F&C Commercial Property trades at the highest premium in the sector – 15.9 per cent according to the AIC – thanks to strong investor demand for its high yield and stable cashflows.
Lovett-Turner says that after the acquisition of a series of office blocks in Aberdeen there are few obvious catalysts for NAV performance in the coming months and there is a strong possibility that the premium and therefore the share price could decline.
“F&C Commercial Property’s shares command one of the largest premiums to NAV of the peer group,” he said. “This reflects a consistent NAV performance in the past 12 months, largely due to the significant weighting to London (17 per cent of portfolio) and exposure to prime assets.”
“Although we expect Q1 NAV to be strongly supported by the impact of the Aberdeen completion, thereafter we suspect the easy gains have been made and the manager will need to deploy the c.£100m of cash to drive performance.”
“Furthermore we note that whilst dividend cover is also expected to improve, it will remain the lowest of our seven UK property fund peers.”
“The shares pay a monthly yield of 5.0 per cent per annum. The current 14 per cent premium is looking increasingly difficult to sustain.”
FE data shows that the trust has made 13.1 per cent in NAV terms over the past 12 months and 19.9 per cent in share price terms.
Performance of trust vs sector and index over 1yr
Source: FE Analytics
Over that period the premium has almost doubled from 7.6 per cent of NAV.
Price and NAV of trust over 1yr
Source: FE Analytics
Monica Tepes, investment trust analyst at Cantor Fitzgerald, says that one reason for investors to be concerned is the uncovered dividend.
Cover dropped to 56 per cent last year and is expected to return to 70 per cent this year.
“The dividend cover is the lowest in the sector,” Tepes said. “With property funds sometimes people justify the rating on the yield you are getting so if it is easily covered you can think about it as a bond.”
“It doesn’t matter if you buy it for 106 or 114 because you’re getting a coupon at the market rate [people reason].”
“But the problem is the dividend is not covered, so unless you have year on year total return you may find to pay the dividend you are paying back some of the capital.”
“If people were holding it for capital gains some of that will come through people might start looking a bit closer at the dividend cover.”
The analyst points out that it is the current policy of the board to run the dividend uncovered.
The possible consequences are having to sell properties to pay the dividend, having to switch into higher-yielding properties or simply cutting the payouts.
She notes that there is precedence for a fund in the sector to significantly cut an uncovered divided.
UK Commercial Property cut its payout by 30 per cent last month, with the trust saying that its previous policy was unsustainable.
The share price of the trust was unaffected, however, and has continued to rise, although the yield is 4.4 per cent, the lowest in the sector.
Performance of trusts vs sector in 2014
Source: FE Analytics
The trust’s premium may be able to remain at current levels thanks to the high quality nature of its underlying portfolio of properties focused on the south east and London.
Tepes notes that the trust’s peers are also trading at heady premiums: UK Commercial Property is trading on a 15.8 per cent premium and Standard Life Property Income 14.7 per cent.
Picton Property Income is cheaper on a 9.6 per cent premium but is more focused on the secondary parts of the market outside London and the South East.
Investors would need to take a view on the relative attractions of the premium and secondary markets to expect this disparity to close, she says.
The Standard Life fund is yielding 6 per cent and the Picton fund 5.2 per cent.
Tepes says that the sector as a whole is in reasonable shape.
“Generally property should do well is you have a good economic environment,” she said. “At the moment there’s talk about UK economic recovery so on that logic you would expect property to do well.”
One of the added benefits of the F&C trust is the monthly dividend of 0.5p, equivalent to 6 per cent per annum and a yield of 5 per cent on the share price.
Lovett-Turner does say that the dividend cover could improve in 2015 if the fund successfully refinances a £230m bond at a better rate.
Cash has decreased from £161m at the end of the year to £122m and should fall further to £91m following the Aberdeen purchase.
“Management expects the improving economic environment to help support the momentum in the commercial property market,” Lovett-Turner said.
“It expects London and the South East to continue to outperform other regions in 2014, but with a broadening of investor demand towards some UK regions and properties containing secondary characteristics.”
“F&C REIT recently upgraded its forecasts for the UK property market and now expects total returns to be 12.2 per cent in 2014 (from 10.5 per cent) and 10.2 per cent (from 9 per cent) in 2015 reflecting better economic growth and a faster pace of yield compression.”
Ongoing charges on the £1.08bn portfolio are 1.29 per cent and it is managed by Richard Kirby.
