Interactive Investor

Stockwatch: Tritax Big Box – quality at a fair price?

Company stands to gain from e-commerce boom and unmet demand for logistics space.

2nd February 2021 12:53

Edmond Jackson from interactive investor

Company stands to gain from e-commerce boom and unmet demand for logistics space.

To what extent do contemporary bond yields and interest rate destruction justify bidding equity yields above other valuation yardsticks – such as earnings and net assets? 

The question is relevant to stocks in general now bulls assert prices can go higher – if only because equities have greater and more durable yields than bonds. Well-positioned companies may enjoy ‘inelastic demand’. This means it does not change much according to product/service price, hence can raise prices as necessary.

Meanwhile, if inflation manifests in the next two years after so much monetary and fiscal expansion, it would render the scant returns from bonds irrelevant.

Such a macroeconomic summary helps explain why £3.2 billion Tritax Big Box (LSE:BBOX) has seen its shares climb from a brief March 2020 low of 89p to 185p currently. This real estate investment trust specialises in major warehouses and the like – logistics facilities – for supermarkets and e-commerce, hence is solidly backed as the digital economy grows.  

Downside protection and a high-quality yield 

A 14 January valuation update cited an 8% increase in value in value of Tritax’s investment and development assets since only 30 June 2020 demand. This should materially boost the interim net tangible asset value of 155p a share – based on European Public Real Estate Association methodology. 

The stock is currently priced for a 3.6% yield which is favourable versus bonds also a great majority of equities lacking such defensive qualities – say if the pandemic disrupts business for longer than anticipated, and/or stimulus measures generate inflation.  

The price of 185p a share implies a circa 10% premium to the implied end-2020 net tangible asset value of around 167p. Although a tough recession would take the edge off that, it is hard to envisage assets serving supermarkets and the digital economy de-rating. Indeed, a modest premium appears fair to price in reasonable expectations of continued medium-term uplift. 

Subsequently, a 28 January update has cited record demand for UK logistics real estate: 50% year-on-year growth by way of 43 to 50 million square feet of space taken up. There is an estimated 112 million square feet of need across the market, “sustaining demand levels in 2021 and beyond”.  

Mind, given an inverse relationship between assets’ price and yield, it has driven prime logistics’ yields below 4%, however that is not out of line with the stock’s 3.6%. It may not be exciting but in terms of core holdings in the current stock market – riding high versus a pandemic that could in fact take years to defeat – I suggest prioritising downside protection with a better return than risk-free cash.   

Consensus profit forecasts likely do not reflect valuation gains 

A key point to bear in mind regarding Tritax’s income statements, is their including “changes in valuation of investment properties”. While demand outstrips supply of big-box logistics space, the first half of 2020 saw £124 million operating profit comprised 45% by such revaluation gains. This works well currently, but in five to ten years’ time it seems fair to assume the UK and Europe will reach capacity and a recession would mean a devaluation charge to the income statement. 

Consensus forecasts target £104 million net profit in respect of 2020 – as if the lowest since 2014 (see table) - then a rise to £121 million in 2021. This would still be below the £141 million in 2019, and well down on circa £250 million profit in 2017 and 2018. Maybe some error is involved, but I suspect they are ignoring recent valuation gains to imply a forward price-to-earnings (PE) ratio on the mid-20s, which seems exotic for a commercial property stock. 

While the inclusion of revaluation gains in profit is a moot point, ultimately the focus of valuation interest in a stock like this is tangible net asset value and yield. There is also demand for shares in a specialist manager of big-box logistics space, as institutional investors lack these skills despite the big insurance companies having a property side. 

Ultimately however, this fashion will lose its shine like others in commercial property – after supply has kicked in. Taking a 30 to 40-year view on Helical (LSE:HLCL), its PE rating soared well over 30x during its heyday for city centre office developments. Since that boom expired, the earnings multiple contracted nearer 10x in a classic mean-reversion to the sense of relatively normal growth in the sector. 

There is still a positive. Property investment is not a complicated business, like an industrial company often having to restructure - in response to market changes or technological advance – hence commercial property financial statements are less prone to exceptional costs. 

The £1.3 billion long-term debt looks manageable 

As of last June, this had risen over six months from £1.1 billion when it generated a 2019 net finance charge of £34 million, taking 28% of operating profit from rents (before a revaluation boost). Its context is £2.6 billion net assets with no goodwill, and arguably it makes sense to be moderately geared like this – to take advantage of the bull market in logistics space.  

Even if short-term market interest rates rise in response to inflation manifesting in the next two years, all of Tritax’s debt is long term so should not be materially affected.  

The portfolio includes more than 60 properties with high-quality rent collection – in contrast with shopping centres and some offices – such that 99% of third quarter 2020 rent due was collected by that August – without need for rent holidays or reductions. In this regard, logistics is ahead of other property sectors, hence capability to support debt as well as benefiting asset value. 

The chief risk would be gearing up further to pay top-cycle prices, say in a big acquisition, but to date this management appears shrewd.   

Tritax Big Box REIT: financial summary 
Year ended 31 Dec

 201420152016201720182019
Net rental income (£million)18.643.874.6108133144
Operating profit (£m)46.7143110265277181
Net profit (£m)41.813491.9248253141
EPS reported (p)14.721.010.419.417.48.4
EPS normalised (p)14.721.010.419.717.58.2
PE ratio (x)     22.6
Operating cashflow/share (p)8.04.27.96.86.55.5
Capital expenditure/share (p)0.00.00.00.00.00.0
Free cash flow/share (p)8.04.27.96.86.55.5
Dividends/share (p)4.05.95.25.15.55.8
Covered by earnings (x)3.63.62.03.83.21.4
Yield (%)     3.2
Cash (£m)98.659.2165.071.947.421.2
Net debt (£m)1023183686377731,127
Net asset value/share (p)104121126140151150
EPRA net asset value/share (p)108125129142153151

Source: historic company REFS & company accounts

Does the chart underline scope for upgrading stance?

Having followed and been positive on Tritax since it was trading around its 100p issue price in December 2013, I tempered my stance six months ago to ‘hold’ at 162p. Dividend growth has yet to significantly materialise, but around 5p a share the pay-outs have delivered a 3% to 5% yield additional to steady capital growth. It makes sense at this stage of expanding logistics’ exposure to favour investment above pay-outs.  

The question is whether teases about stronger-than-expected momentum, revealed in the 14 and 28 January updates, justifies a fresh ‘buy’ stance.  

Before Covid-19 struck, Tritax was trading around 150p a share and had tested 160p in July 2019 – its investment concept in favour with institutions. Arguably, it does merit a premium to pre-pandemic prices given the digital economy indeed supermarkets (requiring added distribution facilities) have been given a material boost, likely to be sustained. 

Not only has there been a permanent shift in the demand curve for e-commerce, an element of pubs and restaurants many not re-open after enough people have adjusted to eating/entertaining at home. A business model based on serving online retail and supermarkets is reinforced against economic slowdown. 

Quality-at-fair-price fits the bill  

So yes, at a time of uncertainty over growth stock valuations and whether cyclicals are rising on a false dawn – Boris Johnson and Matt Hancock’s talk of “banishing the virus for good” and “holidays as normal by summer” – Tritax appeals.  

With dividend payout projected to rise towards 7p in respect of the 2021, a near 4% yield is being sustained despite the stock’s 185p all-time high. Serious investors are likely to continue treating this as a high-quality realistic return, with downside protection from asset strength. 

The chart break-out from 170p looks to me, a moderate ‘buy’ signal for investors currently weighted towards riskier more exposed stocks. ‘Buy’.  

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

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