These are not minnows: Watkin is capitalised around £114 million, makes over £400 million revenue, yet with profits only around break-even currently its stock trades at an all-time low of 44p.
Empiric, meanwhile, is a £515 million mid-cap at 85p, some way off £100 million revenue albeit a fat margin delivers net profits well over £20 million.
Both stocks trade at a discount to net tangible assets, as if the market’s verdict is nowadays scepticism after it was perceived as a hot area. Most typically, when property concepts take off, their related stocks enjoy a premium as growth plays; then as the sector cools a discount becomes more likely, with the possibility of contrarian value.
Business models explain radically divergent financials
You could call it the classic contrast between being agent or principal, in business.
Watkin is an asset developer that has evolved from student accommodation to the buy-to-rent sector generally; which most property experts concur, offers strong long-term demand. But it means profits in any reporting period are subject to timing; hence delays as the property market has slowed under higher interest rates.
Yesterday’s warning from house-builder Crest Nicholson Holdings (LSE:CRST) that the housing market has worsened this summer hit many related stocks, Watkin down 4% albeit Empiric only marginally.
- ii view: housebuilder Crest Nicholson flags lower profits
- Stockwatch: this housebuilder’s discount and dividend are attractive
Empiric's business model is owner-operator, where it has also found a sweet spot in higher-quality, studio-type accommodation serving, for example, overseas and postgraduate students. For the coming academic year, 32% of rooms have been sold to Chinese students. Management cites its “target cluster” marketing as a key strength, with 254 newly refurbished rooms also being delivered this year.
Latest interims declare 2023 as “firmly on track to be another record year for the company”. Its booking cycle for the 2023-24 academic year is significantly ahead of last year with occupancy back at an all-time high of 98%. Strong demand for Empiric’s offering means rental growth of around 9% will be achieved, overtaking previous guidance.
Both companies have experienced challenges
Despite a seemingly robust model, Empiric’s record since flotation in 2014 has been quite bumpy; its chart, volatile sideways. Nor does its financial summary of recent years imply a growth company, but obviously Covid disrupted student living.
In 2017, Empiric’s business model was based on outsourcing; which came unstuck with a big cost overrun, hence the dividend axed and CEO departed. Facilities management was brought in-house and the discount-to-assets narrowed.
Empiric Student Property
Year-end 31 Dec
|Turnover (£ million)||51.2||64.2||70.9||59.4||56.0||73.0|
|Operating margin (%)||63.4||82.5||95.2||-17.9||74.3||113|
|Operating profit (£m)||32.5||53.0||67.5||-10.7||41.6||82.7|
|Net profit (£m)||20.8||40.3||54.8||-24.0||29.2||67.7|
|Reported earnings/share (p)||3.8||6.7||9.1||-4.0||4.8||11.2|
|Normalised earnings/share (p)||3.8||6.7||9.1||-3.8||4.9||11.3|
|Operating cashflow/share (p)||4.0||8.6||6.7||2.9||7.0||7.2|
|Capital expenditure/share (p)||0.1||0.0||0.1||0.1||0.2||0.3|
|Free cashflow/share (p)||3.9||8.6||6.6||2.8||6.8||6.9|
|Covered by earnings (x)||0.8||1.4||0.0||-2.0||0.0||5.1|
|Return on capital (%)||3.6||5.8||7.0||-1.1||4.3||7.6|
|Net Debt (£m)||245||291||333||351||335||332|
|Net assets per share (p)||104||106||110||105||107||116|
Source: historic company REFS and company accounts
Watkin has seen its stock continue to fall since 270p in early 2022. After the chair bought £40,000 worth near 78p last May, I thought the risk/reward profile was tilting attractively; but did hedge a “buy” stance at 70p with a caution that five deals needed closing by end-September.
Mid-July, Watkin warned that market conditions had become more challenging: “In particular, the recent increases in interest rates and prevailing economic uncertainty have impacted negatively on market liquidity. As a result, there is now a greater degree of risk over these transactions completing by the year end.”
Higher rates are also hurting asset values, hence an impairment charge of around £10 million is due. At end-March, net tangible assets had been £153 million or 60p a share, implying only a modest slip to 56p, hence the stock currently representing a 21% discount.
Yet the discount to NTA extends to 38% at Empiric given property-related companies barely have any intangible assets.
Watkin Jones - financial summary
Year end 30 Sep
|Turnover (£ million)||244||267||302||363||375||354||430||407|
|Operating margin (%)||13.3||4.2||14.4||14.9||14.1||8.8||13.3||6.0|
|Operating profit (£m)||32.5||11.3||43.6||54.0||53.0||31.2||57.3||24.3|
|Net profit (£m)||22.2||4.2||35.8||44.2||38.8||21.1||41.9||13.4|
|EPS - reported (p)||10.4||2.0||14.0||17.3||15.2||8.2||16.3||5.2|
|EPS - normalised (p)||11.4||8.8||13.7||15.9||16.0||14.9||16.4||7.9|
|Return on equity (%)||19.6||4.7||31.3||33.2||25.8||12.8||23.8||7.4|
|Return on total capital (%)||25.5||10.7||28.6||17.8||16.0||9.2||17.8||8.9|
|Operating cashflow/share (p)||11.1||5.9||7.5||21.3||9.4||14.9||24.0||-10.4|
|Capital expenditure/share (p)||0.02||0.06||0.1||0.1||0.1||0.1||0.3||0.1|
|Free cashflow/share (p)||11.1||5.9||7.4||21.2||9.3||14.8||23.9||-10.7|
|Net debt (£m)||-40.0||-33.2||-41.9||63.1||60.2||39.2||4.8||-33.6|
|Net assets (£m)||113||103||126||140||161||168||185||177|
|Net assets per share (p)||44.3||40.2||49.5||54.9||63.0||65.5||72.1||69.0|
Source: historic company REFS and company accounts
Watkin chair ‘quintuples down’ buying £194,000 worth at 47p
Perhaps it shows the vices with averaging down, and/or how company directors do not necessary have a full grasp of wider macro influences – given this purchase last July, five times the value of what he bought in May, has yet to call a low
Yet he shows belief in value around current levels despite sluggish property sales disrupting profit guidance.
Watkin’s profit in this second-half-year to 30 September is expected to be similar to the first, where £1.8 million was achieved at the operating level – albeit a net loss over £0.5 million was struck after interest charges and a tax credit.
For the September 2024 year, pre-tax profit in a £15-20 million range was guided for, implying net profit around £13 million and earnings per share (EPS) of 5p, hence a forward price/earnings (PE) of nine. But how reliable is this in the current environment?
- Richard Beddard: this smooth operator is not without a few wrinkles
- Insider: FTSE 250 chief back buying after results slump
A value-driven investor would fret less at timing and act like the chair has done, to accumulate stock on weakness – given that you at least have some margin of safety versus asset value.
Consensus has been for around 4p a share of dividends in the 2024 year after 3.3p this year, and a 1.4p interim was paid, backed by £83 million cash-at-bank, as of 31 March. This representing a prospective yield around 8% shows that the market is sceptical.
Mind a £30-35 million increase in the exceptional provision for remedial works on cladding at legacy properties; this cash cost to be spread over five years, hence ongoing exceptional charges.
Watkin’s numbers and narrative are messy but if you believe – quite like holding house-building equities currently – that a fundamental shortage of UK accommodation exists to rent, similarly as to own, then its stock price is an opportunity. I therefore retain a “buy” stance despite the challenge to call a low.
Accounting perspectives influence perception of Empiric
Last year’s interims were distorted by a near £59 million revaluation versus £10 million this time; which is at odds with Watkin cautioning on the effect of higher rates, unless Empiric has, for example, selected its sites and finished the properties well – helping rents rise – which benefits asset value.
Interim operating profit has advanced 24% to £23 million on revenue up 16% to £41 million. A net profit near £25 million as defined by International Financial Reporting Standards (IFRS) compares with £14 million earnings as defined by the European Real Estate Association EPRA – which strips out re-valuations, gains from asset disposals and the like. Non-core disposal programme generated £35 million from the sale of four properties.
It means a contrast in EPS, hence the PE multiple: say if Empiric makes 4.5p on an EPRA basis this year, then a PE of 19 times, albeit nearer eight times according to IFRS. You could be forgiven for splitting the difference here as to what is realistic, going forward, in a higher interest rate environment.
The interim dividend rises 30% to 1.25p a share with consensus expecting 3.3p this year and 3.8p in 2024, for a circa 4% yield albeit covered modestly around 1.2 times by earnings.
The EPRA-based net asset value, which investors will focus on, edges up 2% over 117p, hence a 27.5% discount. You could say, this plus the relatively much better narrative than Watkin, makes Empiric preferable of the two.
A case for buying both stocks
Barring a worst-case scenario of UK recession and chronic stagflation further hitting the property market, I would not pull a “buy” stance on Watkin, which has contrarian appeal given the timing aspect to property sales has smashed its current earnings window. Both stocks merit further consideration.
Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.
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.
We use a combination of fundamental and technical analysis in forming our view as to the valuation and prospects of an investment. Where relevant we have set out those particular matters we think are important in the above article, but further detail can be found here.
Please note that our article on this investment should not be considered to be a regular publication.
Details of all recommendations issued by ii during the previous 12-month period can be found here.
ii adheres to a strict code of conduct. Contributors may hold shares or have other interests in companies included in these portfolios, which could create a conflict of interests. Contributors intending to write about any financial instruments in which they have an interest are required to disclose such interest to ii and in the article itself. ii will at all times consider whether such interest impairs the objectivity of the recommendation.
In addition, individuals involved in the production of investment articles are subject to a personal account dealing restriction, which prevents them from placing a transaction in the specified instrument(s) for a period before and for five working days after such publication. This is to avoid personal interests conflicting with the interests of the recipients of those investment articles.