Elite Commercial REIT: Impacted by rising cost of debt
- 1H23 revenue of GBP19.1bn slightly ahead of our estimate, coupled with dilapidation settlements of GBP1.9bn
- 1H23 DPU of 1.74 pence fell short of our expectations as a result of higher-than-expected interest expenses
- Cut FY23F/24F distributable income by 1%-6% and lower payout ratio to 90% from 100%
- Maintain HOLD with lower TP of GBP0.33
Related Stories
- Revenue grew 3.4% y-o-y to GBP19.1m in 1H23 from GBP18.5m in 1H22, slightly ahead of our estimate
- Higher revenue was derived from rent escalations of c.13.1% for 136 assets from April 2023
- Partly offset by eight assets vacating from April 2023
- Other property income increased to GBP2.2m in 1H23 from GBP0.2m in 1H22, mainly due to GBP1.9m in dilapidation settlements and a GBP0.4m lease surrender premium
- 1H23 distributable income declined 31.2% y-o-y to GBP8.4m while DPU fell 31.9% y-o-y to 1.74 pence
- This was due to increased interest cost of borrowings, an enlarged equity base y-o-y, as well as a change in the payout ratio to 90% from 100%
- NAV per unit declined slightly to GBP0.51 as at 30 June 2023 from GBP0.52 as at 31 December 2022
- Gearing ratio decreased to 46.0% as at 30 June 2023 from 46.6% as at 31 December 2022, as a portion of the recycled gross proceeds from the dilapidation settlements and divestment of two assets was used for the repayment of loans
- High portfolio occupancy of 92.1% as at 30 June 2023, with 99.9% of rent for 3Q23 paid in advance and within seven days of the due date
- Long WALE at 4.5 years as at 30 June 2023
Our thoughts
Portfolio update. With the 12 assets vacated, dilapidation settlements, amounting to GBP1.9m, have been completed for four assets, which will be used to pare down debt. Further, the manager proposed the divestment of two assets – Openshaw Jobcentre, Manchester (GBP615,000) and John Street, Sunderland (GBP500,000) – for GBP1.1m, at about a 14.4% premium to valuations, while three other vacant assets are also in advanced stages of divestment, above book value, and more divestments could follow. We note that the divestment of the two assets is being executed at above valuations but below purchase prices.
We understand that the strategy is to maximise value through a potential re-letting, disposal, or alternative uses, but we still see some uncertainty surrounding the remaining vacant assets, especially against a backdrop of weaker demand for real estate investment and declining transaction volumes. However, there could be an upside to our conservative assumption of zero occupancy for the rest of FY23F and 50% occupancy in FY24F.
Higher cost of debt to weigh on dividends. Every 100bps increase in the interest rate will impact DPU by c.4%. While 62% of ECR’s interest rate exposure is hedged, borrowing costs have risen more than expected to 5.2% as of 30 June 2023 from 4.9% as of 31 March 2023. With the Bank of England recently hiking interest rates to 5.25% on 3 August 2023 and ECR’s floating debt portion pegged to 150-200bps above the Sterling Overnight Index Average (SONIA) interest rate benchmark, we anticipate a further increase in borrowing costs, which is one of our biggest concerns currently.
Maintain HOLD with lower TP of GBP0.33. We lift FY23F revenue estimates to factor in additional dilapidation settlements for the remaining vacant properties, partially offset by an increase in property expenses, given higher holding costs in relation to the vacant properties. We raise FY23F and FY24F borrowing costs to 5.5% to account for rising interest rates on floating debt. FY23F/FY24F distributable income is revised downwards by 1%-6%; DPU is revised downwards to 3.39/3.57 pence (90% payout ratio). We maintain a HOLD call on ECR, as weak credit metrics remain an overhang on the share price.
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