Picton Property Income — Resilient H124 with fully covered DPS

Real Estate

Picton Property Income

Resilient H124 with fully covered DPS

Interim results (H124)

Real estate

30 November 2023

Price	65p
Market cap	£354m

Net debt (£m) at 30 September 2023		209.6
Net LTV at 30 September 2023		27.7%

Shares in issue	545.2m
Free float	100%
Code	PCTN

Primary exchange	LSE
Secondary exchange	N/A

Share price performance

%	1m	3m	12m
Abs	2.8	(3.6)	(25.0)
Rel (local)	(0.4)	(5.0)	(24.3)

52-week high/low

87.00p

61.60p

Business description

Picton Property Income is an internally managed UK REIT that invests in a diversified portfolio of commercial property across the UK. It is total return driven with an income focus and aims to generate attractive returns through proactive management of the portfolio.

Next events

December 2023 NAV

Exp. 26 January 2024

Analyst

Martyn King

+44 (0)20 3077 5700

financials@edisongroup.com

Edison profile page

For the purposes of the Takeover Code, Edison Investment Research is deemed to be connected with Picton Property Income

Picton Property Income is a research client of Edison Investment Research Limited

In a challenging market environment, Picton Property Income (PCTN) produced a resilient H124 financial performance, supporting fully covered DPS. This was underpinned by continued portfolio outperformance of the MSCI UK Quarterly Property Index, building on a long-term track record of upper quartile performance since inception. Rents continued to grow, asset management initiatives are in place, aimed at capturing reversionary income potential, and borrowings are mostly long term and fixed rate.

Year end	Net property income (£m)	EPRA earnings* (£m)	EPRA EPS* (p)	DPS paid (p)	NAV** per share (p)	P/NAV (x)	Yield (%)
03/20	33.6	19.9	3.7	3.50	93	0.70	5.4
03/21	33.5	20.1	3.7	2.75	97	0.67	4.2
03/22	35.4	21.2	3.9	3.38	120	0.54	5.2
03/23	36.3	21.3	3.9	3.50	100	0.65	5.4

Note: *EPRA earnings exclude revaluation gains/losses and other exceptional items. **NAV measure is net tangible assets (NTA), currently the same as IFRS NAV.

Rents continued to increase in H124

H124 EPRA earnings of £10.0m or 1.8p per share were lower than H123 (£10.7m/2.0p per share) with higher income more than offset by rising property and administrative costs, including inflationary impacts. DPS was covered 1.05x with Q2 cover increasing versus Q1, in line with management expectations. Portfolio rents continued to increase, as was true of the market, and the wide £13.2m gap between current passing rents and estimated rental values represents significant additional income potential. Active asset management plans, including repurposing of selected office properties, are aimed at unlocking this. The portfolio valuation was relatively stable, down 1.2% on a like-for-like basis, and the portfolio total return of 1.0% compared favourably with the MSCI UK Quarterly Property Index (the index) return of -0.5%. NAV per share was 99p (end-FY23: 100p) and adjusted for DPS paid the accounting total return was -0.2%.

Seeking to lever long-term performance

Through an occupier-focused, opportunity-led approach, Picton aims to be one of the consistently best performing diversified UK REITs. Accounting return (without dividends reinvested) has averaged 10.1% pa in the 10 years to end-H124. At a portfolio level, Picton has outperformed the MSCI index in each of the past 10 years and has delivered upper quartile performance since inception in 2005. The company has repeatedly expressed that, mindful of the consolidation taking place in the sector, it would be proactive in pursuing appropriate opportunities that add value for shareholders. On 8 November, Picton confirmed discussions with UK Commercial Property REIT (UKCM) regarding a possible all-share merger, on an EPRA NTA for EPRA NTA basis. Further announcements will be made in due course

Valuation

The current annualised rate of DPS (3.5p) represents a yield of 4.3%. The H124 P/NAV is c 0.67x.

Interim financial results and operational performance

In this report we review the H124 and operational performance in detail. In view of Picton’s merger discussions with UKCM, we do not provide forward-looking guidance or forecasts. The company has said that there can be no certainty that an offer will be made and on 21 November announced that it had been informed by UKCM that its largest shareholder, Phoenix Life Limited, which controls c 43% of UKCM’s share capital, does not support the possible merger on the terms that have been proposed. Picton has until 6 December 2023 to make clear whether it does or does not intend to make a firm offer for UKCM, although this deadline can be extended with the consent of the Panel on Takeovers and Mergers (the Takeover Panel). A further announcement will be made in due course.

Exhibit 1 provides a summary of key H124 financial data, starting with EPRA earnings and a reconciliation to statutory IFRS earnings.

Exhibit 1: Summary of financial performance

£m unless stated otherwise	H124	H123	H124/H123	H223
Rental income	21.6	20.9	3.7%	22.1
Other income	0.4	0.2		0.2
Net property operating costs	(1.5)	(1.5)	1.7%	(2.0)
Void costs	(2.3)	(1.5)	53.1%	(2.1)
Net property income	18.2	18.1	0.6%	18.2
Total operating expenses	(3.4)	(2.9)	15.7%	(3.0)
Net finance expense	(4.7)	(4.5)	5.7%	(4.5)
EPRA earnings	10.0	10.7	-5.8%	10.6
Investment property valuation movements	(11.4)	(21.1)	0.0	(89.7)
IFRS net profit/(loss)	(1.4)	(10.4)		(79.1)
EPRA EPS (p)	1.8	2.0	-5.7%	2.0
IFRS EPS (p)	(0.3)	(1.9)		(14.5)
DPS declared (p)	1.75	1.75	0.0%	1.75
DPS paid (p)	1.75	1.75	0.0%	1.75
Dividend cover	1.05	1.12		1.15
Net assets, IFRS & EPRA (£m)	537.1	636.4		547.6
NAV per share, IFRS & EPRA (p)	99	117	-15.6%	100
NAV total return	-0.2%	-1.6%		-12.4%
Carried value of investment properties	736.6	831.3		746.3
Net LTV	27.7%	24.1%		26.7%

Source: Picton Property Income data, Edison Investment Research presentation

Comparisons are to H123 unless stated otherwise.

■

Rental income increased by 4% or £0.7m to £21.6m and other income by £0.2m, primarily due to dilapidation receipts.

■

Net property costs and void costs also increased, primarily reflecting the impact of inflation.

■

Net property income of £18.2m was at a similar level to H123 and H223.

■

The increase in administrative expenses, by £0.5m to £3.4m, included inflationary impacts, additional staff costs and some non-recurring expenses related to the internalisation of the company secretarial activities.

■

With most debt at fixed cost, finance expenses increased only marginally, reflecting the impact of higher interest rates on debt drawn from the floating rate revolving credit facility (RCF).

■

In addition to £10.0m of EPRA earnings, IFRS earnings included £11.4m of property valuation losses. The total IFRS loss for the period was £1.4m.

H124 earnings benefited from mostly fixed rate debt

In the year to 30 September 2023 (end-H124) the Bank of England base rate increased by 350 basis points (3.5 percentage points) to 5.25%. With most borrowing long term and fixed rate, the impact on H124 finance expense was minimal.

The company has two long-term credit facilities, maturing in 2031 and 2032, with the interest cost fixed at a blended average rate of 3.7%. A shorter-term floating rate RCF2 of £50m was c £15m drawn at end-H124. Total drawn debt at end-H124 was £226.8m at a blended cost (including the RCF drawings) of 3.9% with a weighted average maturity of 7.8 years. Adjusting for cash of £17.2m, net debt was £209.6m and the loan to value (LTV) ratio was 27.7%.

1 The RCF provides the ability to draw and repay during the term of the loan.

Exhibit 2: Summary of debt portfolio

Lender	Canada Life	Aviva	NatWest RCF
Amount drawn	£129.0m	£82.8m	£14.9m
Undrawn	Fully drawn	Fully drawn	£35.1m
Maturity	Jul-31	Jul-32	May-25
Interest rate	Fixed 3.25%	Fixed 4.38%	SONIA +1.5%
Commitment fee	N/A	N/A	0.60%
LTV covenant	65%	65%	55%
Interest cover covenant	1.75x	N/A	2.5x
Debt service cover ratio covenant	N/A	1.4x	N/A

Source: Picton Property Income

Portfolio income

During H124, the externally assessed estimated rental value (ERV) of the portfolio increased by 0.7% to £56.2m pa, reflecting market-wide rental growth and portfolio-specific asset management initiatives. Portfolio contracted rents also increased slightly (0.4%) to £45.8m.

ERV growth was achieved across each sector, with the industrial portfolio ERV up 0.6%, offices up 0.8% and retail and leisure up 0.3%.

Contracted rent benefited from new lettings, renewals and regears, and reviews, all on average above March ERV and/or previous contracted rents, including:

■

13 new lettings, on average in line with the March ERV, generating £0.9m pa of additional rental income.

■

20 lease renewals and regears at an average 2% above March ERV, and 12% above the previous contracted rents, securing an additional £0.2m pa of income.

■

Five rent reviews at an average 1% above ERV, securing an uplift to passing rent of £0.2m or 15%.

■

Additionally, two lease variations to remove occupier break options secured £0.7m of existing income.

Encouragingly, 54% of the new leases (six transactions) and 60% of the lease renewals and regears (eight transactions) related to office properties, despite the wider challenges to the office market. Related to two of the properties where Picton is pursuing change of use strategies (Angel Gate, in London EC1, and Longcross, in Cardiff) four leases were surrendered to facilitate vacant possession, contributing to a 0.8% decline in passing rent, to £43.0m3 pa.

2 The annual rental income currently receivable. Excludes rental income where a rent-free period is in operation.

Taking account of all the leasing activity above, as well as lease maturities, on an EPRA basis, occupancy reduced to c 90% from c 91% at end-FY23. Excluding the impact from the change of use assets, Longcross and Angel Gate, occupancy was 92%, a similar level to that of the index.

At end-H123, ERV was £13.2m above the annualised passing rent of £43.0m. This difference comprises £5.9m pa of additional potential income from letting vacant space, £2.8m pa of income where ERVs are higher than contracted rent and £4.5m pa from the expiry of rent-free periods and stepped rents.

Exhibit 3: Bridge from passing rent to ERV as at 30 September 2023

Source: Picton Property Income data

Most of the potential upside from contracted rents converging on ERV sits within the industrial portfolio, with most of the void reduction potential within office properties. The top five portfolio voids, accounting for 63% of the total, are all office properties, and reducing voids can often bring twin benefits from increased income and reduced empty property costs. Notwithstanding the positive leasing and regear activity that Picton achieved in its office properties in H124, it has identified opportunities to respond proactively to significant changes in the market by adapting some of its assets to alternative use.

Asset repurposing

There are currently four projects under way where the company is seeking planning permission for change of use to healthcare, residential and student living occupation. In addition to Angel Gate and Longcross, these are at Charlotte Terrace, in London W14, and, to a lesser extent, at Colchester Business Park.

At Angel Gate (14% of the portfolio void), during H123, Picton identified an opportunity to secure planning consent for the conversion of 30,000 sq ft of vacant office space to residential use, with plans for 34 dwellings. After extensive dialogue with the local authority, the company has since been able to release from (Article 4 restrictions) the remaining 34,000 sq ft, enabling residential use across the whole property. Picton says that it is now in the process of bringing this asset to the market for disposal in early 2024.

At Longcross (12% of the portfolio void), contracts have been exchanged for its sale to an experienced purpose-built student accommodation developer. The transaction is conditional on planning permission, which will be submitted by June 2024. The sale price is dependent on the exact planning consent obtained and, in particular, upon the number of rooms secured, subject to a collar and cap. Picton says that in all scenarios the transaction is NAV accretive.

Charlotte Terrace (11% of the portfolio void) comprises four adjoining buildings, which total 28,500sq ft of office space and 4,400sq ft of retail space, arranged over five floors. It is located close to Olympia, which is currently undergoing a £1bn redevelopment delivering a new creative district, with a new theatre, entertainment venue, hotel, office, retail and leisure space, which is expected to enhance the surrounding area. Having achieved vacant possession in one of the four buildings, a planning application has been submitted for alternative residential use.

On a lesser scale, but nonetheless reflective of its active approach to asset management, at Colchester Business Park (14% of the portfolio void), Picton secured planning permission for the change of use of a vacant office suite, enabling it to be let to a healthcare occupier. An office building became vacant on the last day of the period, accounting for 60% of the void, with the majority of the remaining void, a recently refurbished industrial unit, under offer.

Index outperformance in H124

During H124, Picton’s portfolio valuation decreased by 1.2% on a like-for-like basis, with valuations generally stabilising in September. Over the same period, the MSCI UK Quarterly Property Index recorded a capital value decrease of 2.7%. Within the company’s portfolio, the industrial sector saw a 0.9% valuation increase over the half year, with the office sector showing a negative valuation movement of 5.3% and the retail and leisure portfolio decreasing by a nominal amount. Including both capital and income returns, the total return on the Picton portfolio in H124 was a positive 1.0% compared with a negative 0.5% index return.

Exhibit 4: H124 portfolio weighting and like-for-like valuation change

	Portfolio value by sector	Valuation (£m)	Like for like change in H124
Industrials	58.6%	£443.7	0.9%
o/w South East	42.0%
o/w Rest of UK	16.6%
Office	30.7%	£232.3	-5.3%
o/w London City & West End	7.0%
o/w Inner & Outer London	1.7%
o/w South-East	8.3%
o/w Rest of UK	9.1%
o/w Alternative use assets	4.6%
Retail & Leisure	10.7%	£81.1	-0.4%
o/w Retail Warehouse	6.8%
o/w High Street Rest of UK	2.3%
o/w Leisure	1.6%
Portfolio total	100.0%	£757.1	-1.2%

Source: Picton Property Income

Exhibit 5 provides detail on Picton’s outperformance of the index in each of the past 10 years and upper quartile performance since inception in 2005.

Exhibit 5: Annualised total property return

Source: Picton Property Income and MSCI

Across the sectors, the company says:

■

Within the industrial sector, there is good demand at its multi-let industrial estates, allowing it to capture rental growth through new lettings, renewals and rent reviews. The five distribution warehouses remained fully leased and a lease at York was extended. The occupational market is remaining resilient, albeit rental growth has slowed but remains positive. There is continued investment demand for good quality assets.

■

In the office sector, occupational demand is weaker and more linked to the type of building, with the very best space attracting most occupiers. Investment demand has weakened, but there is still demand for best-in-class space with good environmental credentials.

■

The retail sector is still suffering from higher vacancy rates, especially on the high street, which has not been helped by the demise of retailers such as Wilko. Leasing demand is improving, however there is investment demand for better quality product where the income position is more certain.

Exhibit 6: Portfolio summary

	30-Sep-23	31-Mar-23	31-Mar-22
	H124	FY23	FY22
Portfolio valuation	£757m	£766m	£849m
Number of properties	49	49	47
Average lot size	£15.5m	£15.6m	£18.1m
EPRA net initial yield	5.0%	5.0%	4.1%
Net reversionary yield	6.8%	6.7%	5.4%
Annualised passing rent	£43.0m	£43.3m	£38.7m
Annualised reversionary rent	£56.2m	£55.8m	£49.8m
Occupancy as % estimated rental value (ERV)	90%	91%	93%
Weighted average unexpired lease term	4.6 years	4.6 years	4.8 years

Source: Picton Property Income data

In addition to sector diversification, the portfolio is spread across 49 assets, let to around 400 occupiers. The end-H124 external valuation reflected a net initial yield of 5.0% and a reversionary yield of 6.8%.

Exhibit 7: Historical financial summary

Year end 31 March (£m)	2020	2021	2022	2023	H124
PROFIT & LOSS
Rental income	37.8	36.6	40.1	43.0	21.6
Other income	1.2	1.5	0.2	0.4	0.4
Service charge income	6.7	5.3	6.2	8.4	4.7
Revenue from properties	45.7	43.3	46.5	51.8	26.7
Property operating costs	(2.3)	(2.4)	(2.5)	(3.5)	(1.5)
Property void costs	(3.0)	(2.2)	(2.4)	(3.6)	(2.3)
Recoverable service charge costs	(6.7)	(5.3)	(6.2)	(8.4)	(4.7)
Property expenses	(12.0)	(9.9)	(11.1)	(15.6)	(8.6)
Net property income	33.6	33.5	35.4	36.3	18.2
Administrative expenses	(5.6)	(5.4)	(5.8)	(6.0)	(3.4)
Operating Profit before revaluations	28.1	28.1	29.7	30.3	14.8
Revaluation of investment properties	(0.9)	12.9	129.8	(110.8)	(11.4)
Profit on disposals	3.5	0.9	0.0	0.0	0.0
Operating Profit	30.7	41.8	159.5	(80.5)	3.3
Net finance expense	(8.3)	(8.0)	(8.5)	(9.0)	(4.7)
Debt repayment fee			(4.0)
Profit Before Tax	22.4	33.8	147.0	(89.5)	(1.4)
Taxation	0.1	0.0	0.0	0.0	0.0
Profit After Tax (IFRS)	22.5	33.8	147.0	(89.5)	(1.4)
Adjust for:
Investment property valuation movement	0.9	(12.9)	(129.8)	110.8	11.4
Profit on disposal of investment properties	(3.5)	(0.9)	(0.0)	0.0	0.0
Exceptional income /expenses	0.0	0.0	4.0	0.0	0.0
EPRA earnings	19.9	20.1	21.2	21.3	10.0
Fully diluted average Number of Shares Outstanding (m)	546.2	546.8	547.3	546.9	546.6
EPS (p)	4.14	6.20	26.93	(16.42)	(0.26)
EPRA EPS (p)	3.66	3.68	3.88	3.90	1.84
Dividend declared per share (p)	3.25	2.93	3.45	3.50	1.75
Dividends paid per share (p)	3.500	2.750	3.375	3.500	1.750
Dividend cover (x) EPRA EPS/DPS declared	1.13	1.26	1.13	1.12	1.05
Dividend cover (x) - paid dividends	1.05	1.34	1.15	1.12	1.05
Total return	4.4%	6.6%	27.9%	-13.7%	-0.2%
EPRA cost ratio (excluding direct vacancy costs)	20.2%	20.8%	19.9%	21.3%	0.0%
BALANCE SHEET
Non-current assets	654.5	669.5	834.4	749.8	740.1
Investment properties	654.5	665.4	830.0	746.3	736.6
Other non-current assets	0.0	4.1	4.4	3.4	3.5
Current assets	41.2	42.9	61.4	42.8	43.3
Debtors	17.6	19.6	22.9	22.7	26.1
Cash	23.6	23.4	38.5	20.1	17.2
Current Liabilities	(20.4)	(19.9)	(20.3)	(20.7)	(19.7)
Creditors/Deferred income	(19.5)	(18.9)	(19.3)	(19.6)	(18.6)
Current borrowings	(0.9)	(0.9)	(1.1)	(1.1)	(1.2)
Non-Current Liabilities	(166.0)	(164.4)	(218.4)	(224.2)	(226.6)
Non-current borrowings	(164.2)	(162.7)	(215.8)	(221.6)	(224.0)
Other non-current liabilities	(1.7)	(1.7)	(2.6)	(2.6)	(2.6)
Net assets	509.3	528.2	657.1	547.6	537.1
NAV per share (p)	93	97	120	100	99
EPRA NTA per share (p)	93	97	120	100	99
CASH FLOW
Operating cash flow	21.4	26.0	28.1	30.9	10.8
Net Interest	(7.9)	(7.5)	(8.1)	(7.9)	(4.5)
Tax	0.1	0.1	0.0	0.0	0.0
Net cash from investing activities	25.0	(1.3)	(33.8)	(26.8)	(1.9)
Ordinary dividends paid	(19.0)	(15.0)	(18.4)	(19.1)	(9.5)
Debt drawn/(repaid)	(27.2)	(1.8)	52.2	5.4	2.3
Net proceeds from shares issued/repurchased	6.1	(0.6)	(0.7)	(1.1)	0.0
Other cash flow from financing activities			(4.0)
Net cash from financing activities	(40.1)	(17.5)	29.0	(14.8)	(7.3)
Change in cash	(1.6)	(0.2)	15.2	(18.5)	(2.8)
Opening cash	25.2	23.6	23.4	38.5	20.1
Closing cash	23.6	23.4	38.5	20.1	17.2
Debt as per balance sheet	(165.1)	(163.7)	(216.8)	(222.8)	(225.2)
Un-amortised loan arrangement fees	(2.3)	(2.6)	(2.0)	(1.7)	(1.6)
Closing net (debt)/cash	(143.9)	(142.8)	(180.3)	(204.4)	(209.6)
Net LTV	21.7%	20.9%	21.2%	26.7%	27.7%

Source: Picton Property Income data

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20 Red Lion Street

London, WC1R 4PS

United Kingdom

London │ New York │ Frankfurt

20 Red Lion Street

London, WC1R 4PS

United Kingdom

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