Stockwatch: A 5% yield and discount to net assets

It's pertinent to review the investment case for mid-cap commercial property investor Hansteen since I drew attention to its shares at 109p two months ago, yielding 5.2%.

On 10 March I also suggested a switch into Hansteen from Tritax Big Box REIT on grounds it offered relatively better value than Tritax which had soared to a 13% premium to underlying asset value.

Both companies have capitalised on demand for light industrial property, as more goods are sold and distributed online, thereby requiring warehouse space.

Moreover, with 58% of revenue/profit derived from Germany, 20% from the Netherlands and only 15% from the UK, Hansteen offered a hedge against sterling weakness. I said it would be interesting to see what the 2016 results declared by way of net asset value (NAV) upgrade, with the German economy performing relatively well and exchange rates supportive.

2016 total underlying return of 20.8%

Latest prelims show a 17.7p advance in NAV to 128.9p on the EPRA basis (European listed property sector association) plus dividends paid of 5.35p, with profit measures varying according to how property is accounted for.

There is a 30% fall in IFRS pre-tax profit to £119.9 million due to a high property valuation on the total portfolio in 2015 not being repeated in 2016, while normalised income profit (excluding the sale of properties) is up 29.4% to £61.1 million and normalised total profit (including property sales) up 4.4% to £66.0 million.

The total dividend declared in respect of 2016 is up 12.4% to 5.9p, implying an historic yield of 5% at the current share price around 118p. While Hansteen's dividend record varies (see table), the board says it is "committed to a prudently progressive dividend policy to reflect the high and growing income generated by the business" – on which basis it's fair to anticipate a minimum 5% yield.

Intrinsically, the end-2016 yield on Hansteen's built portfolio was 7.8% versus an average all-in cost of borrowing of 3.2%, a spread the directors say offers potential for further upside in both income and capital, and compares favourably with property sectors where yields have reached historic lows.

Hansteen's rental growth underpins strong income returns and there is vacant space to let. Furthermore, Hansteen owns 447 acres of undeveloped land that will in time generate value. "We will continue to focus on realised returns allowing us to pay a well-covered and growing dividend," it says. Altogether it implies solid income credentials and steady capital growth in line with the investment case I set out.

Sale of German and Dutch portfolio for £1.1 billion equivalent

Hansteen will however be radically transformed to a smaller UK-oriented business in the months ahead as a result of this transaction: contracts for €1.28 billion (£1.1 billion) have been exchanged with funds related to Blackstone Group, representing a premium of about 6% to the properties' end-2016 valuation; this disposal realising value at a time of high levels of occupancy and rent, also when the euro/sterling exchange rate is favourable.

Management says it represents a circa 30% gain in sterling terms for these properties since end-2015, and is consistent with their long-term strategy which includes realising the investment at a higher point in the cycle" (my italics). This appears carefully-worded so as not to convey belief in a high point currently.

Since terms were agreed, sterling has recovered slightly on news that UK annualised inflation rose to 2.3% in February, overshooting the Bank of England's 2% target for the first time since September 2013, hence stoking speculation of an interest rate rise sooner rather than later. Brexit twists and turns could yet impact sterling further, but if the central bank is perceived as turning hawkish then a UK investment portfolio's need for a sterling hedge reduces. The euro also has to contend with French and German elections this year.

Special dividend looks likely during 2017

The deal is scheduled to complete before the end of June, proceeds to be applied first for capital gains tax and halving Hansteen's debt to £413 million, then distribute some £650 million net proceeds.

The group's current capitalisation near £900 million shows the reduction in scale underway, including a 59% reduction in gross property assets from £1.74 billion to £719 million, leaving predominantly UK properties which yield about 8%. Hansteen's share price tested 130p on the prelims and disposal news, but a drop below 120p may already be pre-emptive selling by index funds as Hansteen will be demoted from the FTSE 250 to Small-cap index.

Within the disposal announcement lies a caveat (lawyers would have insisted upon) that "no final decision has been made as to timing, amount or structure of any cash distribution, nor any assurance as to doing so in a tax-efficient manner." Amid rising taxation on dividends for individual shareholders, versus institutions that pay no tax, some kind of share-based alternative could mitigate taxation, but the caveat means no guarantee.

Where next for corporate development?

Implicitly, management believes the commercial property cycle has further to run: on 17 February a £25.2 million cash offer was made for the Industrial Multi Property Trust, a 5.6% premium to its end-June 2016 NAV of 284p (which may have since improved with the market, also intrinsic values tend to be higher than IFRS numbers).

The IMPT portfolio is described as "very similar in nature to Hansteen's own UK portfolio, can be easily absorbed onto our asset management platforms with limited additional cost."

Such disposing/acquiring means Hansteen's per share figures will need re-working and, as yet, there is no cut-off date when the shares would trade "ex" any special dividend. So an investor's stance may vary according to whether you actually want a substantial special dividend, e.g. as part of tax planning. Selling obviously has its own tax angle, but the drop to 120p may also be explained by some investors tidying up.

But at 118p, Hansteen should still represent a modest discount to the eventual NAV together with a base-case 5% underlying yield as represented by rental income versus borrowing costs.

Despite the prospect of a UK interest rate rise, Hansteen has re-financed its UK portfolio with a new £330 million, five-year loan facility at an all-in cost of 2.6% a year – which ought, if anything, improve the net return. The shares, therefore, remain attractive for sound income with strong asset-backing, the chief risk being a UK slowdown during Brexit years.

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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.