Interactive Investor

London office crash makes these shares much too cheap

23rd September 2020 15:17

Graeme Evans from interactive investor


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A sharp sell-off offers potential rewards for investors prepared to look beyond short-term disruption.

The prospect of desks remaining empty for longer in West End offices owned by Derwent London (LSE:DLN) and Great Portland Estates (LSE:GPOR) hasn't changed one City firm's contrarian stance.

Analysts at UBS argue today that 40% discounts on the net asset values of Derwent and Great Portland represent an opportunity to buy into two “quality names in the sector”.

While UBS has cut price targets by as much as 25% to reflect ongoing working from home (WFH) trends, the feeling at the Swiss bank is that this factor is overdone in valuations.

UBS said: “Sentiment is understandably bearish towards offices, given the WFH theme and its potential impact on long term demand. This argument is easy to make.

“We prefer to take a contrarian view and argue that while WFH will increase in prevalence, the amount of office space that can be dropped by corporates will be limited, at least in the already-tight London market.”

As two of the least geared names in the European sector, UBS said the pair should be able to weather almost any downside scenario. They also point to the track records of the respective companies in outperforming economic cycles.

The London office market has been mired in uncertainty since the Brexit referendum in 2016, with the Covid-19 pandemic putting paid to any momentum offered by the Conservative Party's decisive victory in the December general election.

Shares in London office names have fallen by between 35% and 40% this year, but UBS believes the sharp derating has moved well past fundamentals and now offers potential rewards for investors prepared to look through the short-term disruption.

Its own research points to the West End market being more resilient than others worldwide, reflecting a combination of lower vacancy and supply, higher prevailing job growth and longer leases. UBS also notes that offices are a significant tool for companies to attract and retain talent. 

At the height of the lockdown, Derwent's office usage was as low as 5% as tenants heeded government advice to work from home. By the time of August's interim results, buildings were on average still only being occupied to 15% of their capacity.

Derwent reduced the March and June quarters' service charge by 25% and granted rent free periods or rent deferrals to those tenants most in need. The company said it collected or agreed payment plans on 92% of the March quarter rents with similar levels of performance for June. The next rent day for the property industry falls on Tuesday.

The pandemic failed to stop Derwent from increasing its interim dividend by 4.8% to 22p a share, or from reporting further progress in its estate. This includes completing its first net zero carbon development at 80 Charlotte Street, W1, which is 91% pre-let.

CEO Paul Williams said last month that the company had been working for some time to develop space that is more flexible and adaptable, a trend now accelerated by the pandemic.

He added: “Recent events have highlighted the importance of offices for enhancing collaboration, social interaction and wellbeing to build business culture and attract and develop talent.

“Derwent London's design-led and adaptable space will support our occupiers returning to their offices, an essential part of getting London back to full strength.”

Great Portland's most recent update in mid-July highlighted a strong financial position, including a property loan to value of 15%. It also includes residential and retail use. 

CEO Toby Courtauld said: “Our portfolio is almost fully let and our extensive development pipeline is set to deliver high quality, sustainable spaces that remain in high demand.”

UBS's price target for Great Portland has come down by 25% to 720p, with the bank at 3,400p for Derwent London after a 23% reduction. The respective share prices were today 3.2p higher at 546.6p and 14p lower at 2,400p.

These articles are provided for information purposes only.  Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties.  The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.

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