At the end of last year, I made the case that the elevated risk premium embedded in equity valuations could unwind to deliver a year of positive returns. The double-digit gains registered across European bourses and US Nasdaq indices are certainly indicative of an improvement in risk appetite even if the UK market has lagged.
My prediction was partly based on market participants being too pessimistic about the peak level of interest rates required to reduce aggregate demand given the scale of the monetary tightening already seen. I also felt that peak inflation could come down sharply this year. That has certainly been the case in Europe, and the UK will join the party next quarter when headline inflation receives the lagged benefit of the sharp decline in wholesale energy costs.
Falling UK inflation should act as an incentive for trade unions to settle their protracted pay talks, thus giving the UK economy, which has dodged recession despite suffering lost output during strikes, a boost. The fact that consumer spending has held up so well to date is informative, as is the stabilisation of the housing market. It suggests that as inflationary pressures ease, some of the benefit from falling energy costs – and this year’s downward shift in fixed mortgage rates – will find its way back into the economy and consumer spending, in particular.
A property play on the UK economy
- Net asset value (NAV) total return of 2.4 per cent in the latest quarter
- 0.77 per cent like-for-like valuation increase
- Acquisition of Matalan retail warehousing unit on net initial yield (NIY) of 9.5 per cent
AEW UK Reit (AEWU:97p), a value focused Reit that holds a portfolio of 36 regional UK commercial property assets, offers a play on the domestic economy. The group’s £214mn portfolio is focused on industrial property (44.2 per cent), retail warehouses (20.5 per cent), high-street retail (18.7 per cent), offices (7.2 per cent) and other real estate (9.4 per cent).
Interestingly, AEW’s portfolio manager highlights that the retail sector is an area of particular tenant activity. In fact, such is the strength that a vacant high-street retail asset in Sheffield, which had been under offer to an owner-occupier, has been withdrawn from sale due to the improved occupational interest. The vacant space is now under offer from two tenants. Once let, it will produce an income yield of 13 per cent against the current valuation, suggesting a likely valuation uplift in AEW’s next results.
Smart capital recycling
The group has also been recycling the £4.4mn cash received from the disposal of an industrial property in Milton Keynes and office in Hemel Hempstead – both achieved premiums to book value – to increase its retail warehousing exposure. In late March, AEW paid £6.45mn for a 59,000 sq ft unit in Preston that is let to Matalan with nine years left on the lease.
The purchase price reflects a low capital value of £110 per sq ft and a minimum reversionary yield of 10.7 per cent. The store is one of the top 10 performing units for the retailer. Earlier this year, Matalan refinanced borrowings until 2027 and now has £100mn earmarked for business growth over the next three years.
In addition, AEW has just sold an industrial unit at Deeside Industrial Estate for £4.75mn, or eight per cent above carrying value. It means that the group has £9.6mn to deploy on an attractive pipeline of earnings accretive higher yielding assets.
High dividend yield and discount to NAV
Importantly, AEW maintains a stable loan-to-value ratio of 36 per cent, so has significant headroom (around 45 per cent) on property valuations before any breach of loan covenants. The group also benefits from a low fixed cost of debt of 2.959 per cent until May 2027. This means that, with rent collections almost 100 per cent, AEW can pay a 2p-a-share quarterly dividend to shareholders, having done so for 30 consecutive quarters.
So, having rated the shares a hold, at 101p, at the start of the year, I now feel that investors could start to warm to the investment case again to lock in an 8.2 per cent dividend yield and take advantage of the 8.1 per cent share price discount to NAV. Buy.
This article was first published on 4 May 2023 and updated on 9 May 2023 following news of the disposal of the Deeside Industrial Estate property.
■ 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. The books are priced at £16.95 each plus postage and packaging (P&P) of £3.95 [UK], or both books can be purchased for the promotional price of £25 plus P&P of £5.75.
