Stockwatch: A property company going cheap

Has a 38% drop over 10 months in property regenerator U and I Group run too far, or might it foreshadow a market cooling off? Periodically, questions get posed whether commercial property must be at some kind of peak.

For instance, Schroders' head of real estate has said that, while this property segment has, historically, been stable, its capital values are cyclical. Broadly, they have risen by 25% in less than three years, which may not continue - hence some listed investment and development firms seeing their shares fall.

U and I Group (previously Development Securities) is mainly a developer of public-private partnerships (PPPs) improving undervalued areas of towns and cities for living and business - e.g. in London boroughs and towns like Lichfield and Sittingbourne. Indeed, it has a circa £200 million investment portfolio substantially let to retailers as a means of funding capital growth via regeneration. That continues to offer opportunities as tighter government funding of councils emphasises the most economic means to urban renewal.

So, does the economic or political context really justify such a drop in share price, to a discount around 30% to net asset value (NAV)? The five-year chart shows it reached a previous support level at 180p, and the shares are currently bouncing from this to over 190p.

Heavy insider buying

Last December and January there was persistent director share buying against the trend - they bought nearly £223,000 worth of shares at 227p to 237p - suggesting belief in value here.

U and I then went into its closed period ahead of prelims this Thursday, 28 April, although prospects shouldn't hinge on one set of results. The directors' last words and their share dealings appear promising, although there has been no group update since last October's interims to 31 August, when progress was described as busy and on track, having largely completed the integration of Development Securities with Cathedral Group since May 2014.

"We now have a stronger team with the depth of knowledge and skills to deliver high quality returns across the business," the group said. "Using our combined expertise we have put in place a number of strategic initiatives as we seek to enhance our position as the UK's most respected mixed-use regeneration company."

That's the crux for value - they imply potential of the £27 million acquisition of Cathedral is not properly reflected in the stock price, given the nine regeneration projects and capable management that the deal brought in, despite paying just over net asset value.

At end-August 2015, the group balance sheet had £343.6 million net assets with only £2.3 million intangibles and no goodwill, implying NAV per share of 274p. Debt involved £75.8 million short-term and £162.3 million long-term, £217.0 million net of cash and implying gearing of 63% (with an average interest rate around 6%).

Moreover, the de-rating has created a prospective yield near 3.5% on the ordinary dividend which is significant in wider financial context. The table doesn't show an additional 8.0p special dividend last year, although it's tricky to reckon this could become a regular feature. But unless interest rates rise sooner and more sharply than expected, thereby hitting property values, the risk/reward profile appears positive.

Five-year progress and forecasts are modest

Mind how the table hardly reflects a growth profile in terms of net assets per share and, while profits have re-rated, the broker forecasts imply a slight decline. They are from just one broker (Peel Hunt), though, last October.

But sceptics could say the five-year numbers and what forecast is available only show growth in parts, despite loose monetary policy creating an exceptional period for asset growth. Selling may have been triggered by a sense the macro outlook is inevitably moving closer to interest rate rises, hence discounts to NAV could become prevalent.

Yet such a basic view may not respect the value dynamics now established, including a new approach with much closer collaboration between the development and investment teams to extract maximum value from each asset. Returns of 50% on equity are targeted for short-term trading assets and two to five times equity over two to five years, in a maximum size of £15 million.

Management claims it has a niche in £50-£100 million development projects that are too big for private investors - albeit modest for professionals - and that benefits should flow (if somewhat volatilely) from investments made since 2008. The group's broad skills represent a competitive advantage for PPP tendering, versus others coming from a mainly residential background.

A circa £200 million investment portfolio yields about 7% annually, with PLC/Nationals occupying 62.1% of these properties - Waitrose, Matalan, Sainsbury, Sports Direct and Springheath Leisure - then Local Traders the next most significant with 25.3%.

So, if a Brexit vote happens in June, such businesses may face the risk of more cautious consumers; otherwise these assets provide stable cash to cover costs on the group's development side. Active trading aims to maintain focus on assets with the most rental growth potential.

Results could still warrant advance to 250p

One fund manager holding the stock has noted £55 million gains being possible in the latest financial year with a further £115 million over the next two years, and assumes £150 million conservatively. It will be interesting to see if Thursday's results support this.

The story comes across better than the published figures to date, so if prelims are positive all-round then they will justify the directors' buying.

It only needs the market to respect U & I's progress and positioning in PPP regeneration for the present discount to book value to narrow. That could trigger a re-rating closer to 250p.

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This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.