Watkin Jones (WJG:214p), a construction group specialising in purpose-built student accommodation (PBSA) and private rented housing, has issued a raft of bullish updates since I last rated the shares a buy, at 207.5p, in the summer (‘Watkin Jones on for a record year’, 31 Jul 2019). The share price subsequently hit a high of 241p late last month, but has pulled back after the founding Watkin Jones family sold down 25m shares, at 210p, through an institutional placing late on Friday, 8 November to reduced their stake to 45.5m shares, or 18 per cent of the issued share capital. The institutions have got themselves a good deal and one which you can avail yourself of close to their buy in price. There are sound reasons for doing so.
In the past two decades, Watkin Jones has delivered 41,000 student beds across 123 sites, making it one of the largest players in the PBSA market. It’s a market that is still undersupplied as the UK’s current stock of 639,000 PBSA beds in the UK (Jones Lang La Salle estimate) remains well below the 750,000 intake of first year and international students, so new beds coming onto the market can be easily absorbed. Furthermore, the UK has 12 of the world's top 100 universities, which continues to attract international students to our shores, both for the high quality of education, and value on offer, too. Sterling has depreciated by more than 17 per cent against both the US dollar and euro in the past four years.
The asset class is also attracting hefty investment flows from institutional investors, enticed by an above-average yield profile compared with other mainstream property asset classes, strong and stable performance both in terms of investment yield and occupancy levels, and a relatively low-risk income stream with the ability to capture annual rental growth. Net yields are around 4.5 per cent on new London PBSA developments, and even higher still (5.2 per cent) in the regions.
This positive dynamic explains why Watkin Jones not only forward sold and completed all six PBSA developments (2,723 beds) in the 12 months to 30 September 2019, but has already forward sold all seven of the PBSA developments (2,609 beds) slated for construction in the 2019/20 financial year. Furthermore, 1,928 beds have been forward sold for delivery in the 2020/21 financial year and the directors are aiming to deliver an additional 1,300 beds in that 12-month period, too, of which agreed sales on 448 beds are in the hands of solicitors. The scaling up of the operation is part of a strategic plan to increase the delivery rate to 3,500 PBSA beds over the next five years.
Build-to-Rent opportunity scaling up
It’s not the only attractive business opportunity that Watkin Jones is exploiting. The group is replicating the success of its PBSA capital-light and forward-funded business model in the Build-to-Rent (BtR) market. In fact, the forward sold and secured BtR pipeline now compromises 1,750 apartments across eight sites, the vast majority of which are slated for delivery in the 2020/21 and 2021/22 financial years. In addition, management is in advanced negotiations to acquire sites that would deliver an additional 1,150 apartments by September 2023. This area of the market is attracting huge institutional investment flows, too.
For example, the likes of L&G, Aberdeen Standard, M&G, and Invesco have been increasing their exposure, attracted by the UK’s ongoing population growth (the UK's population is forecast to grow by 7.5m by 2035), the need for additional rented accommodation and attractive investment yields (3.8 per cent in prime regional sites). Indeed, there are now 148,000 BtR apartments under construction in the UK, with an estimated gross development value of £10.6bn, according to the British Property Federation. Analysts at property agency Savills estimate that the BtR segment of the housing stock could ultimately account for 1.7m homes, or a third of the private rented sector.
Record profit to drive share price to new highs
Given this positive backdrop, it’s hardly surprising that Watkin Jones is on course to report another record annual performance. Analyst Paul Hill at Equity Development estimates that adjusted pre-tax profits will edge up to £51m to deliver earnings per share (EPS) of 16p in the 12 months to 30 September 2019 to support a hike in the dividend per share from 7.6p to 8p. Moreover, cash continues to build strongly. Mr Hill believes Watkin Jones now has net funds of £90m (35p a share), or three times higher than three years ago, highlighting the highly cash-generative nature of its business model.
On this basis, Watkin Jones’ shares are effectively being priced on a cash-adjusted price/earnings (PE) ratio of 11 for the year just ended, a rating that fails to take into account its attractive earnings growth profile over the coming years – analysts forecast EPS of 17.1p, 19.2p and 22.7p, for the next three financial years – and the ongoing bumper cash generation that underpins the board’s progressive dividend policy. Indeed, analysts expect a current year payout per share of 8.6p, rising to 9.6p in 2020/21, and 11.3p in 2021/22 based on a 50 per cent payout ratio of net profits. Even after factoring in the higher cash cost of the dividend, both my financial models and those of analysts suggest that Watkin Jones’ net funds could increase by more than 40 per cent to £128m (50p a share) by September 2022.
Trading on a current year forward cash-adjusted PE ratio of 10, and offering a prospective dividend yield of 4 per cent, I feel that Watkin Jones' share price will resume its upward move once the dust settles after the founding family's sell down, so much so that I have raised my target price from 265p to 275p. That's still a discount to Peel Hunt’s raised fair value estimate of 280p (from 265p) and Equity Development’s upgraded sum-of-the-parts valuation of 300p (from 250p).
So, ahead of annual results on Tuesday, 14 January 2020, I continue to rate the shares in a positive light, having first suggested buying at 100p at the IPO ('A profitable education', 3 Apr 2016), since when the board has paid out dividends per share of 20.95p to give a total return of 134 per cent. Buy.
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