The deconsolidation of Aim-traded UK and eastern European property fund manager and investor First Property’s (FPO:52p) shareholding in Fprop Opportunities, the owner of five high-yielding commercial properties in Poland, slightly complicated the company’s latest annual results.
First Property now holds a 40 per cent stake in Fprop Opportunities, which means that investment is now treated as an associate, the effect of which was to reduce the company’s annual pre-tax profit by £1.2m. Put in that context, the 10 per cent decline in statutory pre-tax profit to £8.3m on revenue of £20.4m was a very respectable result. In fact, it was ahead of house broker Arden Partners’ profit forecast, and that was after the brokerage pushed through a 9 per cent upgrade at the time of the pre-close trading update in May. There were several positives to be gleaned from the results.
A positive read through
Firstly, the de-consolidation process has deleveraged the company’s balance sheet with First Property’s gross borrowings of £66.7m equating to only 50 per cent of the combined £133.6m value of its directly held property (£94.6m), investment in funds it manages and associates (£29.5m), and cash on the balance sheet (£9.7m). Importantly, investors can now focus more clearly on the company’s two activities: a fast growing property fund management business, and its directly held property investment portfolio.
Secondly, the asset management side is clearly doing well with divisional pre-tax profits (pre-central overheads) trebling to £3m on 70 per cent higher revenue of £4.96m in the 12 months to end-March 2019, a reflection of the 34 per cent growth to £611m in funds managed on behalf of third parties. In total, First Property has £85m of further equity commitments for investment in funds it manages, thus providing ample scope for organic growth.
Of the 13 property investment funds managed, Fprop Offices LP, a £181m fund launched in the summer of 2017 to invest in office blocks and business parks across England, performed better than chief executive Ben Habib had guided when I covered the half-year results in December. That’s because First Property has opted for a profit share, in lieu of an annual management fee, which Mr Habib expected to be £700,000. The fund actually generated an annual fee of £961,000. Moreover, it is now £146m invested with the properties purchased on an initial yield of 7 per cent, and has potential to gear up, thus enabling the purchase of up to £90m of additional properties.
Thirdly, having acquired control of the companies that own the majority of the buildings in Krakow Business Park, since renamed Eximius, located 15 minutes from the centre of Poland’s second-largest city, when the €47m (£42m) debt secured on the buildings was in default, the company restructured the loans and secured commitments from third-party investors to invest €33m (£29.2m) in Eximius in return for a 76.6 per cent equity interest. First Property retains an equity stake of 23.4 per cent, which has a read through valuation of £10m, or five times carrying value in its latest accounts. The company also earned a £1.05m maiden post-tax profit contribution from Eximius. There is potential for further valuation gains, too. That’s because, having invested in upgrading site, Mr Habib says the company is in talks with a potential major tenant with a view to taking over all of the vacant office space.
Fourthly, First Property directly owns nine properties in Poland and Romania, which are worth £94.6m at open market value, the largest of which is a half share in the CH8 Tower in Warsaw, accounting for 36 per cent of the portfolio’s valuation. Investment bank Citi had been the tenant of half the 20,000 sq metre of office space until vacating the premises in February 2018, thus reducing First Property’s revenue by €2.9m in the 2018-19 financial year. However, the company refurbished the vacant space and has subsequently leased 70 per cent of it and “is in advanced negotiations with parties over the remaining 3,000 sq metres of vacant space”, the upside from which will be seen in the 2019-20 financial year.
Net assets still growing
Admittedly, there was a one-off £3m write-down on the carrying value of an over rented short lease office block in Gdynia, Poland, but this offers potential for uplifts in the future if the tenant who is due to vacate in 2020 signs a new lease, or the property is re-let speedily to a new tenant. In any case, last year’s pre-tax profits are stated after this adjustment.
The impact of the write-down and sterling’s currency strength at the financial year-end (closing exchange rate of £1:€1.16) meant that First Property’s net asset value (NAV) per share increased by 8 per cent to 57.5p in the 12-month period, less than I had anticipated. However, at current exchange rates, spot net asset value (NAV) per share is 59p and there are not many UK-listed property companies generating NAV growth of this magnitude. I would flag up, too, that with free cash of £9.7m on its balance sheet, First Property is well-funded to continue to scale up its fast growing asset management business and take advantage of further opportunistic property acquisitions such as Eximius.
An enviable track record
First Property has an enviable record of valuation creation, having posted annualised growth in adjusted net assets, together with dividends paid of 23.6 per cent over the past five financial years. This explains why the shares have done very well since I first recommended buying, at 18.5p, in my 2011 Bargain Shares Portfolio, since when the board has paid out cash dividends of 10.44p a share to produce a 237 per cent total return.
NAV per share has more than quadrupled in the eight-year period, a positive trend I expect to continue no matter which way Brexit pans out. That’s because 59 per cent of assets under management are UK-based, and 41 per cent are in Poland and Romania, thus offering the company exposure to robust overseas property markets and a currency hedge too, plus potential upside from UK investment mandates once Brexit uncertainty lifts.
Trading on a 12 per cent discount to spot NAV per share, on a price/earnings (PE) ratio of 11, and offering a 3.2 per cent dividend yield, First Property shares remain on my buy list.
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