I had an enlightening call with the directors of currency manager Record (REC:31p) following the fourth quarter trading update. I included the shares in my market beating 2018 Bargain Shares portfolio on the basis of the company’s sustainable high dividend, cash-generative asset light business model (post-tax return on equity of 23.5 per cent in the 2019 financial year), prospects for earnings progression and the reassurance of a rock-solid capital position.
Record holds cash and money market instruments worth £23.4m (11.9p a share), so can declare a high proportion of net profits as dividends after adjusting for regulatory capital requirements. The board hasn’t disappointed, paying out dividends of 5.79p a share in the past couple of years and has committed to maintaining its dividend policy. The directors can afford to do so.
In the first 11 months (to 29 February 2020) of the 2019-20 financial year, assets under management equivalent (AUMe) increased by 13 per cent to US$64.7bn, buoyed by the addition of five new clients to take the total to 72. These are mainly public and corporate pension funds, foundations and trusts that use Record’s currency strategies to hedge equity exposure (47 per cent), fixed income (31 per cent) and for other purposes (22 per cent).
True, the equity market rout during March meant that Record saw a US$4.5bn decline in AUMe due to negative market movements that month, and the strength of the US dollar dented AUMe by US$1.7bn. However, AUMe still increased by 2 per cent to US$58.6bn over the course of the year ending 31 March 2020, and Cenkos Securities is maintaining forecasts that point towards pre-tax profits of £7.9m and earnings per share (EPS) of 3.1p being only slightly behind the 2019 result. Expect the ordinary dividend of 2.3p a share to be maintained, and there is even the chance of another special pay-out as Panmure Gordon forecasts a total dividend of 3p a share, implying a maintained dividend yield of 9 per cent.
The reassuring comments on the dividend aside, another key take from my call with new chief executive and 7.6 per cent shareholder Leslie Hill, and finance director Steve Cullen, was that Record’s “product offering, robust and deep operational infrastructure is being more valued” in light of the recent extreme volatility in financial markets. That’s worth noting as it could well end the downward margin pressure on fees earned from passive mandates which account for US$50.3bn of AUMe (85 per cent of the total).
There is also an opportunity to pick up new clients by exploiting the sharp increase in currency volatility, and offering new products to existing ones. Driven by the fresh impetus under Mrs Hill’s leadership, Record has created a new global macro currency hedging strategy to expand its product offering, and is aiming to increase exposure to the US market (currently accounting for a quarter of Record’s fees) by adopting a more regional focused approach for its sales and distribution channels. Both look like winning strategies.
On a price/earnings ratio of 10.5, and offering an attractive and sustainable dividend, Record’s shares are worth buying ahead of the annual results on 19 June. A return to highs around 42p which were hit after I covered the half-year results (‘Record gaining momentum, 25 November 2019), and perhaps beyond, is not unrealistic when you consider that equity markets have surged since the end of March, adding billions of dollars to AUMe, so there should be further positive news on fund flows. Buy.
A REIT recovery buy
The listed UK commercial REIT sector has taken a tumble this year, shedding more than 25 per cent of its value, due to concerns over the financial distress being felt by tenants who have seen business dry up during the Covid-19 lockdown. I have been impacted because I suggested buying the high yielding shares, at 72p, of Alternative Income REIT (AIRE:45p) in my October 2019 Alpha Report. The company was previously known as AEW UK Long Lease REIT.
AIRE invests almost entirely in freehold or long leasehold property in the following non-traditional sectors: care homes, hotels and serviced apartments, student housing, nurseries, automotive (car showrooms and petrol stations), car parks, and small power stations. Tenants include budget hotel chains Travelodge and Premier Inn Hotels, and motoring groups Motorpoint and Volkswagen Group.
Around 82 per cent of rents were collected when they became due on the March 2020 rent quarter day. However, clearly some tenants are facing unprecedented short-term disruption to their businesses, hence the reason why AIRE is in discussions with tenants and is offering assistance such as conversions to monthly stage payments, while at the same time protecting its own position.
It’s the sensible approach to take especially as I don’t expect any of AIRE’s tenants to go bust, so it makes sense to come to some mutual arrangement to help them trade through the economic slowdown and benefit from the recovery when it arrives. Of course, there is a short-term financial impact, but it was reassuring that the directors have committed to “paying an attractive quarterly dividend even if a prolonged economic downturn results in some potential impairment on the 5.5p-a-share target for the year to June 2020.” It’s equally comforting that although property valuers marked down AIRE’s portfolio by £5.2m to £108.8m in the first quarter this year, hence the decline in net asset value from £76.1m to £70.9m (88p a share), the company’s £41m debt only represents a 38 per cent gearing ratio. The portfolio would have to collapse by a further £33.7m in value before testing the covenants on AIRE’s loan with Canada Life. That’s simply not going to happen.
There are no financing risks as the Canada Life loan only becomes due for refinancing in October 2025 and the servicing cost (fixed interest of 3.19 per cent) is comfortably covered, hence the ability of the board to recycle surplus cash to shareholders. In addition, two of the 19 properties are unencumbered, so could be sold or borrowed against if necessary, and AIRE retains gross cash balances of £4.3m.
The ‘margin of safety’ is huge. Not only do the shares trade on a 50 per cent discount to NAV, but even if the board reduces the targeted annual dividend to 4.5p a share, the yield would still be 10 per cent. Recovery buy.
Circle Property on the money
Circle Property (CRC:183p) a little known internally managed Jersey-registered property company, has reported a near 5 per cent increase in NAV to 290p a share at 31 March 2020, within pennies of my estimate when I suggested buying the shares, at 206p, in my February Alpha Report (‘A deep value property play’, 21 February 2020). The company is the best performing UK quoted real estate company by NAV total return, having produced 101 per cent NAV growth since IPO in 2016.
The key to Circle Property’s success is targeting well located short-let, or partly-let, property acquisitions which are close to vacant possession, so they can be redeveloped and refurbished to maximise the reversionary yield when fully let. The portfolio is almost entirely focused on the regional office sector and has no exposure to retail apart from two public houses and one restaurant in Birmingham. Circle owns 15 office properties of which 90 per cent by gross value are in four undersupplied locations: Bristol, Birmingham, Maidenhead and Milton Keynes. Occupier demand has remained robust in these geographic areas despite Brexit uncertainty subduing economic growth.
FTSE 100 food and support services group Compass Group (CPG) is a major tenant, accounting for 60 per cent of the £2.66m of annual rental income at the Kent Hills Business Park, Milton Keynes that encompasses 241,000 sq ft of office, hotel, health centre and conference facilities. Circle purchased the site for £11m in December 2013 and has spent more than £10m on refurbishments. It’s now worth around £50m, a valuation supported by renegotiating the Compass lease so that it has annual RPI-linked uplifts, capped at 5 per cent, and expires in 2041. Other tenants include a subsidiary of Deutsche Telecom and Grand Union Housing, the latter signing a 10-year lease (subject to CPI linked reviews) in the financial year just ended which added £352,625 to Circle’s rent roll.
The diversified tenant mix, regional bias and weighting towards office property means that Circle is well placed to trade through the current economic uncertainty. The company is well financed, too. The £138.5m property portfolio is modestly geared on a loan-to-value of 41.8 per cent (net of cash on the balance sheet) and Circle has £39m of headroom on its low cost (2.05 per cent above LIBOR) £100m financing facility with HSBC. There is an option to extend the facility to 2025, so there are no immediate refinancing requirements.
Occupancy rates are above 91 per cent and the annualised contracted rent roll is in excess of £9m. Bearing this in mind, 70 per cent of the March 2020 quarter day rent was paid on time, and a further 9 per cent will be paid by the end of this week. Constructive dialogue is ongoing with tenants, balancing the need for genuine assistance against the short-term opportunism by some.
So, with the directors expecting that they will maintain the 6.3p-a-share dividend when annual results are released, implying the shares offer a yield of 3.4 per cent, Circle’s rent roll covering debt service costs more than seven times over, and the tenant mix including some blue chips, the 37 per cent share price discount to NAV offers is unwarranted. Buy.
PCF’s contrarian value proposition
This week's first-half pre-close update from Aim-traded specialist bank PCF (PCF:21p) was much as I had previewed three weeks ago when I rated the shares a bargain buy at 17p (‘Deep value buying opportunities’, 8 April 2020).
Namely, Covid-19 has had a limited impact in the six months to 31 March 2020. New business originations increased by 26 per cent to £153m on the same stage a year earlier, and over 80 per cent were in prime credit grades. The £400m loan book is backed by £340m of retail deposits (mainly fixed term), around £60m of shareholders' equity capital, £30m of wholesale funding under a revolving credit facility, and £25m of the Bank of England’s low-cost Term Funding Scheme. PCF’s common equity tier 1 ratio (CET1) of 17 per cent is well ahead of the regulator’s minimum requirement.
Of course, demand for loans from PCF’s consumer and SME targeted customer base was bound to soften in the current environment, falling short by 26 per cent against growth targets for March and 65 per cent below target in April to date. Customers representing a third of the loan book by value have made requests for payment holidays and/or reduced payments, but that was to be expected as the FCA’s latest guidance to both lenders and consumers allows borrowers to request a three-month payment freeze on certain credit agreements without impairing their credit ratings. It’s only sensible that many have done so even to preserve cash until the UK's lockdown ends. However, the vast majority will not default and trash their credit records. And even when some do, PCF can take possession of the valuable collateral it has lent against (cars, motor homes, machinery, houses etc).
It’s still my view that the market is expecting a far higher level of delinquencies than is likely to be the case. Indeed, Panmure's 2020 pre-tax profit estimate of £10.7m already factors in £3.7m of impairment losses. Moreover, even if that provision were to surge by 70 per cent then PCF would still match its 2019 pre-tax profit of £8.1m and earnings per share of 2.8p. With the shares trading on 0.9 times book value and on a 2019 price/earnings ratio of 7.5, the market is implying profits will be wiped out completely. I beg to differ. Ahead of the half-year results in June, PCF's shares are a recovery buy.
■ Simon Thompson's latest book Successful Stock Picking Strategies and his previous book Stock Picking for Profit can be purchased online at www.ypdbooks.com, or by telephoning YPDBooks on 01904 431 213 to place an order. The books are being sold through no other source and are priced at £16.95 each plus postage and packaging of £3.25 [UK].
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Simon Thompson was named 2019 Small Cap Journalist of the year at the 2019 Small Cap Awards.
