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TEMPUS

Office landlord remains a prize asset

The Times

Helical’s engine keeps cutting out, which for most of the past decade has left the office landlord trading at a discount to the value of its assets. First came the long-lingering aftermath of the Brexit referendum, which cast doubt over London’s allure for multinational companies; then came general election-induced uncertainty, in turn succeeded by the sucker punch of the pandemic on demand for new office space.

The result? Even after recovering almost a third since November 2020, the shares still trade at a 15 per cent discount against the net asset value at the end of September and at a 25 per cent discount to the NAV analysts expect the commercial property group to unveil for its March financial year-end.

Take-up of new space so far this year has recovered sharply compared with the first two months of last year and above the ten-year average, according to Savills. But vacancy rates are also higher, at 9 per cent, 3 points higher than the same time last year and above the five-year average.

So the risk is that landlords like Helical, which develops and leases prime space in the City of London, either struggle to shift newly refurbished offices or have to agree to cheaper rents to entice occupiers. The volume of new leases agreed has been more subdued than before the pandemic, but Helical’s vacancy rate at the end of September was lower than it was at the same time in 2019 and at the end of March 2020.

The property group has been leasing remaining vacant space after completing a wave of major mixed-use redevelopment projects across the London areas of Farringdon and Whitechapel. There’s no sign of cut-price rents yet, with new leases agreed over the six months to the end of March at 2.9 per cent ahead of estimated rental values.

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The priority for Helical is rebuilding the development pipeline, which will give investors sight of further potential NAV growth. Future projects had looked thin on the ground, aside from a 200,000 sq ft office development in Farringdon, due for completion this summer. But the £160 million acquisition of an office building in the Square Mile, which could be due for completion by 2025, has boosted Helical’s pipeline.

Higher supply across the London office market remains a challenge for landlords. For Helical, which this month converted to a real estate investment trust, a high exposure to individual names could also add another layer of risk. The social media platform TikTok accounts for 20 per cent of the rent roll, with the online retailer Farfetch and flexible workspace provider WeWork accounting for 10 per cent each. Rent collection is not back at full strength, at 93 per cent of the amount due for the March quarter. Management expects that to rise to 99 per cent for the current three-month period.

But then those risk factors seem more than accounted for in a substantial discount embedded in the share price versus the reit’s NAV, a metric that has been growing steadily. Analysts at the brokerage Numis have forecast a rise of 8 per cent in the NAV for the year just gone and an annual rate of 6 per cent for the next two years.

The level of the discount attached to Helical’s shares looks more incongruous when set against the larger London office landlord Great Portland Estates, which trades at a more forgiving 14 per cent discount to forecast NAV. The troubled retail sector accounts for a fifth of the latter’s portfolio value, a segment whose estimated rental value has fallen by 21 per cent since a 2018 peak. For Helical, retail accounts for less than 5 per cent of portfolio value, easing the risks from a sector in structural decline.
ADVICE Buy
WHY Discount attached to the shares versus NAV seems to more than account for uncertainty ahead

Kainos
Banking the benefits of booming demand is becoming harder, even for companies notching up lofty growth rates. For the software specialist Kainos, concern that wage inflation will take the shine off profits has pulled the shares 40 per cent below a November peak.

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Caution is understandable, given the human resource-intensive nature of the business, designing IT systems for commercial, public sector and healthcare clients. Wage inflation was running at around 9 per cent last year, a rate expected to continue this year. Along with the return of travel and entertainment expenditure after the pandemic and increased use of contract staff, that meant the gross margin declined to 47.4 per cent over the first half of this year from 52.1 per cent the year before. Analysts expect the margin to remain broadly at that lower level this year.

A slowdown in revenue growth removes some of the cushion to higher wage costs that were present last year. Kainos was one of the so-called winners of the pandemic, with trading largely insulated from lockdowns. It gained the valuation to match that status, with shares priced at just over 60 times forward earnings at their June peak, a multiple that still stands at 33.

Higher IT spend accelerated revenue growth to 33 per cent over the first half of the year, which is expected to have moderated to 27 per cent for the 12 months to March. Management reckons a rate of 15-20 per cent for this year is achievable.

Kainos has characteristics that merit a generous valuation. Even over the three years before the pandemic it notched up adjusted earnings growth at a compound annual rate of just over 20 per cent.

Revenue visibility is high because 92 per cent of the group total is repeat business, while designing the software from scratch gives Kainos a good idea of updates that might be needed down the track. A 38 per cent increase in the contracted backlog of work — revenue for contracts yet to be delivered — at the end of September compared with the same time the previous year provides another reason for confidence.

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But at this price, finding greater favour with investors any time soon seems unlikely.
ADVICE Hold
WHY High forward earnings multiple leaves future growth looking priced in

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