Custodian REIT PLC (LSE:CREI) — 17% NAV discount is an opportunity
At times of elevated inflation — UK consumer price index (CPI) inflation jumped to 9% in April, a 40-year high — investors need to tread carefully. Historically, real estate investment trusts (REITs) have provided good protection against inflation. Within the REIT sector, Custodian REIT PLC (LSE:CREI) (LON: CREI) offers strong exposure to the growing industrial & logistics and retail warehouse spaces. Despite generating a total return per share of 28.4% over the year, its shares trade at a significant 17% discount to net asset value (NAV) and offer a prospective dividend yield in excess of 5.5%.
Custodian REIT recorded another strong quarter, generating a 6.4% total net asset value return over the period ending in March 2022, and taking the total NAV return over the year to an impressive 28.4%. A dividend per share of 1.375p was set for the period, taking it to 5.25p for the full year, and management has a target dividend of no less than 5.5p in the current year. EPRA earnings per share (EPS) for the quarter were 1.6p taking the total for the fiscal year 2022 (FY22) to 5.9p (2021: 5.6p) and providing dividend cover of 110% in FY22, down slightly from 113% in FY21.
The performance continued to reflect buoyancy in the Industrial and logistics space (49% of the group's portfolio by value) while retail warehousing (19% of the portfolio) also continued to report attractive capital growth. Net gearing decreased to 19.1% loan-to-value, down from 19.5% at end-December and 24.9% in March 2021. This decline was due to valuation increases of £94.0mln over the last 12 months, and remains comfortably below management's target of 25%, providing plenty of scope for acquisitions.
Attractive investment case
The key to the investment case is that the group invests in sub £10mln properties which represents a significant yield pick-up on larger properties. At end-March, Custodian REIT had 160 assets providing a net initial yield (NIY) of 5.7%. 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 recent jump in inflation (UK CPI inflation rose 9% in April, up from 7% in March, and its highest in over 40 years), as property values have typically grown in line with inflation.
NAV total return per share was a strong 28.4% in FY22
The stock trades at a chunky 17% discount to the latest NAV of 119.7p per share, which is attractive, compared with a typical 10% premium prior to the pandemic. In addition, the stock offers a 5.8% dividend yield in the current year, based on our forecast, which compares with the 1.9% yield on UK 10-year gilts.
Valuation
Year end Mar 31 · 2020 · 2021 · 2022 · 2023
Value of investment properties £-mln · 559.8 · 551.9 · 665.2 · 720.2
Gearing (LTV%) · 22.4 · 24.4 · 19.1 · 23.3
Revenue from property £-mln · 40.9 · 39.6 · 40.4 · 44.0
EPRA EPS (GBp) · 7.0 · 5.6 · 5.9 · 6.5
Dividend (GBp) · 6.65 · 5.00 · 5.25 · 5.75
NAV/Share (GBp) · 101.60 · 97.60 · 119.70 · 123.50
Custodian REIT's property portfolio value grew by 4% over the quarter to stand at £665.2mln, comfortably ahead of our forecasts of £647.9mln. EPRA earnings per share (EPS) for the quarter were 1.6p, up from 1.3p in the prior quarter. This took the EPS for FY22 to 5.9p (our forecast was 5.8p) up from 5.6p in FY21, with the increase primarily due to a £0.3mln decrease in the doubtful debt provision during the year compared with a £2.7mln increase in the prior year.
The acquisition of DRUM Income Plus REIT PLC in November 2021 was accretive to earnings, with DRUM’s portfolio valuation remaining steady at £49mln.
EPRA occupancy decreased to 89.9% from 90.9% at end-December and from 91.6% at end-March 2021. Net gearing of 19.1% loan-to-value was below our forecast of 21.2% and is comfortably below the company's 25% target, which gives the REIT plenty of scope to make further acquisitions.
Q4 NAV update
During the quarter the company invested £1.875mln on a 24,134 sq ft industrial unit on Moorgreen Industrial Park, Nottingham occupied by Hickling & Squires commercial printers. The unit has a passing rent of £130k per annum, reflecting a NIY of 6.53%.
Following the period end the company acquired an 87k sq ft industrial facility in Grangemouth for £7.5mln occupied by Thornbridge Sawmills with an annual passing rent of £388k, reflecting a NIY of 5.5%.
Also, the company has acquired two retail units on Winchester High Street covering an aggregate 5,228 sq ft let to Nationwide Building Society and Hobbs. The tenants’ leases expire in April 2028 and December 2031 respectively at an aggregate current passing rent of £249,200 per annum, reflecting a NIY of 6.41%. The company said the purchase price of £3.65mln has resulted in net gearing increasing to 20.5% LTV.
Acquisitions
The group's strategy is to provide inflation protection from bricks and mortar, rather than through lease contracts, as management backs open market rent reviews to deliver rental growth. While the inflation theme puts a focus on RPI (retail price index) and CPI linked rent reviews, management argues that an over-reliance on index-linked rent reviews can lead to a disparity between investment values and underlying property values and at some point in a property’s life cycle rents will be re-based to open market values. We note that 81% of Custodian REIT's FY21 rent reviews were on an open market basis, while 11% were fixed and 8% inflation-linked.
Inflation
We have amended our forecasts. We forecast the property valuation to rise to £720.2mln at end-March 2023 (previously £702.9mln), while loan-to-value (LTV) eases back to 23.3% from 24.7%, and we forecast NAV per share will rise to 123.5p. Our EPS for the current year rises to 6.5p from 6.4p and we are maintaining our dividend forecast of 5.75p. We will introduce FY24 forecasts following the final results in June.
Forecasts
The property portfolio value increased to £665.2mln at end-March. The £25.5mln aggregate valuation increase for the period comprised £5.0mln from successful asset management initiatives and £20.5mln of general valuation increases, primarily in the industrial and logistics and retail warehouse sectors. £1.875mln was invested during the quarter in an industrial unit in Nottingham and there was a disposal of a high street retail unit in Norwich at valuation for £1.3mln.
Movement in Net Asset Value (NAV)
