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Segro set to grow

Segro is expected to deliver 17 per cent total return in 2018
November 1, 2018

Back in July, when industrial property real estate investment trust (Reit) Segro (SGRO) reported a 9 per cent rise in first-half net asset value (NAV) and 11 per cent growth in adjusted earnings per share (EPS), the 10 per cent share price premium over NAV seemed justified, given the strong demand for urban logistics from the expanding e-commerce sector. The backdrop remains rosy, with a 2.3 per cent third-quarter rise in the CBRE Monthly UK Industrial Property Index taking the gain for the first nine months of the year to 9.4 per cent. Yet the shares now trade at a discount to forecast NAV, which in our view boils down to Brexit-induced paranoia making investors overly cautious.

IC TIP: Buy at 620.8p
Tip style
Value
Risk rating
Medium
Timescale
Long Term
Bull points

Shares trade at a discount to forecast NAV

Demand from online retailers

Selling assets at a premium to book value

Development pipeline 71 per cent pre-let

Bear points

Brexit uncertainty

Vulnerable to economic shocks

Occupational and investment demand for industrial real estate space is so strong that, rather than buy in assets, Segro has been building its own at a more favourable 7 per cent yield on cost. Now many investors might throw up their hands at the idea of having a development arm at such times of uncertainty, but Segro’s 891,000 square feet (sq ft) development pipeline is already 71 per cent pre-let. And Brexit is unlikely to change the shift to online shopping, and online retailers make up around two-thirds of its rental income.

The current development pipeline, when fully let, has the potential to generate £46m in headline rent, while developments capable of generating £10m in rent are expected to complete in the fourth quarter. Over £500m is expected to be invested in developing the pipeline in 2018, of which £454m has already been spent.

Within the existing portfolio there are several sweet spots, notably space that serves UK airports. This portfolio was strengthened by acquiring the outstanding 50 per cent interest in the APP portfolio, giving it full ownership and virtual control of storage assets surrounding Heathrow.

Segro also operates outside the UK, and recently made an off-market joint acquisition of a big-box warehouse in the Netherlands for £22m (Segro’s share was £11m). A further £25m has been invested in the land bank, with development projects about to begin in London, Bologna and Lyon.

Segro is also prominent in recycling its capital, and made disposals of £200m between July and October at a significant premium to book value. Since then, in its role as venture adviser to the Segro European Logistics Partnership (SELP), it has sold four big-box warehouses and adjacent development land in Belgium, generating itself €41.7m (£37m). 

Strong demand for warehouse space has kept vacancy rates at around the 5 per cent mark, and contracted headline rent in the nine months to September at £52m was 43 per cent ahead of the previous nine months.

The clamour for industrial space also means there is a significant scope to increase rents through rent reviews and lease renewals. At the end of the third quarter, rents on review and renewal were ahead by 9.5 per cent.

SEGRO (SGRO)   
ORD PRICE:620.8pMARKET VALUE:£6.29bn
TOUCH:620.6-621p12-MONTH HIGH:682pLOW: 526p
FWD DIVIDEND YIELD:3.1%TRADING PROP:£34.4m
DISCOUNT TO FORWARD NAV:8%   
INVESTMENT PROP:£8.22bnNET DEBT:35%
Year to 31 DecNet asset value (p)Net rental income (£m)Earnings per share (p)Dividend per share (p)
201544317317.615
201647918118.915.7
201755727919.916.6
2018*63230522.617.8
2019*67733523.719.2
% change+7+10+5+8
NMS:3,000   
     
BETA:0.88   
*Liberum forecasts, adjusted NAV and EPS

Net debt at the end of the third quarter including its share in joint ventures was £2.8bn. Loan to value ratio stood at 31 per cent, and the average cost of debt was down to just 1.9 per cent.

Supply of big-box and last-mile-delivery warehouse space continues to lag demand, and while there has been a significant rerating in valuations, there is likely to be more to come. A combination of further valuation uplifts and dividend payments are expected to generate total returns of around 17 per cent in 2018, and yet the shares are trading at a significant discount to forecast NAV.