The yields on two and five-year UK government bonds shot up to their highest levels since 2008 yesterday as the market reeled from last week’s not-so-mini budget. Land Securities, one of the UK’s biggest commercial landlords, was among the biggest fallers on Friday. The value of central London offices, which have risen sharply in the past decade, should fall to compensate for much higher debt costs.
For FTSE 100 constituent LandSec, the potential decline in ultra-prime offices could hit twice. First, in the overall value of its vast portfolio and assets in development, and second, in the price it secures for the remaining £700 million in mature London offices that it is seeking to offload as part of a £4 billion disposal programme.
The shares, justifiably, trade at a steep discount to the value of the company’s assets, pricing in the expectation of a rise in the yield attached to offices in the City of London and West End, as well as the risk attached to rental growth for its shopping centres and retail outlets.
The canyon that exists between the share price and the net tangible asset value of the portfolio indicates that the risk of slowing rental growth and higher finance costs down the line is far closer to being priced in. The shares are trading 52 per cent below the value of net tangible assets recorded at the end of March, roughly as wide as the discount reached in the wake of the 2008 financial crisis.
LandSec reported a 5.6 per cent increase in the underlying value of its central London office portfolio in the year to the end of March. However, the value of central London offices has now moved out by 50 basis points since the start of this year, which accounts to a decline in capital values of about 10 per cent. That means investors can assume there will be a weakening in valuations in the coming months.
The valuations attached to retail property, about 25 per cent of the group’s portfolio by value at the end of March, have already plunged. since their peak. Valuations and estimated rental values edged lower in the 12 months to the end of March. That doesn’t mean LandSec’s shopping centres and retail outlets won’t fall even more if tenants get into distress amid tighter consumer spending and higher debt costs. About 20 per cent of the company’s retail leases have some link to the level of occupier turnover.
Completing developments is the principal driver of net tangible asset value growth. Management hopes to fund the entire committed development pipeline through £1.2 billion in remaining debt facilities and the proceeds from planned disposals. The cost left to complete those four committed schemes at the end of March was only £325 million.
About 85 per cent of Landsec’s £4.2 billion net debt is fixed rate or hedged, but it has about £500 million due for refinancing in 2024, which is likely to put up finance costs.
Commercial property companies in general are far less highly levered than the loan-to-value ratios touched before the 2008 financial crisis. Land Securities is a good case in point. The value of its property portfolio would need to fall by more than 55 per cent from the level at the end of March and earnings would need to more than halve next year for the company to breach its covenants. Neither scenario seems likely.
Analysts have forecast a marginal rise in net asset value by the end of March, which looks optimistic. But a gradual weakening in commercial property values and wariness over what price the company will stomach on assets for sale, means that the shares are still likely to flounder in the near-term.
ADVICE Avoid
WHY A further decline in property values mean there are few catalysts for share price rises in the near term
Next Fifteen Communications
Marketing and advertising budgets don’t fare well in the face of a recession. Shares in the digital marketing specialist Next Fifteen Communications have already fallen to just over ten times forward earnings which, apart from the March 2020 market crash, puts the shares at their cheapest in at least eight years.
A continuation of an impressive organic revenue growth record over the six months to the end of July indicates that shakier earnings prospects are accounted for in the shares’ weaker valuation.
Important contract wins across the board pushed organic revenue 31 per cent higher. Marketing budgets aside, the higher-margin business transformation division could benefit more from businesses attempting to meet short-term revenue targets or feeling the need for a more dramatic change in strategy in the face of a weaker macroeconomic outlook.
Another shot in the arm? Every one cent rise in the dollar against the pound adds £700,000 to Next Fifteen’s bottom line. It generates roughly 53 per cent in the US and bills clients that contribute a further 7 per cent of revenue in dollars.
A series of one-off costs took the company to a statutory pre-tax loss. Acquisition-related payments added extra expenses, including paying the remaining consideration for the California-based Mach49 business. The group also boosted staff before the revenue was fully recognised from newly won contracts. Analysts expect that to wash through at the full year, forecasting a statutory pre-tax profit of £64.7 million.
The limbo over a hostile takeover of M&C Saatchi should end this year. The deadline for Saatchi shareholders to vote on the rival bid from the veteran technology entrepreneur Vin Murria’s investment vehicle is Friday, which should remove a layer of uncertainty over Next Fifteen clinching the deal. It has already gained sufficient approval from its own shareholders.
The company expects to be in a net cash position by the end of January and although the Saatchi deal would mean Next Fifteen taking on £30 million in debt, that should be cancelled out by net cash of roughly the same amount on its target’s balance sheet.
ADVICE Hold
WHY Prospect of slower growth in near term priced in
