The sharp increase in interest rates over the last year or so has provided a real headwind for the majority of investment trusts with many now available at a sizeable discount to NAV. It has been especially challenging for the income paying alternatives, which have seen their yields and valuations come under pressure, as investors have opted for risk free rates in excess of five percent.
One of the biggest casualties has been the Regional REIT (LON: RGL) that published itsinterim results for the six months to the end of June on September 12. To say that they were badly received is a bit of an understatement with the shares plummeting to less than 30p.
The trust’s £750m portfolio of regional offices suffered an NAV total decline of nine percent during the period with earnings per share falling almost 14%. This resulted in a dividend cut of 27% and a loan-to-value ratio of 52% with an occupancy level of just 82.5%.
Can a 63% Discount And A Fully Covered Yield Of 17% Ever Be Justified?
The broker Winterflood says that it has been a challenging period for RGL, with considerable negative investor sentiment towards the regional office market reflected in a fall in portfolio valuation and inflationary pressures impacting operational costs and earnings.
Although the fund’s gearing is high at 52%, it benefits from a reasonably low cost of debt of just 3.5% per annum, with all the rates fixed, swapped or capped. There is also a programme of disposals and asset management initiatives in place that are designed to bring the debt level back to the long-term target of 40%.
Winterflood regard the reduction in the dividend as a prudent decision, with the new quarterly rate of 1.2p equating to a prospective yield of 17% based on the current share price of 28p. They describe this as attractive, especially as it is fully covered by EPRA earnings.
The broker says that the 63% discount to the estimated NAV of 76p is the widest in the UK Commercial Property peer group, although it is at least partially justified given the uncertainty facing the regional office market. However, they think that the significant discount could make RGL a potential corporate activity target with the high, fully covered yield offering investors some downside protection.
Digital 9 Infrastructure Takes A Pummelling
Disappointing results were also the catalyst for a major sell-off at the £880m Digital 9 Infrastructure (LON: DGI9) whose shares dropped 40% on the day of the announcement. The news was accompanied by a suspension of the dividend that had been reaffirmed as recently as July.
During the six months to the end of June the NAV fell by 8.8%, but the main concern was the lack of liquidity, with the company needing to refinance its £375m revolving credit facility that expires in March 2025. It has received several non-binding offers to syndicate a majority stake in its holding of Verne Global at NAV, but the uncertainty calls into question the going concern basis adopted in the preparation of the accounts.
The broker Investec says that the announcement was confirmation of their long-standing fears, which were a function of strategic mismanagement, although the significant fall in share price exceeded their worst expectations. They struggle to see how the fund can survive these disappointing developments and return to business as usual.
Because of this Investec now regard Digital 9 as a special situation and view it as a tactical buy. At the current price of 40p the shares are available at a discount of 60% to the end of June NAV of 100p, although whether the valuation would hold up in the event of a forced sale is open to question.