As TR Property announces its full year results for the year ended 31 March 2017, Hugh Seaborn, its chairman, commented: “I’m pleased to report another solid year of performance from the Trust. The Board are particularly pleased to announce a final dividend of 6.4p which brings the full year dividend to 10.5p, a 25.7% increase on the previous year. This also brings the 10 year compound annual dividend growth rate to an impressive 9.9 %.”
Over the year, the net asset value rose by 5% to 352.4p, taking shareholders’ funds through £1.1bn and translating into a total return on net assets of 8.0%. The share price total return (assuming dividend reinvestment) was 9.1% and reflects a slight reduction in the discount relative to the net asset value. Revenue earnings per share were up 36.1% to 11.38p, fuelling the dividend increase.
Revenue and Revenue Outlook
Currency was a significant factor behind the increase in revenue as European earnings became worth more in sterling terms. They say that other factors did play a part, with some ex-dividend date changes around the year end being brought forward and some companies moving from annual to more regular dividends in the period.
This step change in the level of earnings can be expected to be maintained whilst sterling remains at current levels. They say that results announced year to date have been positive in the main with dividend growth in many of the stocks in which TR Property invests.
Capital performance
The first half of the year saw a very sharp divergence in the performance of the UK and Continental Europe. The 6.5% return from UK property companies between the beginning of the financial year and 23 June sums up the optimism and expectation of a Remain vote. Over that period, Continental Europe returned just 2.2% in EUR terms. From 23rd June to the end of the first half, 30 September, UK stocks fell -8.2% whilst the Continental names rose 3.9% in EUR terms. These summary figures mask a period of extraordinary volatility in the aftermath of the Referendum result.
The second half of the year saw property shares experiencing an autumnal sell off as investors rotated from defensives and companies seen as ‘bond proxies’ into cyclicals offering greater exposure to an improving global recovery. This rotation gathered pace post the US presidential election as markets priced in a tailwind of fiscal support. Bond yields across all developed markets rose and sub sectors such as German residential which are perceived as stable income streams with restricted growth due to regulated rents fared very poorly in the last quarter of the year. The German element of the benchmark fell over 15% between September and November.
The last quarter of the financial year saw a stabilising of share prices after a strong recovery in December. Investors began to realise that the US had not only embarked on an interest rate normalisation phase but may well now receive an injection of fiscal largesse with the potential lowering of tax rates. However, Europe is not travelling at the same speed and there is no expectation that the ECB is going to lift the base rate soon. Longer dated bond yields have continued to rise modestly, the 10 year Bund rose from -10 bps to +34 bps in the second half of the financial year, but they remain at historic low levels. Investors continue to seek alternative sources of (higher) income than the miserable returns from fixed income. The last quarter of the financial year coincides with the reporting season for companies with a December year end and share prices responded to a steady stream of results which matched or exceeded earnings expectations. The message from companies was one of continued focus on revenue and a broad expectation that the improvements in the underlying economic environment would translate into tenant demand and rental growth. One important distinction between the UK and Continental Europe was the direction of capitalisation rates. The UK listed sector, dominated by exposure to London and large shopping centres is now experiencing rising capitalisation rates as rental growth prospects recede, whilst much of the Continent is still reporting yield compression particularly in prime office markets reflecting the prospect of rental growth.
Investment Activity
Investment turnover (purchases and sales divided by two) equated to 31.6% of the average assets over the period. Whilst investment activity reflected a heightened level of tactical repositioning due to a range of macro factors, the strategic positioning particularly at the asset and sub-sector level saw a continuation of a number of themes which have been running for a while. Our approach to retail exposure is a case in point. They no longer hold either of the UK’s largest pure retail landlords, Intu and Hammerson. Exposure is through Capital & Regional and New River Retail, where they increased the former but decreased the latter. They continue to focus on stocks where rents have rebased to affordable levels and where investors are being rewarded through higher income returns in an area of the market which is suffering huge structural headwinds. Asset management gains are a key part of the overall returns from these businesses and a small number of initiatives can make a large difference in these smaller companies. In the case of the larger stocks, they both have large development and repositioning pipelines but they don’t believe the returns offered justify the risk on such large schemes.
They remain more confident about retail in Europe and here exposure has consolidated into four names, Unibail and Klepierre focused on prime and Mercialys and Eurocommercial in the sub-regional space. They have therefore exited (or are close to completing our exit) from Citycon (Finland), Wereldhave (Netherlands, Finland and France), Vastned Retail (Netherlands, France and Spain) and Deutsche Euroshop (Germany and Central Eastern Europe).
The winners in the game of omni channel retailing are the warehouse landlords and developers. They have been increasing exposure to this sector for several years (as the other side of the reduction in retail) and this accelerated both in the UK and Continental Europe. Segro is now the second largest UK position and the capital raises in September 2016 and March 2017 enabled significant expansion in the position. The stock was the top performing UK large cap in the period, returning 20.5%. Hansteen has been a stock they have traded in over many years and undue share price weakness early last year enabled them to rebuild the position. They were pleased with the announcement of the sale of the entire European portfolio allowing management to concentrate on the UK. London Metric announced their intention to exit over time from retail warehousing and focus on distribution and the company is now 2% of our assets. Tritax Bigbox gives exposure to this sector but they believe its addiction to raising equity will result in a cash drag and sub par earnings growth hence their modest position. This is not the issue at Argan, their preferred logistics play in France, where the CEO and his family own half the business and are focused on organic growth. The stock returned 32.7% in the period.
In London they had been reducing exposure and that strategic move continued up to the Referendum. However they were still exposed into June and that resulted in some weak relative performance in the aftermath. The London office specialists, Derwent London, Great Portland Estates and Workspace are well run businesses with solid balance sheets and low leverage. As a group they did not reduce exposure further post the result. The surprising weakness was in both St Modwen and CLS Holdings, two large holdings. They reduced exposure in the former but the subsequent resilience of the UK regional markets and the appointment of a well regarded new CEO led to a strong recovery in the share price. On a happier note, they held the CLS position and then added to it. Alongside the Vauxhall site (now sold), the business had one of the highest cashflows per share in the sector with a portfolio of edge of city centre and suburban offices in the UK, France and Germany. The total return for the year was 18.4%.
With bond yields across Europe set to rise further as the Eurozone economies improve they have rotated our residential focus to the higher yielding businesses, (Vonovia and LEG) and those with development pipelines (Buwog).
Their renewed interest in Spain evolved further with additional investment in Hispania. The business will be wound up by 2020 and importantly management’s carried interest is paid only on the exit.
Tax changes
Under new legislation effective from the beginning of April 2017, the amount of interest deductible when calculating tax payable has been restricted. Even at low levels of gearing, TR Property will be caught by this to a small extent and the result will be a modest increase in the tax charge. This will be evaluated as a cost of debt when considering gearing levels but is not likely to influence gearing decisions when interest rates remain at current low levels. There are exemptions to these restrictions for some categories of business and Real Estate Investment Trusts are one example, so most of the companies it invests in will not suffer the restriction, however some non-REIT businesses may and they are engaging with their advisers. The Investment Trust industry lobbied HMRC through the AIC to extend the exemptions to regular Investment Trusts, but this was rejected.
Direct Physical Portfolio
The physical property portfolio produced a total return of 2.6% for the twelve months to March 2017 with an income return of 3.4% and a capital return of -0.7%.
At their industrial estate in Wandsworth, London they have completed their programme of lease renewals, extending the expiry profile for the estate so all leases now expire in 2019. This facilitates a redevelopment of the estate at that time. Overall 11 leases were extended and 1 new letting was concluded with the rents received on those units increasing by 25%. Only 2 units are vacant and one of those is under offer. Their other industrial assets in Gloucester, Bristol and Plymouth have performed well over the year with the new lettings in Gloucester delivering further rental growth with a void period of only 2 months.
At the Colonnades in Bayswater, they have experienced a delay in the letting of the ground floor retail units. Their planning application merging two units to facilitate the letting to Babaji, the restaurant operator, was turned down by the City of Westminster planning committee. They believe that Babaji would be an excellent restaurant operator and have therefore made an appeal to the Planning Inspectorate with a decision expected in late September. At the time of writing they have strong interest in the two remaining units from a range of occupiers. They are keen to ensure that the tenant mix is complementary as this will be essential to the success of the overall development and therefore they are not rushing to secure the first possible party. The number of residential lease extensions was modest with only 5 flats extending their tenure. This is not a surprise and reflects the uncertainty generated by the Referendum result. They are in no rush to complete lease extensions as the effluxion of time towards each lease expiry merely increases the landlord’s residual value and the ultimate extension premium which must be paid.
TRY : TR Property plans 25.7% dividend increase