This Reit has bottomed out

Yet, despite residual fears of the death of the high street, some physical shopping formats have just about survived. As some tenants even tentatively begin to let new shops once again, in part because of rock-bottom rents, there are signs that retail asset valuations might have troughed.

This, in simple terms, is the investment case for NewRiver. If retail space has fallen to its residual value, then both rent collection and even increases should be possible without sparking a tenant exodus.

Based on its current valuation, investors may have already – albeit cautiously – accepted that NewRiver has moved past its peak risks. You wouldn’t necessarily think that from the shares’ 31 per cent discount to its latest reported net asset value (NAV) of £410mn. But seen against the raft of reversals in Reit premiums to NAV during 2022, and the fact that NewRiver began last year with its discount a little wider than today’s levels, and the shares’ recent performance has been resilient. Their 11 per cent total return since we looked at the investment case in January 2022, in the face of a brutal year for property, also hints that markets do not expect things to get materially worse.

That’s not to say that the past six months haven’t been tough for the wider commercial property sector. The latest independent valuation of NewRiver’s assets was done on 30 September, as the fallout from the Truss-Kwarteng mini-Budget led to a sharp sell-off in UK-based risk assets and gilts briefly yielding more than some property asset classes.

Retail was not one of those asset classes. Then, as now, its high yields mean it has been less affected by spiking interest rates in relative terms. As chief executive Allan Lockhart commented when half-year numbers were published in November, NewRiver’s valuation had already been “very significantly rebased” by years of challenging trading conditions. By contrast, logistics landlords such as Warehouse Reit (WHR) and LondonMetric (LMP), with their exposure to an asset class with a low yield and sky-high asset values, saw their NAVs plummet by 11.8 and 12.2 per cent, respectively, in the quarter to September. In the six months to September, NewRiver’s portfolio value only dipped 1.5 per cent.

Put another way, online shopping’s multi-year walloping of physical retail eroded NewRiver’s value so much that last year’s rapid rise in interest rates failed to put a dent in the portfolio. It is possible that the continued property downturn since 30 September means the next NAV update will record a drop. Data from CBRE shows overall UK retail property values have fallen 11.5 per cent since September, while consensus analyst forecasts are for NewRiver’s NAV to decline to 122.6p per share when the group’s financial year ends this month. Still, there is little to no indication of a 30 per cent decline on the cards, especially with a positive trend for new lettings renewals.

Indeed, some real estate analysts expect retail to fare better than other corners of the property market over the coming years. Oxford Economics predicts that annual total returns from retail property will average 7.2 per cent until 2027, ahead of industrial, residential, offices, and hotels (see table).

Retailers, too, are banking on the worst being behind them. Many are now expanding their physical presence again after years of cutting back, and NewRiver is reaping the benefits of this. In a January trading update, the company said its occupancy rate was up to 96.5 per cent, up from 95.6 per cent as of the end of March 2022, suggesting the business’s focus on retail parks and shopping centres in areas with good demographic profiles, diversifying occupancy and click-and-collect space is demonstrating its resilience.

Despite strong occupancy levels, the prospects of raising rents anytime soon are mixed. As of January, the average rent across NewRiver’s portfolio is £11.58 per square foot, 0.7 per cent lower than the figure recorded a year earlier, and despite rampant recent inflation. The flipside of a policy of affordable rents is that it attracts cost-conscious tenants, who are likely to drive a hard bargain amid a challenging economic outlook.

There are two tailwinds for NewRiver on rental increases, though. The first is that the landlord calculates that its tenants will benefit from a 19 per cent business rates saving from April 2023, which it believes will give it scope to nudge up rent. Second, rates on new lettings have been trending in the right direction this financial year, and many of the anchor tenants in NewRiver’s portfolios reported strong trading over Christmas.

The biggest question for retail, though, is not cyclical but structural. Online shopping is what has dragged consumers away from physical shops for years, and the data on whether we have reached peak online shopping is difficult to read. Although the pandemic accelerated the trend, it is unclear whether the hype is over or whether ecommerce will resume its long-term incline.

Having dealt with this issue for years, NewRiver’s credentials in the field at least appear well recognised. The trust recently signed a three-year capital-light partnership to manage a retail portfolio of 16 retail parks and one shopping centre on behalf of M&G Real Estate, following a similar mandate from Canterbury City Council.

The other bear point for NewRiver is gearing. With net debt at 68.5 per cent of NAV, its leverage is higher than both the broader Reit sector and its listed shopping centre and retail peers. Should valuations take a further hit, efforts to reduce gearing could end up competing with dividends for capital.

However, investors can take solace in the fact that net debt to cash profit ratios have been falling, and are likely to fall further as earnings pick up. What’s more, NewRiver’s drawn-down debt – a £300mn bond – has the virtue of being fixed at an interest rate of 3.5 per cent with no maturity until March 2028. This overhead compares favourably to the portfolio net initial yield of 7.9 per cent as at 30 September 2022, which as the company points out is “one of the highest spreads in the real estate sector”, and provides some reassurance about the security of the dividend.

This high property yield is in essence what makes NewRiver’s investment case. If the worst for retail is truly over, then NRR’s earnings potential looks undervalued. It’s a big ‘if’, but the shares are cheap enough to justify investor consideration.

Last IC view: Hold, 78.5p, 24 Nov 2022