The durability of Segro’s ascent has rarely been questioned over the past three years, as restricted supply, cheap financing costs and demand from a booming ecommerce industry propelled the warehouse landlord’s net asset value. But investors are newly pessimistic.
A hefty derating in the shares since the start of this year means the beefy premium attached to the stock against forecast net asset value has reversed to a 25 per cent discount. Why? The prospect that falling consumer spending will hinder demand from occupiers and rising interest rates will cause investors to demand higher returns from industrial property and so draw some of the heat out of asset prices.
Any investors looking at the real estate investment trust’s recent track record might think the derating in the shares is too harsh. Last year the FTSE 100 group, formerly known as Slough Estates, recorded underlying net rental income growth of 4.9 per cent, the highest in over a decade, and a 29 per cent rise in the value of its UK and European portfolio.
The downside of market exuberance? Segro has steadily been paying more for assets. The average yield — roughly annual income as a percentage of the property value — on assets bought last year fell to 3.8 per cent, compared with 4.7 per cent in 2019. For that reason Segro has been focusing much of its expansion activity on developing new sites, not that land is getting any cheaper. But the pay-off for taking on more risk is potentially better returns on investment. The commercial landlord has developments costing £380 million in the works, about two thirds of which are of big box sites.
The underlying rental growth derived from rent reviews and re-lettings aside, those developments are behind expectations that the impressive rate of net asset value growth recorded in recent years will continue. Analysts have forecast annual adjusted NAV growth of 13 per cent this year and 9 per cent next year, still punchy enough even if it would represent a slowdown against the annual rate of 39 per cent NAV growth notched up last year and 16 per cent recorded in 2020.
Investors, rightly, have become more sceptical. Segro has the benefit of cheap debt, with the average cost of debt 1.7 per cent at the end of May, 76 per cent of which was at a fixed rate, and the next chunk does not mature until 2027. But rising interest rates mean refinancing that debt should become more expensive and higher debt costs, even if they are from a low base, should be reflected in a reduction in the price investors are willing to pay for warehouse assets and land. Analysts at Shore Capital reckon values of industrial assets across the market will flatten during the second half of this year and weaken next year. The brokerage has a target price of 920p on the stock, below the current 950½p.
A development pipeline weighted towards big box sites adds another risk element, the brokerage reckons. Why? The multitude of profit warnings that have been churned out by online businesses since the start of this year. Amazon, which accounted for 7 per cent of Segro’s headline rents last year, is perhaps the most high-profile. The consumer spending pressures facing the ecommerce giant are hardly unique.
Take-up of new space across the industrial property market in the UK came in at a record level during the first half of the year, according to Savills, and a low vacancy rate, which for Segro reduced to 3.2 per cent last year, provides a cushion against any big fall in occupancy or rental income. But analyst expectations could still be set too highly and investors are right to view them more cautiously.
ADVICE Hold
WHY A potential easing in property yields and weaker consumer spending means NAV growth could slow more than anticipated
Domino’s
Market capitalisation £1.19bn | Dividend yield 3.5%
Domino’s has just got rid of one headache but is due to be blighted by another. The ravages of inflation are hardly unique to the pizza seller, but the pressure of rising costs and weaker consumer spending could derail progress made by resolving a long-running dispute with franchisees.
Franchisees had Domino’s in a headlock, holding back on opening stores and refusing to participate in national pricing strategies, demanding more investment in marketing and technology and better profit share terms. A breakthrough agreement at the end of last year clears the way for an extra 45 new store openings over the next three years.
The result? Total orders grew by 5.5 per cent during the first quarter as a recovery in more profitable meal collections offset a fallback in deliveries, which had spiked during lockdown, and nine new stores were opened.
But the financial pressures facing consumers threaten to hamper progress on order growth later this year. Domino’s might sit at the value-end of the market but lower-income households will also feel the squeeze most tightly. Promotions offer one way to lure customers and increase the volume of orders, but that might also become a tougher task for franchisees dealing with their own cost pressures including higher delivery-driver wages and energy.
Investors are mindful of that twin risk to profits: the shares trade at just under 14 times forward earnings, a lower rating than March 2020 and close to the lowest level in more than eight years.
Analysts think underlying earnings before tax and other charges will be £134.5 million this year, compared with £136.4 million last year, taking into account the end of the VAT cut introduced during the pandemic.
The upside of Domino’s model? An asset-light business means it is highly cash generative and £46 million in share buybacks has been announced this year on top of a generous enough dividend, which this year is forecast to total 10.65p a share, representing a potential yield of almost 3.9 per cent at the current share price. But the shares might still struggle to move higher any time soon.
ADVICE Avoid
WHY Lower consumer spending could curtail growth in orders this year
