The healthy liquidity position of Palace Capital plc (LON:PCA) takes risks down to a modest level, as does the overweight to regional offices and minimal shops. The Hudson Quarter mixed-development site is selling well, and profitability remains at appraisal levels. Hudson Quarter is within the York city walls, has been selling well and is a material positive, set to generate approaching £70m cash for recycling investment. The current returns from this count for zero in reported numbers or forward estimates this year. Even after having devoted significant resource to this successful site, the income yield is above the market average, and with below-market risk.
- FY’20 results: 84% of rents due end-June are paid (or being paid monthly), on time. 93% of March rents are now in. Unsurprisingly, asset values are down but, from here, we expect stable valuations at Palace Capital’s office assets. Some new lettings are taking place. Asset total return outperformed the benchmark.
- Robust balance sheet: Year-end loan to value (LTV) stood at 38%. Loan covenants are fully compliant. £20m gross cash is held, with no facilities maturing until 2022. By that point, Hudson Quarter will have generated significant cash for reinvestment, thereby enhancing ongoing income.
- Valuation: This is a strongly positioned regional REIT. The regional peer group tends not to undertake development, which we see as a Palace Capital upside, but the market does not price as such. Price to historical NAV for Palace Capital is 31ppts below the (unweighted) average for the regional REIT universe.
- Risks: LTV is set for ca.40% at the peak of the apartment and office development project within York city walls. The latter can be retained or sold, thereby ensuring enhanced income, as well as reduced debt. Current markets are uncertain, and Palace Capital has not commented on calendar 2020.
- Investment summary: A comparison with the sector is straightforward. The sectoral and regional exposures point to outperformance in capital values, rental change and total returns. The value uplift and cash-generation benefits from the 13.6% of the portfolio in development assets are clearly visible, but not reflected in the accounts. The balance sheet remains robust.
