The property sector is recovering quickly. But there is still chance to pick up a bargain.
The property sector has bounced back strongly from the carnage of a year ago. It's the behemoths of the sector who've led the way, with Land Securities up 94 percent from its lows, Segro up 91 percent and Hammerson up 78 percent.
Nimble investors have done well from the recovery. The Three Bargain Landlords I wrote about a year ago, for example, have rewarded their shareholders well. The star performer, Public Service Properties (LSE: PSPI), is up 103 percent, with a decent dividend income as well.
And the situation now
The big companies in the sector are looking increasingly fully valued. Most now trade at a premium to their net asset values:
My figures for both Liberty International and Derwent London are based on their 30 June 2009 balance sheets. It's clear the markets are expecting their net asset values to have increased strongly since then, just like British Land, whose recent quarterly report revealed an 18 percent increase in net assets, driven by an 8.2 percent upturn in the value of its properties.
For value investors looking for a bargain that's bad news. Further share price increases will have to rely on growth in valuations. Look away if you are expecting a double dip recession.
And don't forget debt
Most of the big property companies have very high levels of bank debt. Liberty International, for example, has an eye watering £3.2 billion of debt, compared to net assets of £2.4 billion. That's a gearing level of 136 per cent (debt as a percentage of net asset value).
Debt can do funny things to net asset discounts and premiums. Looking at the table above, you might think that Derwent London's property assets need to increase in value by a whopping 42 percent to close the gap to the value placed on the company by the stock market. You'd be wrong. It's actually only 22 percent. That's because the net asset value includes a big slug of debt which is not affected by property revaluations.
One way to take account of this is to use enterprise value rather than market capitalisation in looking at valuation. Enterprise value separates the debt out from a company and treats it as part of the source of financing of a company instead of part of its net assets.
So the total enterprise value of the company is the value of the equity plus the value of the debt. We can then compare this with the value of the assets, excluding the debt. In the case of Derwent London this shows:
| | £m | | £m | Premium |
|---|
| Net assets | 953 | Market cap | 1,349 | 42% |
| Net debt | 849 | Net Debt | 849 | |
| Net assets, before net debt | 1,802 | Enterprise value | 2,198 | 22% |
Doing this allows a comparison of different companies with different debt level.
One more property bargain
So if the big boys of the sector are looking fully valued, where can we find a bargain?
One company which still trades at a sizeable discount to its net asset value and has yet to take part in the sector recovery is Quintain Estates (LSE: QED).
Like many companies in the sector, Quintain was badly affected by a combination of high levels of bank debt and a collapse in property valuations. As a result, last November, it was forced to get out the begging bowl to shareholders, announcing a highly dilutive rights issue at a massive 72 percent discount to its share price and a 60 percent discount to its underlying net asset value.
Although well supported, such a fundraising was hardly likely to endear Quintain to the market and its shares still trade at a 23 percent discount to the ex-rights price.
Nonetheless the action puts Quintain in a much stronger position to develop its business. Based on its September interim accounts, and adjusting for the rights issue, Quintain's net asset value is around 123 pence per share. That's a sizeable 50 percent discount to the current share price of 62 pence. Even adjusting for debt the discount is 32 percent.
The cash injection has also put the company in a much securer footing with its banks, reducing net debt to around £355 million and cutting gearing from 118 percent to just 56 percent.
More than a landlord
Quintain is not just a landlord but is also involved in urban regeneration and fund management. It has two big and prestigious developments:
- Wembley, where it is regenerating 85 acres of land it owns around Wembley Stadium for combined residential, retail and leisure use.
- Greenwich Peninsular, which is a mixed residential and commercial development adjacent to the O2 (formerly Millennium Dome)
As a result it well placed to benefit from a recovery in the London property market and add value with its improved financial muscle.
In addition to that Quintain has a growing fund management business which concentrates on niche areas such as healthcare and student accommodation.
Although Quintain's trading statement in January was naturally cautious, it showed further progress in a number of key areas. It's a bargain which hasn't been missed on the Motley Fool's bulletin boards.
With general property values having strengthened since September I believe Quintain's results in early June will show the start of a recovery in net asset value and demonstrate just how undervalued is the company. I'd expect sentiment to change sharply and the share price to reflect it.
More from Steve Scott:
Steve holds shares in Quintain Estates.
