A mega-merger gives our companies analyst cause to revisit this hugely successful share tip.
Does the £1.4 billion acquisition of a student accommodation portfolio genuinely re-rate prospects for mid-cap Real Estate Investment Trust (REIT) Unite Group (LSE:UTG)?
The company has bought a portfolio – "Liberty Living" – chiefly aligned to high and mid-ranked British universities comprising 24,021 beds, from a Canadian pension fund. As if involving an 18.2% margin of safety, the properties have been independently valued at £2.2 billion versus a consideration of £1.4 billion in a mixture of £800 million cash and £600 million worth of shares.
Additional to the vendor gaining a 20% stake in the enlarged group, there's just been a £260 million placing at 985p, meaning only modest dilution of 10%. While there can often be perceived differences in the value of assets versus what people pay, it is a clear comfort factor, as is contained dilution.
Arguably, it makes sense to raise equity when institutional investor demand is keen on this specialist area of property investment – Unite got the placing away at only a few percent discount to the market price, currently around 1,000p. Despite anecdotal reports that student accommodation demand has swelled, quality and location appear to be tipping factors.
Net asset values in overall valuation context
The 3 July announcement refers to the deal having a neutral effect on net asset value (NAV). However, reading through the statement, two figures are cited for net asset value according to European Public Real Estate Association (EPRA) methodology: 827p is mentioned first under "transaction highlights", referencing the enlarged group, versus 815p later on with regard to Unite at end-March 2019.
Whichever you pick, the stock trades at over a 20% premium to NAV compared with a 40% discount when I initially drew attention to Unite at 185p in September 2011. At that time, property giant Land Securities (LSE:LAND) traded on a 17% discount. Not only had the stock dropped amid summer market turmoil, news articles cited students struggling to pay fees and accommodation costs. So, you might say, what if Britain goes into recession again, as risks rise of a hard Brexit?
In 2011, I took heart that Unite was strongly London-oriented and foreign students would likely make up the shortfall, but a 'buy' stance then was a lot easier with the shares trading at a big discount.
Source: TradingView Past performance is not a guide to future performance
Versus an attractive NAV valuation back then, the forward price/earnings (PE) multiple was a sky-high 40-50 times and the yield a paltry 1%. That compares to before this latest deal when the PE had come down to a multiple barely in double-digits (see table) and a more meaningful yield rising over 3%.
Mind how there's a sizeable differential between accounted and EPRA earnings (see table), the latter focusing on returns strictly from rental income, but which can confuse PE multiples cited.
The 3 July acquisition announcement says it "sustains Unite's medium-term rental growth outlook" with "material earnings accretion from 2020 onwards" and the board maintains a targeted 85% dividend payout ratio for the enlarged group. Time will tell, exactly what boost accrues and if it is any comfort to current holders.
The chief uncertainty appears to be if the UK economy continues to slow, or enters recession under a hard Brexit, and what valuation benchmarks will property-related shares default to.
Though I believe reversion to a NAV discount is much less likely given Unite's track record and this latest deal, given the stock is nowadays at a significant premium I wouldn’t be surprised to see market price exact a higher yield in the short to medium term. The key test-impact of Brexit on the economy and markets will be this winter, and, in terms of university students, decisions as regards the 2020/21 academic year.
|Unite Group - financial summary||Estimates|
|year ended 31 Dec||2013||2014||2015||2016||2017||2018||2019|
|Turnover (£ million)||102||108||209||121||119||128|
|IFRS3 pre-tax profit (£m)||77.1||108||388||201||229||246|
|Normalised pre-tax profit (£m)||80.1||111||389||204||232||69.4||82.8|
|Operating margin (%)||54.2||30.2||31.4||43.4||51.5||57.2|
|IFRS3 earnings per share (p)||46.0||52.3||150||94.7||93.6||90.6|
|EPRA earnings per share (p)||13.6||17.2||23.1||27.7||30.3||34.1|
|Price/earnings multiple (x)||11.0|
|Annual average historic P/E (x)||10.9||4.2||6.8||8.9||9.1|
|Cash flow/share (p)||-3.3||23.6||56.8||33.3||19.4|
|Dividends per share (p)||4.8||11.2||15.0||18.0||22.7||29.0||32.6|
|Covered by earnings (x)||9.6||4.7||10.0||5.3||4.1||3.1||1.2|
|Net tangible assets per share (p)||367||414||568||645||709||729||749|
|EPRA net asset value per share (p)||382||434||579||646||720||790|
Source: Company REFS
Reasons to hold through uncertainty
With such caveats clear, rental income from well-placed high-quality student accommodation continues to look sound. The Bank of England is also keeping its monetary policy flexible, able to raise interest rates if sterling slumps thereby importing inflation, although the more likely scenario is for stimulus via rate cuts. Eagerness among institutions for Unite's recent share placing can be part-explained by desperation for equity that represents a reasonably secure, meaningful yield.
Management's narrative naturally talks up this "transformative" deal that meets a growing need for affordable, high-quality student accommodation in university towns and cities where demand is strong. 82% of the properties are aligned to high and mid-ranked universities, adding exposure also to Southampton and Cardiff.
Operational enhancements are promised, combining the best of both businesses "to leverage university relationships and best practices...and further strengthen Unite's product/service proposition, including a more tailored customer offer... delivering £15 million annual cost synergies from 2021."
A more immediate priority is Competition and Markets Authority (CMA) clearance, with completion targeted by end-September. It's hard to say how realistic rejection might be, but regulation seems worth noting as a longer-term risk if Unite looks more to sizeable acquisitions as they become available.
Amid financial pressures on students generally, and a possible recession, the CMA might want to be seen testing private sector resolve to expand and increase its returns. So there's a modest risk of more regulatory grip.
Like in 2011, I would take heart that foreign students are likely to plug the gap of any shortfall in UK student demand should recession strike. I can recall this being the case even in the early 1980s going through my own university applications. Likewise, Boris Johnson is currently mooting for more apprenticeships "because university isn’t for everyone". This is an old chestnut for politicians to virtue-signal on.
Facts: British universities are a quality export; the global aspiring middle class continues to rise; and being educated in English is advantageous for commerce and the professions.
So I wouldn't fret overly about recession risk in terms of underlying rental demand for Unite, which is likely to adjust to a more international clientele if need be. The chief risk is what it might do to stock market valuations for a while.
APG Asset Management of The Netherlands has edged its stake in Unite up slightly to over 8%, which rather locks them into whatever volatility lies ahead. Possibly they envisage downside stock market/development risks mitigated by a quality income profile.
Not the only investment trust trading at a premium
Without making a direct parallel, it is maybe notable how Lindsell Train Investment Trust (LSE:LTI) was the stock market's biggest faller last Friday, after trading up to twice underlying asset value (the price tumbled when Hargreaves Lansdown removed two of Lindsell Train's open-ended funds from its recommendations list). I'm unaware of any comparable premium in investment trust history, even including 1920's Wall Street when such trusts became go-go leveraged stocks to own (before imploding).
Managerial recklessness of the past was countered by regulation, and proponents of the Lindsell Train vehicle say the true value of Lindsell Train investment management firm (constituting 17% of the trust) isn't fully recognised.
Anyway, and on a broader "market timing" view, it looks notable after a decade of net monetary stimulus that some chunky premiums to NAV have appeared in the sector. Those of conservative financial mind could be excused for wariness towards "bubble" features.
Hold, but be aware of the risks
In conclusion, I like Unite's deal for enhancing medium-term earnings/yield prospects, thus reducing PE and raising the yield, while its stock trades at a premium to NAV.
My caution as to Brexit may be misplaced and, even if there is a recession, shareholders here will mostly hold stock through it. So, having clarified the long-term context of NAV valuation, I'll let holders make their own decision according to risk preference. With fresh money, this stock could get more interesting amid any fall-out from a hard Brexit. Hold.
Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.
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