Regional REIT — Update 27 February 2017

Real Estate

Regional REIT

Update and proposed acquisition

Proposed acquisition

Real estate

27 February 2017

Price	103p
Market cap	£282m

Net debt (£m) at 30 September 2016		202.7

Shares in issue	274.2m
Free float	76%
Code	RGL

Primary exchange	LSE
Secondary exchange	N/A

Share price performance

%	1m	3m	12m
Abs	(1.4)	(2.4)	1.5
Rel (local)	(2.9)	(8.0)	(16.9)

52-week high/low

111p

88p

Business description

Regional REIT owns a commercial property portfolio predominantly made up of offices and light industrial units located in regional centres of the UK. It is actively managed and targets a total shareholder return of 10-15% pa with a focus on income.

Next events

FY16 results	23 March 2017
Deal completion	24 March 2017
Q4 dividend paid	13 April 2017
Q117 trading update	25 May 2017

Analysts

Julian Roberts	+44 (0)20 3077 5748
Andrew Mitchell	+44 (0)20 3681 2500

financials@edisongroup.com

Edison profile page

Regional REIT is a research client of Edison Investment Research Limited

Regional REIT (RGL) has announced a gross asset value update, a fourth quarter dividend for 2016 and the conditional acquisition from Conygar of a portfolio of 31 properties valued at c £129m. We will revise our forecasts following publication of FY16 results and completion of the acquisition. The announcements show that RGL has achieved its aim of paying a dividend yielding 7-8% on the IPO price of 100p; the continued robust performance of the UK’s regional office and light industrial property market; and a significant expansion of the portfolio, rent roll and opportunities for active asset management, in line with RGL’s strategy to provide income and capital value growth.

Year end	Net rental income (£m)	EPRA EPS (p)	EPRA NAV/ share (p)	P/EPRA NAV/ share (x)	DPS (p)	Yield (%)
12/15**	4.6	0.9	107.8	0.96	1.0	1.0
12/16e	37.2	7.7	110.6	0.93	7.7	7.5
12/17e	41.4	8.9	113.7	0.91	8.9	8.6
12/18e	43.3	9.5	115.4	0.89	9.5	9.2

Note: *EPRA EPS is adjusted to include exceptional expenses related to listing and includes estimated performance fees. **56-day trading period only.

Gross asset value and dividend announcement

RGL’s property portfolio was valued at £502.4m as of 31 December 2016, from £403.7m a year earlier. The 24.4% increase included £133.6m of acquisitions, £44.9m of disposals and a 2.25% like-for-like valuation gain (which excludes the Wing and Rainbow portfolios acquired in H116). This implies both a limited H2 revaluation gain on assets which were in the portfolio at the start of the year and some revaluation of the new assets since the EU referendum. The 2.4p dividend to be paid on 13 April in respect of Q416 takes the amount relating to the whole financial year to 7.65p, in line with consensus estimates and meeting the company’s stated aim of paying a fully-covered dividend yield of 7-8% on the IPO price of 100p. This puts RGL among the highest-yielding REITs.

Conditional acquisition of regional properties

The company also announced an agreement reached with Conygar (CIC) to acquire a portfolio of regional office, industrial, distribution and retail assets. The portfolio was valued at c £129m as of 30 September 2016 with contracted rents of £9.7m and at a net initial yield of 7% assuming costs of 6.8%. In consideration, RGL will issue CIC £28m of RGL shares (c 26.3m shares, subject to adjustment), assume £69.5m of debt and acquire Conygar ZDP plc, taking responsibility for the company’s zero-preference dividend share liabilities, currently valued at c £35.7m, on completion of the acquisition (expected 24 March 2017).

Valuation: The deal is in line with REIT’s strategy

The proposed acquisition increases RGL’s portfolio by c 25% in value and adds a similar proportion of rental income. The assets also have considerable scope for asset management. We will revise our estimates when and if it completes, but our initial analysis suggests it to be EPS accretive with a possible effect on dividend.

Proposed acquisition of assets from Conygar

Terms and rationale

RGL will acquire the Special Purpose Vehicles (SPVs) which own the underlying assets for a consideration valuing them at c £129m, slightly above the valuation of the assets at 30 September 2016. The consideration will consist of:

■

26,326,644 shares in RGL at a price of 106.347p (equal to NAV per share at 30 June 2016 adjusted as agreed by both parties). This represents 9.6% of the existing share capital of RGL, or 8.8% post-transaction. These shares will be eligible for the Q117 dividend RGL expects to declare on 25 May 2017. The shares will be subject to lock-ins: one third for six months, one third for a year and the remainder for 18 months.

■

The assumption of two banking facilities totalling £69.5m secured on the properties to be acquired. These have a blended interest margin of c 2% and will mature in 2021.

■

The acquisition of Conygar ZDP, a wholly-owned subsidiary of Conygar, which will give RGL responsibility for funding Conygar’s ZDPs. These have an agreed value on maturity in 2019 of £39.9m, or £35.7m at the proposed date of completion.

■

Following completion of the acquisition (subject to approval from Conygar’s ordinary and ZDP shareholders), there may be an adjustment for the difference between the estimated net asset value of the SPVs and their NAV at completion. This may mean that further consideration is paid.

The acquisition is conditional on approval by Conygar’s ordinary and ZDP shareholders as well as the two banks providing the debt secured on the portfolio.

From Conygar’s perspective, the deal, priced slightly above the portfolio’s most recent valuation, would leave the company debt free, with an income from its RGL shares which will cover its recurring costs and free the management team to focus on development projects, which are its principal expertise.

For Regional REIT the deal is exactly in line with its existing strategy. The assets are located outside the M25, are diverse in terms of use and tenant mix, and complementary to the existing portfolio, having minimal overlap with the current portfolio in terms of geography and tenants. The properties are of institutional investment quality and present significant opportunities for asset management to increase occupancy, reducing void costs and raising rental income, in line with the asset manager’s expertise and not requiring additional resources to manage. It is possible that some retail assets will be disposed of, enabling the manager to recycle capital. The debt facilities have a low interest margin and broaden the company’s banking relationships, meaning that the deal would diversify RGL’s sources of funding as well as income. It is expected that RGL will have a net LTV ratio of 47% post-transaction.

The portfolio

The 31 assets to be acquired consist of 153 units covering 1.3m sq ft, 82.9% let by rental value to 115 tenants, with minimal overlap with RGL’s existing tenant list. The weighted average unexpired lease term is 5.8 years, or 3.8 years to first break. The gross investment value was £129.5m at 30 September: 20% in Scotland and the remainder across England and Wales outside the M25. Offices make up 60% of the portfolio by value, retail and retail warehouses are 21%, 12% are industrial and 7% are leisure assets. The tenants include government departments such as the Care Inspectorate and Lincolnshire County Council, major international corporates such as Hewlett Packard, Dassault and Alcatel Lucent, and large UK businesses like Odeon and Travis Perkins, as well as many smaller occupiers. The largest single asset by value represents 11% of the portfolio.

Two other points were announced at the same time as the gross asset value and dividend: that RGL will commence a partial impairment of goodwill in its next results, to be announced on 23 March, and that it will show an accrual for the manager’s performance fee.

The performance fee is equal to 15% of returns to shareholders above a hurdle rate of 8% per annum and is subject to a high water mark which is currently the listing price of 100p. This will affect EPRA EPS and EPRA NAV. RGL’s balance sheet showed £2.8m of goodwill at 30 June 2016, c 0.5% of total assets, and its impairment will have a small effect on EPRA NAV.

We will revise our estimates following the publication of FY16 results on 23 March and the expected completion of the acquisition on 24 March. At this stage, if the acquisition were to take place with no adjustment to the consideration paid to Conygar, the liability regarding the ZDPs rising to £39.9m in FY19 and assuming that goodwill is fully impaired by the end of FY18, our model indicates that EPRA EPS could be c 10.0p and 10.5p in FY17 and FY18, respectively (vs current estimates of 8.9p and 9.5p). This would also affect the dividend, because the Property Income Distribution paid by a REIT must be at least 90% of profits from property income. Without changing our revaluation assumptions there is no significant effect on EPRA NAV per share.

Exhibit 1: Financial summary

Year end 31 December	£'000s	2015	2016e	2017e	2018e
PROFIT & LOSS		IFRS	IFRS	IFRS	IFRS
Gross rental income		5,361	41,509	45,466	47,574
Non-recoverable property costs		(754)	(4,291)	(4,092)	(4,282)
Revenue		4,608	37,218	41,374	43,292
Administrative expenses		(1,353)	(7,380)	(7,963)	(8,212)
EBITDA		3,255	29,839	33,411	35,081
Gain on disposal of investment properties		87	(75)	0	0
Change in fair value of investment properties		23,784	3,623	7,504	5,152
Operating profit before financing costs		27,126	33,387	40,914	40,233
Performance fees		0	(95)	(974)	(828)
Exceptional items		(5,296)	0	0	0
Finance income		177	97	68	25
Finance expense		(997)	(8,757)	(9,161)	(9,161)
Net movement in the fair value of derivative financial investments		115	(2,024)	0	0
Profit Before Tax		21,124	22,608	30,847	30,268
Tax		0	0	0	0
Profit After Tax (FRS 3)		21,124	22,608	30,847	30,268
Adjusted for the following:
Performance fees		0	95	974	828
Exceptional items		5,296	0	0	0
Net gain/(loss) on revaluation		(23,784)	(3,623)	(7,504)	(5,152)
Net movement in the fair value of derivative financial investments		(180)	1,904	0	0
Gain on disposal of investment properties		(87)	75	0	0
Profit before Tax (norm)		2,370	21,059	24,317	25,944
Period end number of shares (m)		274.2	274.2	274.2	274.2
Average Number of Shares Outstanding (m)		274.2	274.2	274.2	274.2
Fully diluted average number of shares outstanding (m)		274.2	274.2	274.2	274.2
EPS - fully diluted (p)		7.7	8.2	11.2	11.0
EPRA EPS (p)		0.9	7.7	8.9	9.5
Dividend per share (p)		1.0	7.7	8.9	9.5
Dividend cover		N/A	100%	100%	100%
BALANCE SHEET
Fixed Assets		407,492	516,918	532,421	545,573
Investment properties		403,703	514,132	529,635	542,788
Goodwill		2,786	2,786	2,786	2,786
Non-current receivables		1,004	0	0	0
Current Assets		35,803	27,284	22,351	15,497
Trade and other receivables		11,848	13,816	13,195	14,527
Cash and equivalents		23,954	13,468	9,157	970
Current Liabilities		(21,485)	(28,622)	(30,693)	(32,362)
Trade and other payables		(12,576)	(15,354)	(16,917)	(18,169)
Deferred income		(5,906)	(9,588)	(10,097)	(10,514)
Taxation		(2,387)	(1,239)	(1,239)	(1,239)
Bank and loan borrowings - current		(200)	0	0	0
Derivative financial instruments		(416)	(2,440)	(2,440)	(2,440)
Long Term Liabilities		(126,469)	(214,771)	(214,771)	(214,771)
Borrowings		(126,469)	(214,771)	(214,771)	(214,771)
Net Assets		295,341	300,809	309,308	313,937
Derivative interest rate swaps		416	2,440	2,440	2,440
EPRA net assets		295,757	303,249	311,748	316,377
IFRS NAV per share (p)		107.7	109.7	112.8	114.5
EPRA NAV per share (p)		107.8	110.6	113.7	115.4
LTV		25.4%	39.2%	38.8%	39.4%
CASH FLOW
Operating Cash Flow		(2,232)	28,800	35,130	34,589
Net Interest & other financing charges		(411)	(9,244)	(9,093)	(9,136)
Tax		0	0	0	0
Purchase of investment properties		(4,191)	(139,251)	0	0
Sale of investment properties		5,348	40,369	0	0
Capex			(8,000)	(8,000)	(8,000)
Acquisition of subsidiaries, net of cash acquired		26,659	0	0	0
Net proceeds from issue of shares		0	0	0	0
Equity dividends paid		0	(12,340)	(22,349)	(25,639)
Other (including debt assumed on acquisition)		0	1,077	0	0
Net Cash Flow		25,172	(98,588)	(4,312)	(8,187)
Opening net (debt)/cash		(127,886)	(102,714)	(201,303)	(205,614)
Closing net (debt)/cash		(102,714)	(201,303)	(205,614)	(213,801)

Source: Regional REIT, Edison Investment Research

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Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

245 Park Avenue, 39th Floor

10167, New York

Sydney +61 (0)2 8249 8342

Level 12, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

245 Park Avenue, 39th Floor

10167, New York

Sydney +61 (0)2 8249 8342

Level 12, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

245 Park Avenue, 39th Floor

10167, New York

Sydney +61 (0)2 8249 8342

Level 12, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

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