m loan on the development replaces an existing $12.9m facility and releases $15.5m of free cash for the company to deploy elsewhere. Also, all of Fountainside's 27 pre-sold units have been released as collateral which will result in $19m of unrestricted sales proceeds upon handover of these units in the near future.
Before these transactions, Macau Properties had gross debt of $151m on a portfolio worth $548m, representing a loan-to-value ratio of 27 per cent, and free cash on its balance sheet of $10.4m. So by my reckoning the loan-to-value ratio is now closer to 31 per cent, and Macau Properties’ free cash has risen more than four-fold to $46m, or the equivalent of 38p per share, after factoring in the net proceeds from the 27 pre-sold units at Fountainside.
Some of this cash is sensibly being used for net asset value accretive share buy backs: the company purchased 3.6 per cent of its share capital in the second half of last year at an average price of 245p, and in the past few weeks has repurchased a total of 950,000 shares, representing 1.2 per cent of its share capital at an average price of 214p, a 29 per cent discount to the last reported book value per share.
The company’s investment manager, Sniper Investments, clearly sees the value on offer as it purchased 250,000 shares last week at 210p each to take its stake in Macau Properties to 10.65m shares, or 13.7 per cent of the share capital. I would expect further buybacks because every one per cent of the share capital repurchased costs the company £1.66m – Macau now has 77.5m shares in issue – and boosts net asset value per share by almost a penny. It is also supportive of the share price, by removing excess stock off the market. I reckon the spot net asset value per share is currently around 305p.
So although the property market in Macau is clearly less active than last year, I feel that this fact is more than reflected in a 30 per cent discount to spot net asset value per share. I also believe the medium-term fundamentals of the market are sound. On a bid-offer spread of 210p-214p, I rate Macau Property's shares a medium-term value buy.
Please note that I published an article with all the share recommendations I have made this year at the end of last month.
■ 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 £2.95 postage and packaging. Simon has published an article outlining the content: 'Secrets to successful stockpicking'
