Shaftesbury risk could deliver much reward

Carnaby Street has lost its swing to Covid-19. Visitors to London’s West End, which in a typical year total more than 200m, have dwindled as tourism has been severely curtailed by travel restrictions, and lockdown has limited trips to shops and restaurants. For Shaftesbury (SHB), which owns large swathes of West End real estate, that has resulted in reduced rent collection over the second, third and fourth quarters. This has been accompanied by a fall in the valuation of the group’s portfolio. 

But, after falling more than 50 per cent since the start of the year, there may be longer-term upside lurking in the shares of this real estate investment trust (Reit). 

Shaftesbury plans to raise up to £307m via a share placing and open offer at 400p. That gross figure includes £12m of costs and a £10m non-underwritten element. The money would enable the commercial landlord to substantially pay down debt and strengthen its balance sheet to withstand further shortfalls in quarterly rent payments as occupiers grapple with reduced footfall in the near term. Meanwhile, the group’s portfolio, which is clustered within iconic locations across the West End, includingCarnaby Street, Covent Garden and Chinatown, should continue to attractgood-quality tenants over the longer term. 

With the shares trading at their largest discount to net asset value (NAV) on record, the anticipated decline in the value of the group’s estate has arguably been more than adequately accounted for. Indeed, the extreme pessimism reflected in the valuation presents a good opportunity for investors with a higher risk appetite to profit as a recovery in footfall and improved rental income could prompt a major re-rating of the shares. 

No gain, without pain

There is no getting away from the financial pain being felt by retailers and food and beverage outlets, which account for 69 per cent of the estimated rental value of Shaftesbury's portfolio. These have been among the businesses worst affected by government lockdown measures. The latter has taken the added blow from the requirement to operate at reduced capacity to enable social distancing and the imposition of a 10pm curfew. A greater number of staff working from home has also resulted in less custom from office workers to city centre shops and eateries. 

Even after a modest recovery since non-essential retail and leisure outlets were allowed to reopen, Shaftesbury has estimated that daily visits to the West End are now at around 40 per cent of pre-pandemic levels. That has inevitably put a strain on the finances of many of Shaftesbury’s tenants. 

Combined with the temporary ban on commercial lease forfeitures for the non-payment of rent – which has been extended until the end of the year – that led to only 44 per cent of rent due for the second, third and fourth quarters being paid by 28 September. There has also been a 6.6 per cent annual like-for-like decline in estimated rental values (ERV) in the core, wholly owned portfolio during the year to 15 September. ERV represents the annual rent that would be expected were properties re-let today under normal trading conditions.

Investor expectations of a further fall in asset values – an indicator of the portfolio’s rental income prospects – have been reflected in the shares trading at a steep discount to NAV at the end of June. The share price now sits a just about the level NAV would be expected to fall to based on the dilution from the fund raising and management's "reasonable worst-case scenario" for the property portfolio. Key elements of the worst-case scenario are a further 25 per cent fall in property values and spending £45m to cover losses from the business in 2021.

While brokers are waiting until the fund raising is approved to update their forecasts, Peel Hunt guides to a rough 8 per cent impact to its pre-placing estimates, which would see full-year NAV bottom out at about 590p next September.

Strengthening defences 

At present, the group has the ability to withstand a 34 per cent fall in the value of its portfolio before breaching loan-to-value covenants attached to its debt. A more pressing issue for the landlord has been ensuring future compliance with interest cover covenants against rental income. Waivers relating to two revolving credit facilities (RCF) totalling £225m and a £135m term loan were secured, but are due to expire between December this year and next July. 

However, the core underwritten portion of the capital raising – a net £285m – would give the group leeway to terminate an undrawn RCF and repay a separate, fully-drawn £100m facility. That would release £252m of properties secured against the former facility, increasing the group’s pool of uncharged assets to £686m, and potentially removing the need to secure further covenant waivers. Meanwhile, net debt would fall by 30 per cent and the group’s loan-to-value ratio would drop to 21 per cent.  

Management is in discussions around extending the interest cover covenant waiver attached to another £250m term loan, which is due to expire in April. On that score money raised would also give it more breathing room, with £12m earmarked for permitted "cash cures" in the event covenants are breached. The remaining proceeds would also provide the group with enough to fund operations and finance costs for 2021 in a worse-case scenario that assumes the portfolio vacancy rate doubles to 20 per cent and quarterly rent collection sticks  at just 25 per cent until June 2021, rising to only 45 per cent by the end of the year. 

Portfolio with a USP

What separates Shaftesbury from other commercial landlords is its near-impossible to replicate portfolio in traditionally high-footfall West End locations, with Carnaby Street and Covent Garden accounting for two-thirds of its 16-acre estate. The group has a good track record of generating value from its portfolio, with the estimated rental value rising by a compound rate of 4.6 per cent during the 10 years to March 2020. That includes broadly flat rental values during the six months to March and 2.7 per cent growth during the year to September 2019. This compares with other commercial landlords with high exposure to retail and leisure, which reported declines in rental values even before Covid-19 reared its head. 

Occupying prime locations also means that the group should be better placed to continue attracting tenants in the event that some of its occupiers go out of business or surrender the lease. And the typically small size of the units means that no one tenant dominates the rent roll, with the largest representing under 1 per cent of annual contracted rent. For retail occupiers, it also means the estate is better suited to the growing trend towards omnichannel trading, with each tenant requiring a lower level of physical space.  

The fundraising is due to be voted on at a general meeting on 17 November, although shareholders representing just over 52 per cent of share capital have pledged their support. Effectively this represents the near equal-sized stakes in Shaftesbury held by the Norwegian sovereign wealth fund and rival, listed West End landlord Capco, which bought out most of the holding of Hong Kong tycoon Samuel Tak Lee at 540p over the summer. Meanwhile, in regard to the seven-to-58 placing and open offer, the shares are now ex-entitlement, meaning new buyers cannot participate, which will be reflected in the share price..

The extent to which – and how quickly – Shaftesbury rental income recovers will largely depend on the shape lockdown restrictions take over the coming months. However, a considerably stronger balance sheet will give the group better means to cope with the shortfall in collection rates in the immediate term and a foundation to take advantage of a return to more normal footfall to the West End in the long term. For those with a higher risk appetite the shares have re-rating and recovery potential. 

Last IC View: Hold, 461p, 25 Sep 2020