With a portfolio of city-based offices outside of London, this regional property company is well-placed to benefit as more businesses cut costs by moving out of the capital.
|Master Investor Magazine
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Palace Capital (LON:PCA) is an internally managed property investment company that plans to convert to a real-estate investment trust (REIT) at the start of August. It mainly focuses on offices and industrial buildings in major regional cities and university towns in the UK, and has a portfolio that is externally valued at £286.3m.
The company has a proven track record of acquiring properties where it can add value by enhancing the rental income and generating capital growth through refurbishment and development opportunities. According to the analysts at Edison, it has achieved an impressive average NAV total return of 15.8% per annum since its first significant acquisition in 2014.
Returns like this would normally result in a premium rating
Returns like this would normally result in a premium rating, but the attractive 6.7% yield is higher than a peer group of similar regionally focused commercial property companies and its 30% discount to NAV is wider. The management has committed to maintain the current dividend of 19p per share despite a near-term earnings cover shortfall – the latest earnings were 17.3p per share − in anticipation of recurring income growth.
Edison believe that the existing portfolio offers significant refurbishment and development opportunities that have the potential to create additional value over the next few years. This provides the scope to deliver decent returns even if the sector enters a cyclical downturn.
The key driver is the Hudson Quarter development in York, a two-acre site within the city walls and just a minute’s walk from the railway station. After many years of negotiation, the company finally received optimal planning consent in August 2017 to build three residential buildings totalling 127 flats and 35,000 square feet of top grade offices. The funding is mostly in place and there is a fixed fee construction contract that is scheduled for completion in early 2021.
It is thought that the development gains should add more than 20p per share to the NAV and that the sale of the residential element would materially reduce the gearing with the net Loan-To-Value ratio falling by about ten percent to less than 28%. The commercial property component should increase the gross rental income by more than five percent to help ensure that the current level of dividend would be more than covered by recurring earnings.
As with most property companies, the main risk would be an economic slowdown, but this already seems to be priced in. Palace Capital has done what it can to protect itself by building a diversified portfolio across property types, locations and tenants. It has also covered 59% of its debt by interest rate swaps, thereby mitigating the risk of higher interest rates.
Even if the Brexit ‘doubters, doomsters and gloomsters’ are right, Palace Capital still looks like a decent bet, and if they are wrong then sooner or later the company should be positively re-rated. Numis has a buy recommendation with a target price of 350p. The shares are currently trading at a mid-price of 285p.
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