The company is due to report full year results for the 12 months to end June 2016 in a fortnight’s time, so this is a good time to consider current trading prospects especially as the shares have now recovered all of their post Brexit losses and are priced just above the 305p level at which I last recommended buying (‘Property income play with capital upside’, 23 Feb 2016). It’s a business I know well, having first advised buying the shares at 198p ('A high-yield play in the north', 18 Feb 2013), since when the board have paid out total dividends of 34.4p a share to give a total return of 71 per cent on the holding, or almost three times the total return on the FTSE All-share index.
Availability of credit is key
The first point Mr Ziff made was that post the EU Referendum “the most important thing is that we don’t see any change in the availability of credit”, adding that the financial markets can “cope far better now with the unexpected as the banks are better capitalised.”
The fact that the Monetary Policy Committee (MPC) of the Bank of England have reacted swiftly post Brexit to boost liquidity in credit markets is therefore a major positive and one reason why gilt yields have subsequently fallen to record lows. The £60bn expansion of the Bank of England’s asset purchase programme for UK government bonds is imparting monetary stimulus by lowering the yields on securities that are used to determine the cost of borrowing for households and businesses. It is also triggering portfolio rebalancing into riskier assets by current holders of government bonds, further enhancing the supply of credit to the broader economy.
Additional measures introduced by the Bank of England earlier this month include a new Term Funding Scheme (TFS) to make sure the 25 basis point cut in Bank Rate is passed onto borrowers and provide UK banks with a cost effective source of funding to support additional lending to the real economy. The scheme also provides insurance against the risk that conditions tighten in bank funding markets. The launch of a £10bn purchase programme of UK corporate bonds is significant too. It adds liquidity to lending markets and should provide more stimulus than the same amount of gilt purchases. That’s because corporate bonds are higher-yielding instruments than government bonds, so investors selling corporate debt to the Bank of England are more likely to invest the money received in other corporate assets than those selling gilts. Furthermore, by increasing demand in secondary markets, purchases by the Bank of England could reduce liquidity premia and stimulate issuance in sterling corporate bond markets.
The point being that the effects of the Bank of England’s actions are already benefiting consumers, and not just the 15 per cent or so on tracker mortgages. For instance, fixed rate mortgages have hit record low rates in the past month which means that high quality borrowers are now able to access both five-year and seven-year fixed rates mortgages at interest rates below 2 per cent. Unsecured loan rates are also more keenly priced, a reflection that the ultra low interest rate environment is here to stay for far longer than many had previously anticipated. Former Chancellor George Osborne’s prediction of a rise in mortgage rates in the event of a Brexit vote has proved wide of the mark.
Impact of Brexit on retailers
The other point that’s worth noting is that Mr Ziff says “from a retail perspective, most tenants are selling imported goods, and that does worry me. The retailer is going to take some of the pain. We may see further stress in the world of retail”.
He has a point as the 13 per cent devaluation of sterling against the euro and dollar since the EU Referendum makes imports more expensive and puts pressure on retailers’ profit margins, or could put a break on demand if they are passed on to customers in full. That said, the company has a good regional geographic spread with operations in affluent centres in Leeds, Manchester, Glasgow, Edinburgh and some activity in North London.
In terms of the portfolio mix, the flagship Merrion Shopping Centre in Leeds accounts for a third of the investment portfolio by value, a further quarter is invested in retail and leisure, and 14 per cent in out-of-town retail. This means that nearly three-quarters of the £330m investment portfolio has a retail element.
Bearing this in mind, the property book has a decent spread of high-quality tenants, low vacancy rates and generates strong cash flows. Occupancy rates were about 97 per cent across the portfolio at the start of this year and the company has not had a problem attracting new tenants to keep voids low, completing in excess of 100 leasing transactions in the six months to end December 2015.
It’s interesting that the Office for National Statistics has released the UK retail sales figures for July which have confounded the sceptics who predicted consumers would rein in spending. In fact, growth of 1.4 per cent in the month suggests the referendum result had a negligible impact on household purchases in the short term at least. Moreover, there appears to have been an improvement in consumer confidence in August with the GfK consumer confidence index showing improvement on its July reading. Given that Mr Ziff previously noted that retail activity in Leeds and Manchester is strong (which drives occupier interest and underpins institutional demand for property), then a read across from the ONS retail figures and consumer confidence surveys, would suggest that its business has probably been largely unaffected since the Brexit vote.
And that’s worth considering because analysts expect Town Centre Securities to report net rental income of £18m from its investment properties in the financial year just ended, enough to cover annual administrative expenses of about £5m, finance costs of £6.6m, and still have cash to fund the £5.5m cash cost of a 10.4p a share annual dividend. A dividend yield of 3.4 per cent is an attractive return for a company that has a progressive dividend policy, having raised the payout by two thirds in the past decade.
Development pipeline
The £330m investment portfolio aside, Mr Ziff says Town Centre Securities is on track with the redevelopment of Merrion House in Leeds, encompassing a refurbishment of 120,000 sq ft of offices and the addition of 50,000 sq ft new office space. Around £18m of the £34m cost of the project is being part funded by Leeds City Council, the joint venture partner in the development. Completion is scheduled for the first quarter in 2018 and should add £5m to Town Centre’s net assets which analysts at brokerage Liberum Capital predict will be around £193.7m, or 364p a share, at 30 June 2016. The redevelopment also adds £900,000 to the £18m rental income.
The company is progressing redevelopment of the Merrion Hotel in Leeds, located opposite the Leeds First Direct Arena, a 13,000 capacity entertainment venue. The project includes a 134 room Ibis Styles hotel and 4,000 sq ft Marco Pierre White restaurant. The build cost is £9.2m and completion is scheduled for the first half of 2017. On completion, the project is expected to add £600,000 to rental income.
Town Centre Securities has also signed a 25 year lease with an initial annual rent of £680,000 with budget hotel operator Premier Inn on a 136 bedroom hotel on Whitehall Road, part of the Whitehall Riverside Scheme in the West End of Leeds. The development is expected to complete in the first half of 2017 and has an estimated value in excess of £12.5m, a decent uplift on the £10m cost.
It’s of interest too that the company has been making selective purchases in suburbs of North London (Wood Green, Kilburn and Holloway Road, Islington) to benefit from the demographic pull of these areas. For instance, it acquired three retail units in Wood Green, North London for £6m on an initial yield of 5.5 per cent with a view to refurbishing the property and converting the upper floors into residential flats.
Importantly, Town Centre Securities’ board have the firepower to continue to make selective property purchases. That’s because it has a loan-to-value ratio of only 49 per cent, reflecting net borrowings of around £180m on the £367m portfolio, including the development book and a £20m portfolio of car parks. Moreover, £106m of debt is funded through a mortgage debenture that has 15 years to run and carries a coupon of 5.375 per cent, and the company has substantial headroom on its banking facilities, having renewed revolving credit lines with Handlesbanken (£35m), Lloyds (£35m) and RBS (£30m), all of which are on three-year terms.
Previous guidance points towards around £20m of property assets being sold this year and the cash recycled into new investments with potential to enhance tenant mix, rental income and yield.
Property outlook
In the first half of the financial year to end June 2016, Town Centre Securities net asset value per share rose by 4 per cent to 359p, reflecting a 4 per cent like-for-like property revaluation, driven evenly by a rise in estimated rental value on the portfolio and a 20 basis point compression from 5.8 per cent to 5.6 per cent in the initial yield used by surveyors to value the £330m investment portfolio.
Admittedly, I would expect surveyors to be a tad cautious in their valuations post Brexit, but equally it’s worth pointing out that Town Centre Securities’ initial yield is still above the 5 per cent level that marked the commercial property market peak in 2007. And as I pointed out in my investment column on LXB Retail Properties (LXB:65p) yesterday (‘Hot property sales’, 31 August 2016), there are transactions being done on high quality retail assets at prices sub 5 per cent net initial yield. I feel comfortable with the valuation of the portfolio, especially as the yield spread above 10-year gilts has ballooned to 5 per cent following the collapse in UK government bond yields, thus highlighting the relative yield attractions of high quality regional commercial property. I also feel there is upside from the £35m being invested in new schemes, so there is a strategy in place to add value to the portfolio.
Valuation
The bottom line is that Town Centre Securities offers a stable income stream from high quality retail assets and car parks, coupled with a track record of delivering decent investor returns. These are attractive attributes as is the rock solid dividend.
The company became a real-estate investment trust (Reit) in 2007, so is obliged to pay-out 90 per cent of the profits of the property rental business, after certain deductions, to shareholders as a Property Income Distribution. Edward Ziff, the son of founder and philanthropist, Israel Arnold Ziff, and his brother, Michael, control 46 per cent and 27.1 per cent, respectively, of the issued share capital, so there is every incentive for the board to maintain the payout. And as I noted earlier, the rental income from the investment portfolio fully supports the current level of dividend without any need to make disposals.
Interestingly, there appears to be an increasing investor appetite for small cap property shares as highlighted by the performance of my recent sector recommendations:
■ Inland: Buy at 56p, target 95p (‘Deep value small caps’, 12 July 2016)
■ Mountview Estates: Buy at 10,250p (‘Four small caps with upside potential’, 26 July 2016)
■ Conygar: Buy at 140p, revised target 180p (‘Insiders buying on solid foundations’, 11 August 2016)
■ First Property Group: Buy at 46p, target 56p (‘Exploiting sterling weakness’, 18 August 2016)
■ Telford Homes: Buy at 289p, target 370p (‘London property trading play’, 22 August 2016)
■ Alpha Real Trust: Buy at 88p, target 105p (‘Alpha seeks alpha’, 23 August 2016)
■ LXB Retail Properties:Buy at 64p (‘Hot property sales’, 31 August 2016)
So, with Town Centre Securities’ shares trading on a bid-offer spread of 305p to 310p, valuing the equity at 15 per cent below net asset value estimates of 364p a share at 30 June 2016, I feel that the shares are too lowly rated ahead of the forthcoming results on Wednesday, 14 September 2016. I have an initial price target of 336p, coinciding with a return to January’s eight-year high, and envisage further upside if the board's outlook statement is better than investors are currently discounting. Trading buy.
