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Take advantage of Segro's long-term growth potential

The logistics property group is well positioned against any short-term loss of income
May 21, 2020

When Segro (SGRO) stole Landsec’s (LAND) crown as the largest UK-listed real estate group last year, it was recognition of the solid rental growth on offer within the logistics market caused by the rise of e-commerce. However, after the broader market sell-off, the hefty premium attached to them at the start of the year has been much reduced and we think an attractive buying opportunity now exists.

IC TIP: Buy at 812p
Tip style
Value
Risk rating
Medium
Timescale
Long Term
Bull points

Diversified tenant base

Conservative loan-to-value

Portfolio value rising

Exposure to growth in e-commerce 

Bear points

Potential loss in rent

Development delays

There has been natural anxiety among investors around shortfalls in rental income for commercial landlords as tenants are put under greater financial strain. At 25 March, 71 per cent of the rent due had been paid, while around 25 per cent was subject to discussions over payment delays to provide relief for tenants that have been hit hard by the crisis. 

However, the group’s balance sheet is in robust enough shape that it can withstand a sizeable reduction in income. Rental income would have to fall by 80 per cent or asset values by 64 per cent before any of Segro's borrowing terms are breached. It also had cash and undrawn facilities totalling £1.2bn at the end of March, against future investment commitments of £280m. That liquidity gave management the confidence to be one of the few within the real estate industry to proceed with paying a final dividend for the 2020 financial year. 

Earnings are expected to take a hit from a delay in developments that were due to complete this year and lower valuations on some larger assets, as well as pressure on some rents. Based on recurring rental income, broker Stifel forecasts a slight drop in EPS this year, followed by a solid pick-up in 2021. The majority of developments are pre-let prior to work commencing. Of the 826,200 square metres in development projects approved, contracted or under construction at the end of December, 60 per cent of rent had already been secured. 

The group develops and leases big-box and urban logistics warehouses to a good-quality tenant base across a broad range of industries and geographies. The top three tenants by annual headline rent were Deutsche Post, Amazon and Federal Express last year, and the top 20 tenants represented only 32 per cent of annual headline rent in total. What’s more, store-led retail logistics accounts for the smallest proportion of Segro’s annual rental income, according to Panmure Gordon analysis, and it has a lower exposure to that segment than peers LondonMetric (LMP) and Tritax (BBOX). 

There are some concerns that UK industrial property valuations have peaked. But Segro differs from its London-listed peers in the size of its exposure to the less mature continental European logistics markets, which accounted for 31 per cent of rental income last year. That should pay off in the longer term as online retail penetration rates continue to rise within the region. Last year, the like-for-like value of the European portfolio rose 13.5 per cent, compared with 2.5 per cent for the UK.   

There has been an inevitable slowdown in investment activity within the UK industrial market following the outbreak of Covid-19, with transactions slowing from £617m in February to £480m in March, according to research by real estate services provider Colliers International. The March figure was 25 per cent below the 2019 monthly average of £642m. Industrial property capital values also declined by 0.9 per cent in April, according to data from CBRE, but that was a smaller reduction than that suffered by the office and retail markets, which fell 1.1 per cent and 3.6 per cent, respectively.

SEGRO (SGRO)    
ORD PRICE:812pMARKET VALUE:£9.01bn
TOUCH:803-815p12-MONTH HIGH:945pLOW: 642p
FORWARD DIVIDEND YIELD:2.9%TRADING PROPERTIES:£20.2m
FORWARD PREMIUM TO NAV:6%NET DEBT:24%
INVESTMENT PROPERTIES:£9.5bn*  
Year to 31 DecNet asset value (p)Pre-tax profit (£m)Earnings per share (p)Dividend per share (p)
201755619419.916.6
201864824223.418.8
201970827324.420.7
2020**72027223.722.0
2021**76929726.423.6
% change+7+9+11+7
Normal market size:2000   
Beta: 0.64   
*Includes investments in joint ventures
**Stifel forecasts, adjusted NAV, PTP and EPS figures