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Value opportunities

Value opportunities
April 11, 2017
Value opportunities

Shares in Local Shopping REIT (LSR:32.5p), a small-cap retail sector-focused property investment company that's selling down its portfolio with a view to returning the cash proceeds to shareholders, have risen sharply after the company announced the latest auction results of its properties.

The 15 lots marketed at auction in March achieved a total price of £3.64m, or £300,000 above book value, reflecting the fact that they were higher-quality, lower-yielding property. This follows the sale of 22 properties at auction in February which realised a total of £3.53m, below book value of £3.86m, and the disposal of 22 properties in the final quarter of 2016 which realised £2m, or 1.75 per cent above book value. The company's strategy is to sell a total of 90 smaller or management intensive properties with higher non-recoverable costs at auction between October 2016 and the end of 2017 to realise around £10m of cash proceeds. In addition, a further 25 geographically dispersed properties will be marketed for private treaty sale to realise a further £5m, and a similar amount should be raised from the sale of low-yielding properties.

This means that £9m of the £25m of planned sales has now been achieved, which leaves the company with a portfolio worth £65.3m to divest. The fact that the sales have been on average in line with book value is reassuring as is the fact the company is on course to hitting the aforementioned sales targets. The key point being that if Local Shopping REIT offloads £25m of properties as planned, then this will have the effect of halving its net debt to £20m and reduce the loan-to-value-ratio on the portfolio to around 36 per cent. Having extended its £43.5m banking facility with HSBC until the end of 2019, and at an attractive rate of 2 per cent above Libor, the company is under no pressure to have a fire sale. Assuming all goes to plan, then by early next year Local Shopping REIT's property managers plan to market the company's core portfolio of 200 larger better quality properties which have a combined book value of £55m. The current proposal is to offer these a whole for a limited period.

The progress being made has not been lost on investors as Local Shopping REIT's share price is now up 22 per cent on my advised buy-in price of 26.5p when I initiated coverage last summer ('Shopping for a property bargain', 23 Aug 2016), and well ahead of the 28.5p level when I last rated the shares a buy ('Built for gains', 19 Dec 2016). As a result, the share price discount to the reported net asset value (NAV) of 43p a share has narrowed to 24 per cent.

My view now is that if Local Shopping REIT's board can continue to achieve sale prices around current valuations, and the portfolio was last valued on an equivalent yield of 9.5 per cent, then a liquidation value of £30m, or 36p a share, is a minimum target. I have arrived at this figure after deducting all net borrowings secured on the portfolio, factoring in retained net profits earned by the company between now and the start of 2018, and after accounting for all professional fees.

It's also entirely possible that as the auction process proceeds - Local Shopping REIT is offering 15 of its smaller properties at bi-monthly auctions - and the rump of the portfolio becomes more concentrated on the higher-quality and larger properties, a larger rival may become interested in buying the company. This would offer upside to my liquidation value which in any case could yet prove conservative. In the circumstances, I feel it's well worth running your paper gains on this holding and await news of the next round of property auctions. Run profits.

 

easyHotel has multiple options

Aim-traded shares in budget hotel operator easyHotel (EZH:89p) have drifted slightly after the company announced that Islington Borough Council has refused retrospective planning permission in relation to 78 of the 162 bedrooms at its Old Street hotel, located on the edge of London's financial district, which were built without planning consent.

I first advised buying the shares at 83p ('Check in for a profitable booking', 14 Dec 2015), reiterated that advice after the company pulled off a £38m share placing at 100p a share in the autumn ('Investors check into easyHotels', 6 Oct 2016), and remained a buyer at 93p after the full-year results ('Investments worth checking into, 12 Dec 2016). When I initiated coverage I was fully aware of the planning issue, and flagged it at the time, and feel that some perspective is needed here.

Firstly, the current management team led by chief executive Guy Parsons, the former chief executive of leading budget hotel chain Travelodge, inherited this issue when they were appointed as the Old Street hotel had been extended three years ago by previous management. The important point is that all of the options available to the company suggest a cash profit enhancing outcome for the company.

That's because the net book value of the hotel is £13m and it generated cash profits of £1.6m on revenue of £2.7m last year based on an average occupancy rate of 85 per cent and an average room rate of £54 per night, according to analyst Alex Paterson of broking house Investec. He notes that the board is confident that a sale of the hotel should fund the development of at least 500 new rooms in the UK, implying a sale price of £27.5m or double the book value based on Investec's estimated development costs of £55,000 per room. The property only has five floors, whereas the neighbouring one has seven, so offering a developer potential to build further floors subject to planning consent, and apply for change of use to exploit the valuable location of the site. If this scenario pans out then Investec believes the cash proceeds could be recycled to produce annual cash profits of £3.4m based on a return on capital employed of 12.5 per cent, or more than double the current level of the hotel's profits.

Another option outlined by easyHotel's management is a partial sale of the upper floors of the Old Street property which were developed without planning consent, the proceeds from which would fund the development of 170 rooms in the UK. This suggests cash proceeds of £9.35m from the sale of the upper floors which could be recycled to generate cash profits of £1.2m based on a return of capital employed of 12.5 per cent. Investec believes that the reduction in room stock at Old Street would enable the hotel to lift its occupancy rate to 90 per cent, and its average daily room rate to £60, meaning that a partial sale would still be accretive to cash profits.

The third option outlined by Investec is to retain the whole building and simply let out the upper floors as office space which would bring in up to £1m of annual rent at minimal cost. Add in the income from the rooms with planning consent on the lower floors of the building and this option would also be accretive to cash profits.

The final option is to let out the whole building as office space at between £60 to £65 per sq ft to generate a minimum of £2.4m of rental income, or 50 per cent higher than the cash profits earned from the hotel last year, implying a value of the property of £27.5m based on a yield of 8.7 per cent. This option is also accretive to cash profits.

The point here is that all options available to the company should in the medium term provide a boost to cash profits. Of course, there will be a short-term dip in profits as the company will have to stop trading from the upper floors of the Old Street hotel to comply with Islington Borough Council refusal of retrospective planning consent, but I can see beyond this. And so can non-executive chairman Jonathan Lane OBE who has just splashed out almost £100,000 buying 115,000 shares at 86p each.

His purchase has solid foundations. As I pointed out in my previous articles, post last autumn's share placing at 100p a share, easyHotel has pro-forma net assets of £70m, a sum worth 70p a share, of which net cash of £43.1m is being used to fund the accelerated hotel development rollout and one which supports my 120p target price. I would therefore use the small pullback in easyHotel's share price as a further buying opportunity. Buy.

 

Deep value offering

When I included shares in Aim-traded investment company Gresham House Strategic (GHS:855p) in last year's Bargain Shares Portfolio at just shy of 800p, the share price was trading 18 per cent below book value of 975p even though the company was cashed up to make new investments - net funds of £15.2m at the time equated to 42 per cent of the company's NAV.

Since then NAV per share has risen 10 per cent to 1,072p by the end of March 2017, a fairly impressive performance considering the relatively high proportion of cash on the company's balance sheet. One reason for this decent investment performance is the 28 per cent rise in the share price of Aim-traded technology company IMImobile (IMO:191p), a business that helps companies engage with their customers across all mobile devices by offering smart software products based on proprietary technology. This is Gresham House Strategic's largest holding and it realised some of this paper gain by transferring up to £7.5m shares in IMImobile into a Strategic Co-Investment Agreement with Gresham House Strategic Public Equity Fund LP. It still retains a decent holding, though, which is sensible as IMImobile's valuation is not overly extended and recent contract news, and an earnings-accretive acquisition, both announced in the past few weeks, suggest that investors are likely to continue to warm to the company's shares.

Moreover, in line with the board's policy of returning some of the profit from realisations to shareholders, Gresham House Strategic's board is distributing £861,000, or almost half the £1.7m realised profits, through dividends and share buybacks. The directors will seek approval to pay a maiden dividend of 15p a share at the forthcoming annual meeting following the release of final results for the 12 months to 31 March 2017. The proposed payout will cost £553,000 with the balance of the capital return being deployed on share buybacks.

That's well worth doing because share buy backs are highly accretive to NAV with the shares trading on a 20 per cent-plus discount. In fact, analysts at Liberum Capital calculate that the company's NAV has kicked on again this month, rising by 4.3 per cent to 1,118p a share since end of March 2017. That's because a number of portfolio companies have seen their share prices perform well in the past six trading days: IMImobile is up by 9.2 per cent to close in on an all-time high; plant hire company Northbridge Industrial Services (NBI:100p) is up almost 6 per cent; book publisher Quarto (QRT:265p) has risen 5 per cent; and Aim-traded shares in newly listed Warpaint London (W7L:185p), a specialist supplier of colour cosmetics and owner of the W7 brand, has surged 16 per cent.

Cashed up to make further investments, and with potential for outperformance of investee companies, I continue to see obvious scope for Gresham House Strategic's 23 per cent share price discount to narrow. Buy.

 

MORE FROM SIMON THOMPSON...

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