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OPINION

Hot property

Hot property
January 7, 2016
Hot property

LXB rock solid investment opportunity

The penny has dropped with investors that LXB Retail Properties (LXB: 97.5p), a Jersey resident closed-end real estate investment company focused on edge of town and out of town retail assets, offers a compelling buying opportunity and a low risk one at that. I highlighted the investment case in quite some detail a few months ago (‘Bag a retail property bargain, 6 October 2015) when the shares were trading at 86p, or 10 per cent below net asset value at the time.

Having run through the company’s development programme, and forward funding arrangements, it is apparent that there is substantial hidden value in its balance sheet. That’s because LXB has entered into contracts with blue chip institutions to sell a number of its retail assets over the next few years, the true value of which is not accurately reflected in its reported net asset value figure. This is down to the fact that under IFRS accounting rules independent valuers report fair value for investment properties under construction by applying the ‘Residual Method of Valuation’. Under this approach, total costs including construction costs, professional fees, contingency and finance costs together with an allowance for developer's profit are deducted from the valuer's estimate of the investment's value at completion to arrive at a surplus which is called the ‘Residual Land Value’.

The problem with valuing property on this basis is that valuers are required to reflect, amongst other things, that only a small portion of the space is pre-let even though there will be significant take up of space as the scheme reaches its fit-out phase. As a result the surveyor’s valuations, which are properly recognised for accounting purposes, are far lower than the values which LXB’s board would place on those assets when considering offers for its investments. In most cases there is a marked difference between the carrying value and the price the company would accept for a property development. At its last balance sheet date £153m of LXB’s investment portfolio, which was worth a total of £208m, was valued using this conservative 'Residual Land Value’ approach.

And this is very relevant right now because in LXB’s full-year results for the 12 months to end September 2015, released a month ago, the board have committed to put proposals to shareholders in the coming weeks which will outline the likely cash returns they can receive from a raft of property disposals over the next 14 months with a view to winding up the company in March 2017. Bearing this in mind, the company posted a 10 per cent rise in underlying net asset value to 103p in the last financial year, and analysts at broking house Stifel believe that an orderly wind up could see the company’s end net asset value rise to between 120p to 130p. I wholeheartedly agree with this assessment and with good reason too.

Calculating a sum-of-the-parts valuation

For instance, LXB’s Rushden Lakes development, a major new leisure and shopping destination in Northamptonshire, has already been pre-sold to The Crown Estate whereby it will purchase the whole Rushden Lakes investment when the pre-completion conditions are satisfied and will fund all future development costs. LXB will oversee the development and pre-letting of the remaining space.

It’s worth flagging up that practical completion of the first phase of the scheme is now expected in the first quarter this year at which point LXB will receive initial cash receipts of £70m from The Crown Estate, reflecting an over yield of 4.65 per cent for the retail elements of the scheme. Once ownership passes onto The Crown Estate, LXB will be able to book a valuation increase of at least £19.5m on the Rushden Lakes scheme, a sum worth 11p a share, or more than 10 per cent of the company’s current net asset value.

The earlier disposal of LXB’s Biggleswade retail development to Aberdeen Property Trust, under which LXB received £68.7m and is due a further £11.3m on completion of the second phase of the development, is worth considering too because the second and third phases of the development are expected to complete this spring. In fact, the development is 92 per cent pre-let and only three units remain to be leased out.

So by my reckoning, the Rushden Lakes and Biggleswade developments will generate a cash inflow of £81m in the coming months. In addition, at the end of last week, LXB sold off its investment site at Brocklebank, Greenwich to The Charities Property Fund and received initial cash proceeds of £22.8m. A further cash receipt, which is currently estimated to be £5.2m, will be paid once the scheme has achieved practical completion in the autumn. The bumper cash windfalls don’t end there either as post LXB’s financial year-end, the company received a final cash payment of £5.7m from The Crown Estate on the sale of its Banbury Gateway development, and a further £1.3m from two property disposals in Gloucester and the Isle of Sheppey.

So after factoring in all these disposals and cash receipts, I reckon that by the March 2016 half year-end, LXB’s last reported net debt position of £48.1m will have been completely wiped out. In fact, the company could be sitting on net funds of £63m, a sum worth more than a third of its market capitalisation of £172m. I also believe that within a matter of months spot net asset value could be somewhere between 117p to 120p. These are chunky cash sums and sensibly the board have already started returning some of this cash to shareholders. In the past week LXB has bought back £8.2m of shares at an average price of 96p as part of a £18m buy-back programme. However, the majority of the balance of the cash is likely to be returned as a dividend, the process through which a 45p a share cash return was made last May. Expect the company to make a further announcement regarding the likely scale and timing of the total cash return to shareholders in the coming weeks.

The bottom line is that this looks a very low risk investment opportunity to me given the schedule for practical completion on the rest of LXB’s property developments. So although the share price is within a penny of my initial target price of 99p, I now feel that on a six-month basis a valuation of 120p a share is possible. That’s my new target price. Needless to say, I rate LXB shares a strong buy on a bid-offer spread of 97p to 97.5p.

Urban&Civic well placed

Shares in Urban&Civic (UANC: 286.5p), a listed property group specialising in strategic residential land developments in key growth areas of the UK, have moved up from around 274p when I highlighted the investment case (‘Plotting a break-out’, 15 October 2015), buoyed by a positive set of full-year results which revealed a 9 per cent rise in EPRA net asset value per share to 270p and a 66 per cent hike in the full-year dividend to 2.65p a share.

The company’s key developments encompass a residential pipeline of 25,000 homes including a 1,432 acre freehold site at Alconbury Weald, incorporating Cambridgeshire's Enterprise Zone with permission for 5,000 homes; Waterbeach, a 700 acre site north-east of Cambridge where Urban & Civic has been selected by the Defence Infrastructure Organisation to develop 6,500 homes; Rugby, a 1,170 acre development in partnership with Aviva Investors where permission has been granted for 6,200 new homes; and a 2,600 plot site in Newark-upon-Trent in Nottinghamshire where Urban&Civic has an 82 per cent interest, having acquired the previous owner, Warwickshire-based property group Catesby for £34m in February. Catesby also owns another 20 sites in the Home Counties and Midlands.

In terms of these developments, the land value at Alconbury rose from £15,400 to £18,500 per unserviced plot in the 12 months to end September 2015 based on an average sales price of £230 per sq ft. This represents a 15 per cent increase on the plot value in March 2015. And executive chairman Nigel Hugill expects further gains to come, pointing out that he “will be disappointed if arrangements with all three housebuilders at Alconbury do not realise respectively more than twice the September 2015 valuations”. In other words, guidance is for a further £92.5m valuation uplift worth 64p a share on the current book value of the site. Hopkin Homes has started construction on the site and a further two housebuilders will start work in the first half this year. True, progress is six months later than prior estimates but the valuation uplift and raised guidance on final sales values more than compensates.

The site at Rugby is worth noting too. The local housing market there is strong and the unserviced plot value increased by 6.5 per cent to £12,900 in the six months to end September 2015 based on an average sales price of £230 per sq ft. Davidson Homes will build the first 250 homes and contracts are in solicitors’ hands with a second housebuilder to start work on the site soon.

So with the UK housing market strong, Urban&Civic exposed to affluent areas of the market which are benefiting from high employment and real wage growth, both of which are decent indicators for house price inflation, then the odds favour a continuation of the growth in asset valuations in the company’s land and development portfolio. I am not the only one thinking this way as analysts at Stifel forecast a further 10 per cent rise in net asset value per share to 309p by September 2016 based on their estimate of adjusted book value, and those at JP Morgan Cazenove are pencilling in a figure around 291p for the same period, rising to 318p by September 2017.

Those estimates don’t seem unreasonable to me and with the company also having the benefit of an ungeared balance sheet – net funds were £32.2m at the end of September 2015 – and borrowing facilities in excess of £100m, I am very comfortable maintaining my buy recommendation and 325p target price. On a bid-offer spread of 285p to 286.5p, I rate Urban&Civic shares a buy.

Conygar value opportunity

Shares in Aim-traded property vulture fund Conygar (CIC: 172p) have yet to hit my target price of 200p, but there are reasons to believe that the sideways consolidation in the share price could be over. I initiated coverage when the price was 131p ('Shrewd insider buying at property play', 30 Sep 2013), and last rated the shares a buy at 185p (‘Hitting target prices’, 28 April 2015).

Firstly, the shares trade on a harsh 15 per cent discount to net asset value of 203p even though that valuation is very conservative as not only are development assets of £46.6m in the books at cost, but sale prices of investment properties in the past year have been fetching almost 10 per cent more than book value. Moreover, the investment portfolio of 36 commercial properties which has a rent roll of £9.8m, and was last valued on an equivalent yield of 8 per cent, is set to benefit from higher rental income as the refurbishment of a development in Farnborough completes, and the vacant space at a site is Colwyn Bay has been recently let out. Combined, these two developments should generate more than £1m of annual rent. Also, the improvement in regional property investment markets, coupled with higher occupational demand, means that yield compression (30 basis point in the last financial year) is likely to continue with the net result of boosting asset values.

Secondly, half the carrying value of Conygar’s development portfolio is tied up in the company’s site in Haverfordwest which is in the books for just shy of £24m. The infrastructure and highways work to service the site and the 729 planned residential units completed last month and marketing of the residential units will start shortly. Also, having sold 9.6 acres on the site to Sainsbury’s for £13.75m in May 2014, the company has just bought back the land for a bargain basement £3m after the supermarket decided not to develop a 60,000 sq ft foodstore due to the current state of the food retailing market. Conygar plans to submit a planning application in March for a retail/leisure development on the land, so we can realistically expect newflow on residential sales of ‘oven-ready’ land parcels to housebuilders, and potentially planning consent for the commercial development in the months ahead. An average plot value of £40,000, or £12,000 above the value in Conygar’s accounts, would not be an unreasonable sale price.

Thirdly, the company has been recycling cash from investment property sales into opportunistic and value accretive property purchases. It certainly has the firepower to do so as balance sheet gearing is only 8 per cent of shareholders funds of £168m and the company has £57m of free cash available on its balance sheet.

Fourthly, having repurchased 4.372m shares, or 5.1 per cent of the issued share capital, at an average price of 181.5p in the 12 months to end September 2015, the board are continuing with the buy-back programme. Indeed, a further 1.66m shares were repurchased at 174p last month. This makes sense as it’s accretive to net asset value per share and also removes stock off the market.

So, with the portfolio conservatively valued, buybacks taking stock off the market, yield compression set to continue, the rent roll set to get a boost from new lettings, and news on land sales at a major development site likely in the coming months, there is no way that the shares should be trading 15 per cent below historic book value and 21 per cent below Liberum Capital’s estimate of 218p for the September 2016 year-end. The board also held the 1.75p a share dividend to provide shareholders with a 1 per cent dividend yield. It goes without saying that I rate Conygar's shares a value buy on a bid-offer spread of 171p to 172p.

Please note that I have written six columns on 14 companies this week all of which are listed below and also on my IC homepage....

MORE FROM SIMON THOMPSON...

I have written articles on the following companies this week:

Grainger: Buy at 243.5p, target 280p; Dart Group: Take profits at 580p; Crystal Amber: Hold at 159p; Redde: Take profits at 203p; Burford Capital: Run profits at 196.5p; Renew Holdings: Run profits at 404p; Plethora Solutions: Speculative buy at 4.5p (‘Stock check’, 5 January 2016)

Elegant Hotels Group: Buy at 118p, target price 130p to 135p (‘Check in for a profitable stay’, 6 January 2016)

Safestyle: Run profits at 272p ahead of pre-close statement on 25 January 2016 (‘Clear cut gains’, 6 January 2016)

Epwin: Run profits at 143p, new target 170p (‘Epwin on the acquisition trail’, 6 January 2016)

GLI Finance: Recovery buy at 37.5p (‘GLI shelves fundraise and its chief executive’, 6 January 2016)

LXB Retail Properties: Buy at 97.5p, new six-month target 120p; Urban&Civic: Buy at 286.5p, target 325p; Conygar: Buy at 172p, target 200p (‘Hot property, 7 January 2015)

■ 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