Stockwatch: 5% yield at a discount

Is it too late to consider commercial property-related shares in this cycle? The sector plunged after the EU referendum, only to bounce back - although it's still possible to find discounts to underlying net asset value (NAV) and useful yields to boot.

But with higher inflation already prompting some analysts to caution on the 2017 economic outlook, the need for a margin of safety in many shares is rising too. Along such principles it's interesting to consider the Mid 250 shares in Hansteen Holdings. At about 109p, the shares are projected to yield 5.2% from light industrial property, a segment of commercial property yet to surpass previous highs.

Hansteen is dialling into demand for warehouse space as more goods are sold and distributed online, much like Tritax Big Box REIT - another stock I have regularly drawn attention to.

At Hansteen's end-August 2016 interims, the company's operating yield (rent divided by property value) was 7.6% compared to a borrowing cost ratio of 3.2% - at the upper end of the earnings scale in the real estate investment trust sector.

The company's real estate investment trust (REIT) status means Hansteen has not paid tax on gains from qualifying property rental since 2009, on the basis that 90% of that income profit is distributed annually.

The income aspect is therefore significant and should continue to mitigate downside risk. If there's a bad mark on Hansteen as a share, it's its relative boredom following a 2013 rise from 80p to 108p - the shares have traded within a 95-128p range and are currently at a median price level.

With the majority of its assets based on the continent, this reflects sterling's strengthening against the euro before the end of 2015. Since June's EU referendum, however, this trend has reversed.

Sterling weakness enhances NAV

NAV measures vary somewhat, which doesn't help clear-cut comparisons. For example, the interim results to end-June 2016 showed NAV according to the European Public Real Estate Association (EPRA) up 11.9% to 124.4p, although this shrunk to 120.5p on an "adjusted EPRA" basis and 116.0p on an accounting International Financial Reporting Standards (IFRS) basis.

Anyway, you can see a modest discount against the current share price in these last-reported figures, and the underlying commercial trend has been good. With a currency tailwind it should be possible to see useful NAV growth in the March 2016 prelims.

If the UK sees an economic slowdown, it is wise to diversify currency exposure

Further down the interim release is a table summarising the rents and underlying values of the property portfolio in euro and sterling. Of total properties worth £1,234 million, 18.7% are UK-located, 58.3% in Germany and 22.9% in The Netherlands, Belgium and France. In other words, a portfolio that is about 81.3% exposed to the euro.

This table clarifies euro figures translated at an end-June exchange rate of £1 = €1.2081, since when the exchange rate has slipped to about €1.16 and sterling has continued to weaken overall. A 4% fall isn't going to re-rate the shares alone, but it reinforces Hansteen's appeal for sterling-based investors looking for a useful yield with good downside protection - unlike various high-yielding cyclicals. It also provides a hedge against sterling as Brexit negotiations get underway.

Not to assume a weak sterling scenario when poor Italian finances and the French presidential election could conflate to hurt the euro; but if the UK sees an economic slowdown and tough talking from Brussels, then it is wise to diversify currency exposure.

While the consensus firmly favours the dollar, a crowded trade is exposed to unexpected events. So without over-emphasising currency factors in the investment case for Hansteen, they grow and enhance its appeal.

Strong market

Results for the first half of 2016 show normalised income profit up 28.1% to £29.2 million, although normalised total profit rose just 2.3% to £30.8 million. "Income profit" excludes property trading gains/losses, whereas "total profit" included £7.3 million of these such gains and other income in the first half of 2015, which made it a tough comparator.

Two months is enough time to see market jitters, but Hansteen's risk/reward profile weighs to the upside

Rental income growth of 11.2% to £44.7 million and a near-doubling of associates' contribution to £8.2 million drove income profit. The downside of a strong market is limited acquisition opportunities: spending £49.7 million on units from the Ashtenne Industrial Fund was incestuous - if a good deal - in that the founders of Hansteen were joint chief executives of Ashtenne Holdings before it was sold to Warner Estates in 2005. Remaining interests in Ashtenne were then acquired last July.

There's a positive angle for corporate development, with scope for the mature business cycle to bring more assets onto the property market as shareholders benefit from strong yield credentials.

Hansteen has 450 acres of undeveloped land that will eventually deliver value; presumably by way of sale unless a development partnership is established. In terms of financial flexibility for development/acquisitions, net debt rose 20% to £571 million in the first half partly reflecting a £17 million mark-to-market adjustment and £41.9 million from the euro's strengthening, otherwise net debt to property value rose from 41.2% to 44.9%.

With average maturities of 2.9 years and significant headroom on covenants, Hansteen can withstand a downturn. The interim net finance charge (helped by higher interest income) was 24 times covered by operating profit. In the second half of last year, new loan facilities were established, giving £786.6 million of total facilities.

£50,000 of shares snapped up

On 17 November the chairman's wife bought 47,406 shares, the only recent trading by insiders - albeit a significant amount. This was followed by a 5 December portfolio update citing rental growth emerging in the UK and Germany. Overall vacancy reduced to 4.2 million square feet or 10.2%, compared with 5.3 million square feet or 12.9% at end-June, and management had seen an "increased investor appetite for multi-let light industrial property across Europe".

Two months before prelims is more-than enough time to see market jitters, and radical actions by the new Trump administration could hurt sentiment. Yet, all-considered, Hansteen's risk/reward profile weighs to the upside and its euro exposure offers sterling-based investors a means to diversify.

Mind that other EU ructions in 2017 could also weaken the euro, such as the National Front in upcoming French election rounds. Hansteen's geographic exposure is mainly towards Germany and The Netherlands, however, with France representing just 2% of annual profits.

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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.