Posted on 23 Jun 2017

A royal investment


It was difficult not to be impressed by the full-year results from Palace Capital (PCA:380p), a regional commercial property investment company. Reflecting a combination of trading profits, revaluation uplifts and profits on disposals, reported pre-tax profit and net asset value per share both increased by 7 per cent to £12.6m and 443p, respectively, in the 12 months to the end of March 2017.

Recurring pre-tax profits, which exclude revaluation and disposal gains, surged up by 20 per cent to £6m to deliver EPS of 22.2p, a performance that enabled the board to hike the payout per share by 15 per cent to 18.5p. The directors were able to do so because the company's 165 tenants produce a total contracted rent roll of £12.7m and a net income of £11m after head rents, service charges and business rates on empty property. This easily covers interest costs charged at an average rate of 2.9 per cent on gross borrowings of £78.7m, one of the lowest rates in the sector, secured on the £184m portfolio. In turn, the company retains ample firepower to make further shrewd off-market property purchases offering potential to add value through active asset management, refurbishment and development initiatives. In fact, since the company made its first major acquisition in the autumn of 2013 its NAV per share has more than doubled.

Prospects for the year ahead look rosy given the potential to add further value to developments as recently refurbished and shrewdly acquired office space in Manchester, Leeds and Milton Keynes is let out. Chief executive Neil Sinclair points out that these lettings "will have a material effect on values, too". He has a valid point. Take, for example, last summer's opportunistic purchase of Boulton House, a 75,300 sq ft multi-let office building close to Manchester Piccadilly Station. The net initial yield on the £10.6m purchase price was 5.5 per cent and equated to a capital value of £145 per sq ft, which was predicted to rise to 6.9 per cent based on conservative rental values of £12 per sq ft. Palace Capital has since refurbished 13,500 of vacant space as well as the ground floor reception and entrance hall at a cost of £700,000. I understand that terms are being negotiated with potential tenants at rentals "ahead of expectations at the time of purchase". I would also flag up that the company is looking to pull off a £20m property acquisition to use the £11.2m low-yielding free cash on its balance sheet and boost net income.

Trading on a 14 per cent discount to book value, offering a 4.9 per cent dividend yield, and with the benefit of a modestly geared balance sheet that includes unencumbered property worth £15m, I think the shares have further upside potential. So, having initiated coverage on the shares last autumn at 335p ('A royal investment', 17 Oct 2016), and upgraded my target price to 400p when I subsequently advised buying at 350p ahead of the recent full-year results ('Running bumper gains', 7 Mar 2017), I would run profits as the valuation discrepancy with peers is unwarranted. Run profits.