Commercial landlords could use some good spin after the steep falls in property values and unpaid rent bills they’ve been forced to stomach over the past two years. Rapidly rising inflation may prove the perfect marketing opportunity for some, as investors seek to hedge against their returns being eroded.
LXi Reit may actually have a better claim than most in protecting against swiftly rising costs. About 96 per cent of the real estate investment trust’s leases are inflation-linked or have fixed annual uplifts, the majority of which are pegged to the retail prices index. Rising inflation also prompted the company to increase the target dividend for the next financial year by 5 per cent to 6.3p a share, equivalent to a yield of roughly 4.5 per cent at the present share price.
Those advantages have not gone unnoticed by investors. Shares in the FTSE 250 constituent are near a record high, although still equivalent to only a slight premium versus forecast net asset value at the end of March this year.
The commercial landlord invests in a range of property types, including food stores that are let to leading supermarkets, industrial assets and hotels. About a third of its investments are in forward-funding developments that are fully pre-let, with another third in sale-and-leaseback deals with owner-occupiers looking to free up some capital.
The common theme across the portfolio is that assets are let on long leases of at least 15 years, but typically between 20 and 30 years. Naturally, long leases mean nothing if a tenant goes bust or doesn’t pay up, but on that score LXi has held up pretty well. The Reit is now on track to collect 100 per cent of rent due for the 12 months to the end of March this year, a sturdy performance in this Covid era that was reflected in underlying NAV growth of 7.8 per cent during the first half of the financial year and a 4.1 per cent increase over the third quarter. Analysts forecast compound annual NAV growth of almost 10 per cent over the three years to 2024.
Of 70 tenants, Travelodge was the only one to have carried out a company voluntary arrangement, although it is the Reit’s largest tenant. But cutting a separate deal with the budget hotel chain to hand over unused land for free meant that LXi recouped its potential losses. The Reit’s exposure to Travelodge as a proportion of rental income has dropped to 5 per cent post-capital raise, in line with the manager’s rough target ceiling for any single tenant.
Raising £250 million in cash to help to fund a pipeline of deals by issuing new shares also has tipped the Reit’s market cap further over the £1 billion threshold, permitting some American institutions to add their names to the shareholder register. If the shares maintain their momentum, the Reit should fall within the mandates of more large investors, providing a broader range of potential support for the shares. Those nine acquisitions were typical LXi fare, including three Co-Operative convenience stores and a sale and leaseback deal with the car financing specialist Cazoo.
There are caveats. Around two thirds of leases have a capped increase of 4 per cent a year and around a fifth are fixed at 2.5 per cent, which isn’t a pure hedge against inflation when economists at the Bank of England expect the rate to hit 7 per cent this spring.
On the other hand, unlike those with index-linked and floating financing arrangements, the Reit has some breathing room when it comes to both rising interest rates and inflationary pressures. Just over 40 per cent of its debt facilities are fixed-rate term loans, which don’t expire until 2033, while the remaining revolving credit facilities have interest costs that are capped until expiry in 2024. That means the Reit’s overall cost of debt is capped at 2.4 per cent. A 2 per cent premium versus forecast NAV is small beans for LXi, which traditionally has traded at a premium since its 2017 float. Inflation linkage and reliable NAV growth could well gain the Reit more plaudits.
ADVICE Buy
WHY Consistent NAV growth and inflation-linked income could push the shares higher
Synthomer
The music has stopped early for Synthomer, a chemicals specialist that was a big beneficiary of the pandemic rush for personal protective equipment. Margins attached to sales of nitrile butadiene rubber, used in the manufacturing of disposable medical and cleaning gloves, fell back to pre-Covid levels last month, ahead of previous guidance for some time during the first quarter of this year.
• Gloves are off as Covid demand slips
That business, the catalyst behind a doubling of profits last year thanks to higher demand and pricing, is also suffering from a high level of stock now in the market. Rates of growth within the nitrile butadiene rubber market are expected to return to 2019 levels during the second half of this year.
What all that boils down to is no pandemic premium being banked by the group this year, which Numis, the broker, had estimated at roughly £50 million. It took a scythe to its target price on the stock, cutting it from £6.50 to £4.50, and reduced its forecasts for earnings before interest, tax and other charges for 2022 and 2023 by 20 per cent and 11 per cent, respectively.
Like other so-called pandemic winners, the shares have been on a downward march since the start of this year as investors prepare for a return to more normal trading patterns. Adjusted pre-tax profits for Synthomer, which makes polymers used in everything from adhesives to building materials to carpets, are forecast by analysts to drop by almost a third this year. A forward price/earnings ratio of almost nine, closer towards the 2019 range of multiples, seems apt.
Some of the fruits of the pandemic rush will be longer-lasting, with part of the profits generated put towards financing the $1 billion acquisition of Eastman, an American adhesive technologies specialist, expected to be completed by the end of March. The deal will expand its presence in the hygiene, packaging and high-performance tyre additives markets.
Cost inflation is a natural headwind, though typically Synthomer has passed on higher raw materials expenses to customers via price rises. A more rapid return to pre-pandemic rates of demand for nitrile butadiene rubber this year remains a greater risk.
ADVICE Hold
WHY Lower valuation reflects a weaker earnings outlook
