Attractive inflation hedge
Custodian REIT generated an impressive 8.5% total net asset value (NAV) return over the December quarter, reflecting a particularly strong performance in the industrial space, which is the group's largest sectoral exposure. It also reflected the acquisition of Drum Income Plus REIT at a discount to NAV along with asset management activity.
Industrial and logistics (47% of the group's portfolio) experienced an 8.2% capital uplift over the quarter, driven by rental growth due to occupational demand exceeding supply, and yield compression through the volume of UK and overseas monies chasing the ‘in vogue’ sector. Retail warehousing and high street retail also reported capital growth and the company says that rents in these areas appear to be bottoming out.
Custodian REIT's property portfolio value grew by 13% over the quarter to stand at £637.9mln (30 Sept 2021: £565.3mln). The growth reflected a £36.2mln aggregate valuation increase, £49.2mln invested in DRUM REIT's portfolio and a £1.1mln profit on disposal from the sale of four properties for an aggregate consideration of £14.8mln. Custodian REIT completed the acquisition of Drum in November. The deal was paid for through the issue of just over 20.2mln shares at 94.5p. Drum was sub-scale, which meant it was difficult for its management to grow, and Custodian REIT was able to acquire it at a £7.3mln discount to NAV.
Earnings per share (EPRA basis) was 1.3p for the quarter, which was below the 1.6p earnings in the prior quarter, mainly due to easing leverage levels and the EPRA occupancy decreasing to 90.9% from 91.6%. Of the vacant space, 34% is currently under offer to let and a further 32% is planned vacancy to enable redevelopment or refurbishment. Net gearing was 19.5% loan-to-value (30 Sept 2021: 19.6%) remaining below the company's 25% target, which gives the company plenty of scope to make further acquisitions.
Attractive investment case
The key to the investment case is that the group invests in sub £10mln properties, which at present generate around 189 basis points (100 bp = one percentage point) additional yield than larger properties, according to data from Custodian REIT. Consequently, the group generates attractive rental income, and grows this income, while reducing the risk through broad regional and sectoral diversification. No single property generates more than 2% of group rental income. Also key to the investment story is the stock offers a strong hedge against the current inflationary pressures (UK inflation was 5.4% in December, its highest since 1992), as property values have typically grown in line with inflation.
NAV total return per share was a strong 8.5% in December
The stock trades at a 6.4% discount to NAV of 113.7p, which is attractive, compared with a typical 10% premium prior to the pandemic. In addition, the stock offers a 4.9% dividend yield in the current year, which rises to 5.4% next year, and compares with the 1.6% yield on UK 10-year gilts.
Valuation
Year end Mar 31 · 2020 · 2021 · 2022 · 2023
Value of investment properties £-mln · 559.8 · 551.9 · 647.9 · 702.9
Gearing (LTV%) · 22.4 · 24.4 · 21.2 · 24.7
Revenue from property £-mln · 40.9 · 39.6 · 40.4 · 44.0
EPRA EPS (GBp) · 7.0 · 5.6 · 5.8 · 6.4
Dividend (GBp) · 6.65 · 5.00 · 5.25 · 5.75
The company paid a dividend of 1.25p for the September quarter and approved a dividend of 1.375p for the December period. It intends to pay further quarterly dividends of at least 1.375p to achieve a target dividend for the current year of at least 5.25p and for the year ending 31 March 2023 of at least 5.5p. The board's objective is to grow the dividend on a sustainable basis, at a rate that is fully covered by net rental income and does not inhibit the flexibility of the company's investment strategy.
Dividend policy
We have amended our forecasts, and we now assume that property acquisitions will push the gearing back up towards 25% by March 2023. We assume that revenue from property grows roughly in line with property valuation in financial year 2023 (FY23) with a dividend payout ratio of 90% in that year.
Forecasts
The acquisition of Drum REIT at £7.3mln below NAV boosted NAV per share by 1.6p in the period; however, the issuance of new shares at a discount to NAV along with acquisition costs reduced the accusation gains to 0.9p. General valuation increases added 6.8p to the valuation over the period, while EPRA earnings added 1.3p. This was below the 1.6p earnings in the prior quarter, mainly due to easing leverage levels and the EPRA occupancy decreasing to 90.9% from 91.6%. Finally, the interim dividend of 1.25p paid during the quarter reduced the NAV by that amount, hence, the NAV per share increased by 7.3% over the period, while the NAV total return per share, which includes the 1.25p dividend, was 8.5%.
The 8.5% December quarter NAV total return compares with 8.2% for Picton Property Income, 9.5% for Standard Life Investments Property Income Trust and 8.7% for UK Commercial Property REIT (LSE:UKCM).
Movement in Net Asset Value (NAV)
