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CLS has plenty of room to boost rental income

Vacancy rates give plenty of room for rental growth
March 15, 2018

CLS Holdings (CLI) has been busy recycling capital and investing in high-growth areas such as the German commercial property market. For shareholders, this has meant strong net asset value (NAV) growth, accompanied by noteworthy broker forecast upgrades, along with a well-covered and growing dividend, and plenty of potential for increased rental income. To top it off, the shares are available at a 21 per cent discount to forecast 2018 NAV, rising to a 24 per cent discount in 2019, and that's without considering the potential for further upgrades.

IC TIP: Buy at 243p
Tip style
Value
Risk rating
Medium
Timescale
Long Term
Bull points

Significant new investment in the fast-growing German property market

Sale of Vauxhall Square de-risks development arm

Plenty of room for rental growth

High-quality list of tenants

Bear points

Relatively high gearing

Vulnerable to possible UK economic downturn

Last year CLS made substantial gains on property disposals, the biggest of which was a site at Vauxhall Square in London which sold for a net £144.1m against a December 2016 book value of £100m. And as the site was almost empty in preparation for development, net rental income was largely unaffected by the sale. Disposals contributed to a raft of forecast NAV upgrades during the past year, with broker Liberum increasing its predictions for 2018 NAV by 23 per cent over the past 12 months and 25 per cent for 2019.

All in all, disposals generated £170m on property in the UK, £25m in Germany and £7m in France at an average net initial yield of 3.3 per cent. These funds were put to work through £188m of purchases in Germany and £50m in the UK at an average net initial yield of 6.5 per cent. The turnover in the portfolio has also added to the potential for rental growth by boosting the vacancy rate from 2.9 per cent to 5.8 per cent, above CLS's upper target of 5 per cent. On average acquired properties had a 9 per cent vacancy rate compared with 3 per cent on those sold. The combination of acquisitions, disposals and currency movements left rental income in 2017 ahead by £2.4m at £93.7m. 

Development risk has reduced, with two major projects nearing completion. Ateliers Victoires in central Paris has already been pre-let, while 16 Timworth Street in London will become the group’s new headquarters. There is also plenty of scope for boosting rental income through a rolling refurbishment programme. Three buildings were refurbished in 2017, costing £22.9m.

Of the leases renewed during 2017, the biggest was on 14 properties leased to the Secretary of State for Communities and Local Government, with an average 6.8 years to the first lease break. Overall new lettings were secured at a premium to estimated rental value, and the group expects to realise about one-third of the portfolio's reversionary value of £5.7m (properties let below the current market rate) this year.

The German property market, which accounts for 32 per cent of the portfolio, remains very attractive, and acquisitions there included the Metropolis portfolio of 12 properties across major cities in Germany for £140.1m at a yield of 6.3 per cent. Crucially, the vacancy rate was high at 11 per cent, giving plenty of room for improved asset management. There is also a significant gap between supply and demand, which should underpin German asset values.

CLS HOLDINGS (CLS)   
ORD PRICE:243pMARKET VALUE:£990m
TOUCH:241-245p12-MONTH HIGH:255pLOW: 170p
FORWARD DIVIDEND YIELD:3.0%TRADING PROPERTIES:£18m
DISCOUNT TO FORWARD NAV:24%NET DEBT:68% 
INVESTMENT PROPERTIES:£1.75bn  
Year to 31 DecNet asset value (p)*Net operating income (£m)Earnings per share (p)*Dividend per share (p)
2015**208858.54.5
20162469312.35.8
20172869712.86.4
2018*30910913.76.8
2019*32111714.87.4
% change+4+7+8+9
Normal market size:1,500   
Matched bargain trading    
Beta:0.30   

*Liberum forecasts, adjusted EPS and NAV figures

**Adjusted for 10-one share consolidation on 8 May 2017