Interactive Investor

Stockwatch: an income stock in recovery mode?

27th January 2023 11:05

by Edmond Jackson from interactive investor

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This company pays a generous dividend, but analyst Edmond Jackson downgraded his stance last year at what turned out to be the peak. Here’s what he thinks now after a share price slump.

Shares up concept 600

Last March, I examined Tritax Big Box Ord (LSE:BBOX), a UK-focused mid-cap real estate investment trust (REIT) that provides warehouses for the digital economy and other major retailers such as supermarkets. Its stock had a fine steady run from around 100p at flotation in late 2013 when I found it easy to be keen, to near 250p a year ago. 

Inflation and interest rates have de-rated property asset values 

It is harder now, significantly because its rise partly benefited from ultra-low interest rates and inflation, helping asset prices. That has obviously changed, although I would not lose sight of how essential property assets can resist inflation in the longer run, given building costs will be rising. 

Deciphering the state of warehouse provision is also tricky. In my experience of following property cycles, a decade’s growth is good going as you would expect the concept to attract imitators.  

At around 240p, I turned cautious, with the stock price at a 3% premium to net tangible asset value based on principles established by the European Public Real Estate Association (EPRA). Having watched the life-cycles of various property stocks over decades, I am aware how they can enjoy a premium to net asset value when their investment/development is in vogue, but a stock price discount is more normal once it reaches maturity and/or the economy slows down. 

With 54% of this company’s rents linked to retail and consumer prices, this appeared to offer some protection. But how durable could such terms of rent increase prove – say if the UK became stuck in stagflation – as a means to support dividend growth? 

I rated the stock a “hold”, saying that if the market fell in months ahead, taking the stock down to nearer 200p, it might again represent a medium-term “buy”. 

In actuality, it fell to 125p last September and is currently 155p – creeping up again after a 25 January update assuaged key concerns, assuming it is reliable. 

Management asserts “record development lettings and further development starts in a strong occupational market”, although the value of investment assets fell 15% over 2022 – all in the second half, given it was down by 20%.  

EPRA-based, net tangible asset value is said to be in line with market expectations, albeit with quite a range, from 168p to 195p where an average 181p represents a 14% discount for the stock currently. This compares with 243p as of last June, hence a 26% intrinsic drop if we use the current average estimate. 

Buying the stock now therefore assumes this de-rating, at very least, prices in the change in interest rate regime and also a UK recession. Inflation, if it sticks say in mid-single-digits, will benefit the value of quality physical assets.  

While enough traders are reacting to a big drop on the chart and a bullish update, I am mindful how some extent of discount to net assets tends to be a feature of property investment companies and investment trusts over the long run. Premiums usually associate with the period when a development concept is in vogue.

A conservative long-term view of Tritax would therefore be to expect a modest discount unless its specialist sector continues to sport growth credentials. Also, as industry leader, it has sufficient "moat" versus rivals. 

Narrative continues to project earnings growth 

Management talked up earnings growth after shareholders supported a £300 million equity- raise at 204p a share in September 2021 (relative to a current market cap just under £3 billion). 

Last September’s interim results continued to entertain an  “acceleration in future earnings growth” by way of deploying this capital “into accelerated development activity...we are quickly letting this space...and adding £17.8 million of new rent to our annual roll...as these assets are built they will produce income from mid-2023 and 2024, supporting further EPS [earnings per share] and dividend progression.” 

This latest update proclaims: “UK supply remains constrained with ready-to-occupy vacant space at just 2.0% versus 1.6% in the fourth quarter of 2021”. 

The last year saw 2.9 million square feet of development starts, with 82% let to diverse customers. Management boldly maintains its guidance for two to three million square feet being added a year, involving £200 million to £250 million spend, with a 6-8% yield on this cost. 

A 31% “loan-to-value” figure is asserted for the end-2022 balance sheet “with substantial covenant headroom” – in line with my reading of near 32% net debt from the end-June balance sheet. Interim diluted EPS rose 12% from the income statement, although according to adjustments could be seen as flat or down 7%.   

If a growth scenario holds, then Tritax rates a “buy”, although I find the macro and corporate context both complex to judge. 

Are yield characteristics attractive as an income stock anyway? 

Consensus anticipates a 3% rise in the 2022 dividend to 6.9p a share and 7.2p for 2023, implying a 4.6% prospective yield.  

Mind, it is a close thing with EPS of 7.5p as consensus for 2022, rising to 7.9p in 2023. Earnings cover has dropped to near 1.0x (see table) yet an ambitious development programme continues. 

Tritax Big Box REIT - financial summary 
Year ended 31 Dec

20142015201620172018201920202021
Net rental income (£million)18.643.874.6108133144162185
Operating profit (£m)46.71431102652771814921,013
Net profit (£m)41.813491.9248253141449973
EPS reported (p)14.721.010.419.417.48.426.355.0
EPS normalised (p)14.721.010.419.717.58.226.355.1
Operating cashflow/share (p)8.04.27.96.86.55.58.111.1
Capital expenditure/share (p)0.00.00.00.00.00.00.00.0
Free cash flow/share (p)8.04.27.96.86.55.58.111.1
Dividends/share (p)4.26.06.26.46.76.96.46.7
Covered by earnings (x)3.53.51.73.12.61.24.18.2
Return on total capital (%)5.710.09.04.911.518.5
Return on equity (%)14.812.15.916.427.8
Cash (£m)98.659.2165.071.947.421.257.671.1
Net debt (£m)1023183686377731,1271,2861,274
Net asset value/share (p)104121126140151150170218
EPRA net asset value/share (p)108125129142153152176223

Source: historic company REFS & company accounts.

The update does reassure, however, that near 15% growth in annual contracted rent to £224 million was achieved. The 2021 annual cash flow statement showed £114 million going out as dividends. 

Moreover, property market yields for “high-quality, rack-rented buildings with around 15-year unexpired lease terms” have risen to 5.0%, up from 3.5% in the fourth quarter of 2021.  

As part of a diversified portfolio, Tritax does have attraction for yield, and it has been popular with institutions, with its operations run by specialists in warehouse property. 

I prefer, however, to judge equity on wider criteria. 

Was the second half of 2022 drop in asset value a one-off? 

This is likely the crux, and where you take a view. 

While the table shows some big historic profits, they reflect for example in 2021, £841 million upward revision of property fair values. Operating profit otherwise rose 21% to £178 million chiefly comprising rental income. 

Despite the recent devaluation, management says: “More recently, however, given the attractive long-term fundamentals of UK logistics, we are seeing encouraging early signs of stabilisation in the investment market and greater discernment over asset quality which plays to the quality and strength of our portfolio.” 

That is reassuring to holders, but with fresh money is it sufficient to imply both rising asset values from here and, ideally, a closing of the 14% discount to underlying net assets? 

By way of comparison, £450 million Helical (LSE:HLCL) nowadays trades at a 36% discount to net assets – as an investor/developer of central London offices – while priced for a 3.2% yield, with the stock at 359p. While it did nearly halve in value from 500p in January 2020, as Covid bore down and ingrained working-from-home as a modern practice, Helical’s long-term chart shows it has been in a volatile sideways trend for two decades.

I recall times when analysts tried to justify at least a 20% premium to NAV as worth paying for Helical’s strong development record. Even the most dynamic property managers are somewhat hostage to the macro context. 

If you agree with Tritax management that the UK remains in tight supply of big box warehouse assets, then buy its stock on the assumption that capital appreciation is now resuming. But I remain wary that its decade-long run from 100p to 250p was likely its best days, and reliability of income is becoming a more realistic benchmark. Hold. 

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.

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