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Bond of the Week: 25 October 2012
Bond of the Week : 25 October 2012
St. Modwen 6.25% 2019
Tumbling off the bus at Liverpool Street Station, bowling along Broad street, to my right casting an anticipatory eye at Corney and Barrow, steadying myself slightly as I pass on my left the beautician’s offering all day half price Brazilian blow dries* and into the office for an early 9.30am start (oh chiz chiz you professional city readers chained to your desks for a 6.45am start) when Kerthump; another new retail bond issue lands on my desk; back in the jug again. I reach forward and dip my pen in the inkwell. We have:
This is the fourth property company to come to the ORB in the last couple of months. This can be taken two ways. On the one hand this area of the retail bond market is now rather crowded which suppresses demand for new issues. But on the other, we may now say there are enough issues in this sector for us to be able to “compare and contrast” as essay questions used to pose between the various offerings.
Here is a short description of St Modwen. The company describes itself as a regeneration specialist rather than either a developer (they are anxious not to be seen in this risky category) or a pure property company. They are based in the Midlands where they hold most of their assets, but they do have land holdings nationwide. The plan of the company is to acquire large plots of ex-industrial or “problem” land and then go through a slow process (of 5 to 10 years) in which they change the current use. Much time is put into planning the use for the site, consulting the local authority and gaining the relevant planning permission and then getting a partner to develop part of the site. Some sample properties are the ex-car manufacturing site of Longbridge Birmingham and the Edmonton Shopping Centre.
They do not act as a traditional property landlord. Their tenants occupy properties pre rather than post regeneration. St. Modwen’s aim to cover the cost of development by these lettings. Although only 50% of their land portfolio (by value) is let out, the income from that has over the last 5 years covered the operating costs (including interest) of the company. They are able to achieve this because of the high rental yield (9.2%) on the second rate/ unimproved properties. There is a high churn rate but occupancy rates have been a good 88% for the last three years. Having only some 50% of their land let means that they have a large land bank of 5,800 acres which can be used for a variety of commercial and residential schemes. Most development will be done with a partner (they have a joint venture with Persimmons the house builder) or pre-sold to an occupier (Sainsbury’s Tesco’s etc.).There is therefore little direct development risk.
Here are a few quick financial statistics. Net assets are £500 million, with a property portfolio valued at £1.1 billion. The weighted average maturity of their debt is 3.2 years and no facility is due to expire until November 2014. Interest cover is 2.7 times. The purpose of this bond is not to create further debt but to replace bank financing in order (as ever) to diversify sources of funding and lengthen the maturity profile of their debt. It will also free up some encumbered properties which at some later state could be used as collateral. Like other property companies they did have a rights issue post the start of the financial crisis but they have nevertheless consistently remained profitable through the last 5 years.
Now we should look at relative value among the four property companies. Mid prices are shown (except for the St. Modwen).
PHP is a specialist builder and landlord of GP surgeries and heath care properties. Lettings are substantially to the government they have an attractive niche with very good tenants on long leases. On the other hand, their bond has no covenants (unlike the other issues), rental yield is low and there is no real tenant diversity. Should something go wrong it would be difficult to find alternative tenants for the specialist properties at a similar rental yield.
CLS is more of a general property company with holdings in London and on the continent. Their buildings occupy the space just below prime. However, they still have an impressive tenant list, 40% public, and perhaps most importantly the interests of the management (major shareholders) is closely aligned with shareholders and they have proved themselves prescient by selling a large proportion of their flagship properties before the financial crisis. Workspace has a very different model. They only have properties in London and have sites which are multi occupied by many small tenants. All tenants have the right to break their leases after three months but with so many different tenants this should not be a major problem. The best thing about workspace is their location: London. Commercial property prices are still some 20-30% below their peak so there is good opportunity for capital gain.
As to which is the best value it is a question of personal opinion. All companies are quoted on the LSE and have similar sized market caps. Their LTVs are not too dissimilar, although Workspace and St. Modwen’s are slightly less geared, which is to be expected as they are non-traditional property companies. Finally I would say that I have spoken to equity analysts about the above companies and they all have their fans. All are perceived to be well run companies. St. Modwen yields the most, which is perhaps correct for a “regeneration specialist”. Staring from here however, I think I would indeed go for St. Modwen’s as first choice as I like the extra yield and the company has a good 25 year track record and the balance sheet is strong. All that makes up for the lack of what is traditionally and perhaps myopically looked for in property companies (almost to the exclusion of all else) – good quality tenants locked into long term leases.
Conclusion. In all the froth that has understandably been created by the LSE issue (a record breaking £300 million), St. Modwen’s has been rather overlooked. I suspect they may not even manage to raise the full amount of money desired. It is also true that as a “developer”, albeit one with a rental stream to cover costs, it is a harder sell. However, I think the coupon is not bad and the company has a good battle plan which has proved to be a winner in the past. It does have at least one advantage over the LSE bond and that is the yield and maturity. Although I liked the LSE 4.75% 2021, it does carry duration risk with little interest cushion. The St. Modwen, if you are happy with the credit, can afford to be locked away. Finally with regard to performance in the after-market, an issue that arrives without fanfare and with a smaller issue size may well have a good secondary market reception for technical reasons. Few will buy with the intention of stagging so little stock is likely to flow back onto market makers’ books. Being somewhat cynical I also expect that in time the superior coupon will tell to St. Modwen’s advantage as that is the first thing yield hungry investors will look for. I shall be adding to my portfolio of retail bonds by buying St. Modwen’s. I think it may turn out to be a bit of a dark horse.
* If any lady reader could let me know what the beautician is up to I would be most grateful. I have contemplated putting my head round the door but I am not a courageous man.
Oliver Butt Oliver Butt is a Partner in City and Continental LLP, a leading independent broker in fixed income.
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