- Change of investment strategy to maximise cash returns to shareholders
- Cash from sale of industrial property portfolio and Hudson quarter to be returned to shareholders after debt settled.
Palace Capital (PCA:280p), a high-yielding regional commercial property Reit which has a portfolio bias towards regional offices, industrial warehouses and retail warehouses, has amended the strategy it outlined last month to reposition the group as an ESG driven regional office market specialist (‘On the hunt for small-cap property bargains’, 11 June 2022). It’s well worth noting.
That’s because following shareholder feedback, the board will now focus on maximising cash returns. Assuming the group is successful in selling off eight industrial properties (book value £46.5mn), as seems highly likely given the strength of the asset class, net proceeds after debt repayments will be distributed to shareholders by either a special dividend or tender offer.
Moreover, the directors will continue to dispose of non-core properties – £4.5mn has been realised since the 31 March 2022 financial year-end – and seek to complete the sales of the 36 remaining residential units at Hudson Quarter, York. The proceeds from these disposals will be distributed to shareholders, too.
Bearing this in mind, a £6mn share buyback of 2.3mn shares completed last week at an average price of 260p, adding 7p a share to Palace’s last reported European Public Real Estate Association (EPRA) net asset value (NAV) of 390p. This means that the shares are priced on a 30 per cent discount to proforma net tangible asset value of 397p based on a market capitalisation of £123.2mn and proforma NAV of £174.6mn.
There is an obvious opportunity to use future cash returns to narrow the share price discount to NAV as well as enhance NAV per share, too, as highlighted by Alpha Real Trust (ARTL: 160p). The property focused investment group has now completed a £9.5mn tender offer at 175p per share and lifted its NAV per share from 216p to 219p (‘On the property beat’, 30 June 2022). Alpha’s share price has risen 26 per cent since the end of June.
In the case of Palace Capital, let’s assume it returns £40mn (91p a share) to shareholders from a low-ball estimate of £60mn total property disposals. On this basis, current net debt of £75.1mn (adjusted for the £6mn share buyback and the previously announced £4.5mn of disposals) would be slashed 27 per cent to £55mn with the loan-to-value ratio maintained at 28 per cent on the remaining £199mn property portfolio.
If the 91p a share is paid out as a special dividend it lowers NAV per share from 397p to 306p, but if the share price discount remains at 30 per cent then the share price will settle at 214p post the special dividend, or only 65p below the current share price. However, if the share price discount to NAV narrows, as seems likely as some investors will recycle their cash return proceeds to make further open market purchases, then shareholders will gain even more.
Alternatively, if Palace Capital uses £40m to tender 11mn of the 44mn shares in issue at a price of 364p a share, or 30 per cent above the current share price, the effect is to reduce NAV from £174.6mn to £134.6mn. However, with a lower share count, NAV per share rises from 397p to 408p. Assuming the share price discount holds at 30 per cent, then Palace’s share price rises to 285p but shareholders also get to bank a 30 per cent premium on 25 per cent of their holdings. It’s a win-win situation, and one that has effectively created a floor for the share price.
Palace Capital's high yielding shares have delivered a 36.6 per cent total return since I initiated coverage (Alpha Research: ‘A Reit royal value play’, 11 March 2021) and I maintain my 350p target. Buy.
Simon Thompson was named Journalist of the Year at the 2022 Small Cap Awards.
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