Retail landlords have spent the best part of a decade in a battle for relevance as commerce has shifted online. Shaftesbury Capital can make the case better than most.
The commercial property group has a certain cachet. Born of a merger between FTSE 250 constituents Capital & Counties and Shaftesbury completed earlier this year, the footprint spans the swinging Carnaby Street in London’s Soho, Chinatown and historic Covent Garden.
The estate has a heritage that is more difficult to replicate than the average city centre steel and glass shopping centre. But that does not mean Shaftesbury Capital avoided the same challenges as its more vanilla peers.
The rapid rise in interest rates has amplified the downturn in retail property valuations, which remain about 24 per cent below the pre-pandemic level. Likewise, the estimated rental value of its portfolio is still 8 per cent below 2019, and 20 per cent for its retail properties, which account for about a third of the portfolio.
Investors are still sceptical. The shares have traded at a persistent discount to both the most recent and forecast tangible net asset value. The valuation gap currently sits at a gaping 46 per cent against the latter.
The transactional evidence should inspire more confidence in the group’s paper valuation.
This year has been a busy one. There have been rent reviews, renewals or new leases on 440 of its buildings, which represent about 20 per cent of the portfolio.
Those were completed at an average 9 per cent ahead of estimated rental values at the end of last year. Sales have also totalled £82 million — 12 per cent ahead of estimated rental values at the end of June. The value of Shaftesbury Capital’s remaining £4.9 billion estate edged 0.1 per cent higher in the first six months of the year.
Ian Hawksworth, the chief executive who came with Capital & Counties, has set a target of growing rents at a compound annual rate of between 5 and 7 per cent over the next three to five years. That is in line with an average of just under 7 per cent, on a pro-forma basis, between 2010 and 2019.
The group hopes that will drive a total accounting return averaging between 8 and 10 per cent. There is a big caveat. Hitting that total accounting return target is dependent on property valuations holding firm.
The average yield, calculated as rental income as a proportion of the property value, on retail assets in London’s West End has remained within a range of between 2 and 6 per cent throughout economic cycles over the past 30 years. But the past can only go so far as a guide. When the base rate was last north of 5 per cent 15 years ago, the retail industry was much different and the online share of spend was lower.
Appetite for risk is low. Management does not have a taste for major, ground-up developments. Instead, projects are focused on refurbishing existing buildings in the hope it can eventually charge higher rents. Capital expenditure is set to be capped at 1 per cent of the value of the property portfolio, or roughly £50 million a year, hardly a departure from history.
Cash and undrawn debt stands at more than £500 million and a recent refinancing has extended the duration of its debt to five years. However, the gap between the average property yield, of 4.2 per cent, and cash cost of debt, at 3.3 per cent, is still narrow.
Asset disposals could free up more cash and also bring down debt. Management is aiming for £250 million, or 5 per cent of the portfolio, over the next three to five years. A sale of its Fitzrovia estate, one of four property clusters, would go a long way towards the group hitting that target.
The estate was last valued at £118 million, but there are reports of slow progress in funding buyers. Progress on making sales here could help eat away at the gap between the group’s share price and asset value.
Advice: Hold
Why: The discount accounts for the risk of a further fall in valuations
Polar Capital Technology Trust
The world’s largest technology companies regained their stellar stride this year. The re-rating is the product of a flight to the safety of stocks with billions of dollars on their balance sheets post-Silicon Valley implosion and the expectation that interest rates have reached their peak.
Polar Capital Technology Trust has benefited from the re-rating, with its shares 42 per cent higher and within less than 10 per cent distance of the record reached at the end of 2021. The fund counts several of the so-called magnificent seven stocks among its largest holdings, including Nvidia, which this year became the first chipmaker to surmount a $1 trillion valuation, and Microsoft, which has been turbocharged by its bet on machine learning with OpenAI.
However, Polar is underweight in large cap technology stocks, compared with the Dow Jones Global Technology Index, the yardstick it attempts to beat. The fund’s investment manager, Ben Rogoff, has favoured small and mid-sized companies, which he believes have better growth prospects.
Holding cash on deposit, equivalent to 5.5 per cent of assets, was another drag on performance. That has since fallen to 4 per cent as the trust has invested more fully.
In the six months to the end of October, the trust failed to beat the index. The value of the FTSE 250 constituent’s assets rose 12.1 per cent during the period, just shy of the 12.8 per cent turned out by the index, although it did come out in the top quartile of its peer group.
The attraction of the Polar Capital trust? Its shares trade at a discount north of 13 per cent to the trust’s net asset value. Next year, there is the risk that the sustained interest rate increases by the Federal Reserve will be amplified and weigh on US economic growth. Valuations are not cheap, either, particularly for those companies that have laid claim to capitalising on the artificial intelligence boom.
Yet for investors willing to take a long-term view and with an appetite for higher risk, the valuation gap is compelling.
Advice: Buy
Why: The discount attached to the shares is attractive
