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A trio of property plays

Simon Thompson has been reaping high returns in the property sector, and expects to continue doing so
October 16, 2017

The real-estate and housebuilding sectors have been a profitable hunting ground over the past few years, and not by chance, either. In fact, I have targeted property-related plays in order to exploit the positive tailwind on companies’ earnings and asset values, which has resulted from the ultra easy monetary policy being pursued by the Bank of England.

One effect of rock-bottom gilt yields is to force investors up the yield curve in search of income, property being an obvious home for their capital. Moreover, when the Bank of England’s rate-setting committee finally starts raising base rates again, and they are expected to do so at next month’s meeting, the interest rate cycle is going to be painfully slow, so don’t expect any material change in the yield curve on which swap rates are priced and that dictate borrowing costs for both residential and commercial mortgages.

I am also alert to the fact that the best property gains are derived in regions with high levels of employment and positive demographics. This is why I have focused on housebuilders and land developers specialising in the south-east of England property market. I even made a contrarian call on the London market last summer ('London property trading play', 22 August 2016), when I spotted a value opportunity in the shares of east London housebuilder Telford Homes (TEF:397p). At the time I believed that investors were being overly cautious about the company's trading prospects even after factoring in a cooling of the housing market in the capital. I maintained a positive stance when I last updated the investment case ('Running profits and banking gains', 5 June 2017), when Telford’s share price was around 412p, a decent return on the 289p initial entry price. Since then, the company has paid out a final dividend of 8.5p a share to make a total of 15.7p a share for the 12 months to the end of March 2017.

Importantly, the company continues to de-risk its £1.5bn plus development pipeline of 4,000 new homes by entering into build-to-rent funding arrangements with large institutional investors on whole sites, while at the same time targeting the lower end of the London property market where there are chronic housing shortages. This strategy not only de-risks the forward sales pipeline, but accelerates profit recognition, drives a higher return on capital as Telford no longer needs to fund these developments, and reduces the company's gearing levels as capital is released from its land bank and from working capital. Net debt of £14m at the March 2017 year-end equated to a meagre 7 per cent of shareholders' funds.

Telford is currently developing 500 build-to-rent homes with a gross development value of £236m, and earlier this year signed an agreement with Greystar, a US real-estate developer and management company, to deliver 894 build-to-rent homes at the former Royal Mail Depot in Battersea, south London. Detailed planning consent on that site is expected early next year. I also understand that “discussions are progressing with a number of large-scale investors regarding individual deals and long-term partnerships”. This underlines Telford’s status as a highly skilled partner able to acquire land, achieve planning consents and build quality homes.

The focus on the lower end of the London market – the average selling price was £530,000 in the first half to the end of September 2017 – is highlighted by two recent announcements: the acquisition of a 1.06-acre site in Hackney Wick, east London, with planning for 120 homes; and the selection of the company as the preferred partner by the London Borough of Brent for the redevelopment of 236 homes on a site in Kilburn, north London. The gross development value of both sites is around £175m.

The combination of Telford’s build-to-rent forward sales and lower price points on open-market sales means that the business has experienced limited impact from market uncertainty surrounding Brexit negotiations, and the fallout from stamp duty and income tax changes that have directly impacted buy-to-let investors and subdued demand in the prime London market. Indeed, Telford's forward order book of £580m equates to 70 per cent of forecast sales over the next two financial years, and it is on track to increase pre-tax profit from £34.1m last year to in excess of £40m in the 12 months to the end of March 2018, supporting expectations of a hike in the dividend to 17p a share. Post a pre-close half-year trading update, analyst Gavin Gago at broker Peel Hunt predicts that EPS will rise from 36.6p to 47.1p based on pre-tax profits of £44m on revenue up 19 per cent to £346m. Mark Hughes and Hannah Crowe at Equity Development have similar forecasts.

On this basis, the shares are rated on 8.5 times forward earnings, offer a 4.25 per cent prospective dividend yield and are priced on 1.3 times likely year-end book value of about 300p. That’s still an attractive rating in my book, and one that offers scope for a narrowing of the valuation gap with peers: 9 per cent discount on a PE ratio and 25 per cent on a price-to-book value basis, according to Equity Development. I would also flag up that Telford is targeting pre-tax profit of over £50m in the 2018-19 financial year, and has already secured more than 60 per cent of the gross profits needed to hit that target. Run profits.

 

Revisiting a bootiful investment

I have been taking another close look at residential land developer and construction company Henry Boot (BOOT:305p). It’s a business I know well, having made a strong case to buy the shares at 205p ('A bootiful investment', 19 February 2015). The price subsequently hit my 300p target price after the company announced a strong start to the year ('Five growth opportunities', 30 May 2017), news of which prompted analyst Nick Spoliar at broker WH Ireland to raise its full-year pre-tax profit and EPS forecasts by 10 per cent to £45m and 25.9p, respectively. Those forecasts look solid after Henry Boot raised its half-year pre-tax profit forecast by almost 9 per cent to £22.6m, representing exactly half the full-year estimate.

The company’s property development arm is delivering schemes with a gross development value of £700m, and has over £500m of work in the pipeline. Contracts have been de-risked as the division is taking on larger, pre-funded and pre-let schemes, the trade-off being lower margin for lower risk. For example, two massive warehouse distribution schemes at Markham Vale, located off Junction 29a of the M1, have both been forward-funded and expect a handover to the tenants at the end of this year. The £333m Aberdeen Exhibition Centre, fully funded by Aberdeen City Council, is progressing on time and on budget, with the first phase due to complete in mid-2019.

The solid income from these de-risked construction projects is supplemented by rental income from a £132m investment property portfolio and by the sale of land by Hallam Land, the company’s land development arm, which holds interests in 169 sites, equating to over 12,000 acres of land. In the first half, Hallam Land won planning permission on 2,675 plots and ended the six-month period with almost 18,000 plots for sale across 53 of its sites, and a further 9,700 plots across 27 sites in the planning process.

This huge land bank is held in Henry Boot’s balance sheet at a cost of £106m, so there is massive hidden value here. Based on the land bank eventually yielding 53,000 permissioned plots, analyst Guy Hewitt at broker FinnCap values it at a discounted net present value of £430m – a sum worth 324p a share – explaining why the company makes chunky profits when land is sold at its open market value. In the first half, Hallam Land made an operating profit of £8.2m on £40.2m of land sales from eight sites with planning permission for 960 homes. Since then it has sold more than 1,000 plots, has exchanged four contracts for delivery in 2018 and has another six in negotiations. This is highly supportive of another hefty profit contribution in the second half and beyond, not to mention underpinning expectations of a 33 per cent reduction in net debt to £42m by the 2017 year-end, as analyst Daniel Cowan at Investec Securities predicts, representing modest balance sheet gearing of 16 per cent. It also represents good news for the dividend that was raised by 12 per cent at the half-year stage, in line with analysts’ estimates of a full-year payout of 7.8p a share.

So, with the shares trading on 12 times full-year earnings estimates, offering a 2.6 per cent prospective dividend yield, and priced on a 22 per cent discount to FinnCap’s 398p-a-share sum-of-the-parts valuation, I rate the shares a buy.

 

A regional property play

Leeds-based property investment and development company Town Centre Securities (TOWN: 310p) continues to offer a medium-term investment opportunity, and a decent income, too. The board has just raised the dividend per share from 11p to 11.5p, with the final payout of 8.25p going ex-dividend on Thursday 7 December.

It was the prospect of a solid income – the board has never cut the payout since the company listed in 1960 – coupled with capital upside from a regional property recovery that prompted me to recommend buying the shares at 198p ('A high-yield play in the north', 18 February 2013). The board has paid out total dividends of 45.5p a share since then.

Key to the payout is a £19m annual rent roll derived from a £323m investment portfolio, underpinned by £10m rent from the flagship Merrion Centre shopping complex in Leeds, which is 99 per cent let out and boasts some blue-chip tenants and government leases; a car park business that generated £3.9m operating profit last year; and rental income that’s coming through strongly from a development programme.

For example, in a few months' time, Town Centre will complete a state-of-the-art 170,000 sq ft office building, Merrion House, in Leeds, which will be occupied by joint-venture partner Leeds City Council on a 25-year lease. On handover, its share of the rental income increases from £700,000 to £1.64m, supporting expectations of a 7 per cent rise in net income to £21.4m in the financial year-end to June 2018. This rent roll will also see the full benefit of £680,000 of annual rental income from a Premier Inn at Whitehall Road, Leeds, which was completed just before the end of the 2017 financial year, and a new Ibis Style Merrion Hotel, located opposite the 13,000 capacity Leeds First Direct Arena, which was completed in March and is trading ahead of expectations. The company is also in line for a decent cash return on the Urban Splash-led redevelopment of Brownsfield Mill, Manchester, into 31 loft-style flats. Town Centre will receive £1m on the granting of planning permission and 12.5 per cent of the sale proceeds of the apartments.

Interestingly, Town Centre’s directors also see upside from the private rented sector, having retained ownership of the residential development at Piccadilly Basin, Manchester. It is on site with a 91-unit development that is expected to take 21 months to complete at a cost of £22m and generate annual rental income of £1.2m. In addition, planning permission has been granted for a further 126 units as part of a framework agreement that could see 800 units, worth £250m, being developed. Bearing in mind the capital requirement for these developments, Town Centre’s net borrowings of £188m equate to just half the £381m portfolio value and there is ample headroom on bank facilities. Also, it has made £19m-worth of property sales in Scotland at prices ahead of book value with a view to recycling the capital specifically into developments in Leeds, Manchester and London suburbs.

Trading on a 14 per cent discount to net asset value of 359p a share, offering a dividend yield of 3.7 per cent, and with Town Centre’s management targeting some interesting value-accretive developments, I continue to rate the investment case positively, having last advised buying the shares at 295p (‘A five-timer of small-cap plays’, 24 July 2017). Medium-term buy.

■ Simon Thompson's book Stock Picking for Profit can be purchased online at www.ypdbooks.com for £14.99, plus £2.95 postage and packaging, or by telephoning YPDBooks on 01904 431 213 to place an order. It is being sold through no other source. Simon has published an article outlining the content: Secrets to successful stock picking