Conversion to REIT status; FY19 results announced

Palace Capital’s results (4 June) show 37 new leases were completed. Most importantly, these were 14% above ERV (i.e. the level which previous valuers had estimated). This is one of several factors underpinning significant medium-term expansion in capacity to pay growing dividends. Further, the REIT status enhances the capacity for investment and for dividend payment, through the elimination of corporation tax payable. Total property return was 7.1%, ahead of the MSCI UK Index figure of 4.6%. Like-for-like valuations edged ahead by 0.5%, compared with MSCI UK index capital growth at 0.1%. Cost of debt fell to a competitive 3.3%.

• REIT status and FY’19 results: Both items are of great significance for Palace Capital shareholders. REIT status brings a rise in earnings as a function of the REIT nil tax regime. The results confirm the company’s continued outperformance – which we quantify in this report. We initiate FY21 estimates.
• Results and prospects: Property return was strong – beating the benchmark; as did rents. NAV, though, fell 2%, primarily due to tax and a modest loss on part-disposal of the RT Warren portfolio. We expect a covered dividend next year, ahead of the large benefits from the York development in FY22.
• Cash paid by tenant for early lease surrender a further positive: A lease event, announced on 7 May, saw an FY20 profit and cash upgrade. A £2.85m cash premium has been agreed with the tenant. We note the most recent valuation of this asset was only £2.2m. Economic value has been created.
• A track record of outperformance: In the five years to 2018, Palace Capital’s accounting return has been in the first or second quartile vs. our small basket of six most comparable regional UK REITs. (Note that, in FY18, this excluded the distorting effect of equity.) Since 2013, NAV has more than doubled.
• Risks: The normal risks of real estate apply. The weighted average length of unexpired lease to break is 4.5 years. Generally, covenants are good. Retail exposure (bar Wickes and Booker) is minimal. Gearing, at 34% LTV, is conservative and, although expected to rise as the York development progresses, management has previously stated an intention to keep it below 40%.