Brexit-induced pessimism makes Derwent’s real estate trust shares a bargain
THE continuing debates over whether Brexit will be good, bad or neutral for the British economy and whether the Bank of England was right to start to raise interest rates are hanging over many domestically facing stocks. Among those in the doghouse are real estate investment trusts (Reits), especially those with exposure to the capital. Derwent London is just such a stock – yet this could prove to be an opportunity, as pessimism can throw up the chance to buy good companies cheaply. This column first tipped the shares at just below £24 and the worries have not stopped them from producing a pleasing capital gain, with the 38.5p final dividend and May’s 52p special thrown in for good measure. There could also be more to come, judging by the company’s solid third-quarter trading update last week.
Derwent London announced that it had let or pre-let 674,800 square feet in the first nine months of the year. Vacancy rates have declined to just 1.4pc, lettings values have risen and the £496m in asset sales were struck at prices 10pc above the values recorded in the company’s balance sheet in December. None of this sounds even vaguely like the doomsday scenario implied by the shares’ lowly valuation. The share price of £26.25 compares with June’s net asset value of £35.82, or a discount of some 25pc.
This is not to say the doom-mongers are certain to be wrong. Questor’s crystal ball is no better than theirs, and the sceptics are clearly worried that Derwent’s new projects leave it exposed, as a further 620,000 square feet of buildings is under construction. Yet 45pc of these are already pre-let and 94pc of the assets developed this year already have confirmed tenants. Even if the bears are right and a Brexitinduced hit to the economy prompts an exodus of businesses, or the Bank of England overdoes it, or both, that 25pc discount to net asset value already factors in the prospect of substantial declines in occupancy levels, rents and therefore property values.
If the doubters are wrong, the share price could just motor, helped by a possible narrowing of the discount and potential increases in asset values. The yield is a small welcome bonus and the company’s lowly loan-to-value ratio means its balance sheet should be able DLN hold
Market value: £3bn
Turnover (Dec 2017 estimate): £158m
Pre-tax profits (Dec 2017 estimate): £104m Yield: 2.2pc Most recent year’s dividend: 52.36p
Net debt (Jun 2017): £565m
Return on capital (Dec 2016): 1.8pc
Cash conversion ratio (Dec 2016): –153.2pc
p/e ratio (Dec 2017 est): 30.3 to withstand any normal propertycycle downturn without undue concern. Well, this is tricky. Our thesis that M&S’s first-half results would surpass a very lowly set of expectations was borne out on their release last week. Unfortunately the shares just sniffed and moved slightly lower as the market preferred to focus on near-term issues such as margin pressure in the food business and the lack of growth in clothing and home, never mind the long-term threat posed by lower-cost, more fast-fashion-facing online rivals.
This puts Questor in a quandary, especially as the plans outlined by the chief executive, Steve Rowe, and the chairman, Archie Norman, make good sense – and the latter’s blunt words suggest M&S now has a management team that is embracing, rather than denying, the challenges it faces.
The shift to slowing the expansion of food stores is prudent; the population can eat only so much, no matter how good the quality of the product. Tackling excess floor space in clothing and home is also a welcome acceptance of the truth, especially when added to a drive to improve online services and grow volumes here: improved stock turn means lower markdown, lower markdown means better margins and better margins mean better profits.
The rub is that all of this is going to take some time and some investment, so anyone who wants immediate momentum should look in a different aisle for their next stock pick. But patient value seekers can stick with M&S for now, especially as the 5.8pc yield means they are being paid to wait to see what improvements Rowe and Norman can achieve.
When analysts describe a company that still makes more than £500m a year as broken, contrarians will naturally become interested, even if the operating environment is undeniably difficult.
hold MKS 314.1p