NewRiver Retail (NRR) Price 219p; Market Cap £659m Feb 27, 2019 Investment Case NRR trades at a 10% dividend yield and at a 25% discount to the NAV - September 30, 2018. NRR is tainted with the same brush as the UK retail property sector which is challenged by the structural shift to online sales, highly visible failures in the retail and casual dining sector and negative sentiment due to Brexit. But NRR operates in the value sub-sector comprising discounters and low value retailers such as Primark, B&M that are winning the retail battle and are online resistant. Operating where rents are low and affordable it can withstand recessionary conditions. Business REIT- buying, managing, developing and recycling convenience-led, community focused retail and leisure assets Assets have both convenience (convenience stores, shopping centres, retail parks) and community (pubs, shopping centres, convenience stores) characteristics. Convenience-Retail and leisure assets are conveniently located in the heart of communities across the UK. Convenience spend: Requires instant fulfilment and is often essential in nature Is low value, high frequency with a low dwell time Increasingly involves fulfilment of an online order through click and collect (to grow 56% in the next 5 years Occupiers-grocery (Co-Op), discounter (Lidl, Aldi), value clothing (B&M), coffee (Costa) , grab & go food, health and beauty, budget gym. Convenience location Assets located close to where shoppers work or live or between the two (edge of town retail park); average travel time to an NRR shopping centres is 13 minutes. Easily accessible and typically offer free parking. Community spend Often linked to a service and requires face to face interaction Tends to be complementary to convenience spend
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NewRiver Retail (NRR)Price 219p; Market Cap £659m Feb 27, 2019
Investment Case NRR trades at a 10% dividend yield and at a 25% discount to the NAV - September 30, 2018. NRR is tainted with the same brush as the UK retail property sector which is challenged by
the structural shift to online sales, highly visible failures in the retail and casual dining sector and negative sentiment due to Brexit.
But NRR operates in the value sub-sector comprising discounters and low value retailers such as Primark, B&M that are winning the retail battle and are online resistant. Operating where rents are low and affordable it can withstand recessionary conditions.
BusinessREIT- buying, managing, developing and recycling convenience-led, community focused retail and leisure assetsAssets have both convenience (convenience stores, shopping centres, retail parks) and community (pubs, shopping centres, convenience stores) characteristics. Convenience-Retail and leisure assets are conveniently located in the heart of communities across the UK.
Convenience spend: Requires instant fulfilment and is often essential in nature Is low value, high frequency with a low dwell time Increasingly involves fulfilment of an online order through click and collect (to grow 56% in
the next 5 years Occupiers-grocery (Co-Op), discounter (Lidl, Aldi), value clothing (B&M), coffee (Costa) , grab &
go food, health and beauty, budget gym.Convenience location
Assets located close to where shoppers work or live or between the two (edge of town retail park); average travel time to an NRR shopping centres is 13 minutes.
Easily accessible and typically offer free parking.Community spend
Often linked to a service and requires face to face interaction Tends to be complementary to convenience spend Community services: civic amenities (GP surgery, dentists, libraries and town halls. Services
that cannot be provided online-opticians, hairdressers, nail bars, laundrettes, cobblers, post offices, coffee shops and pubs).
Community location Walking distance from residential neighbourhoods. Adjacent to public transport links and civic services
NRR Underlying Beliefs Serve needs for essentials goods and services to consumers Affordable rents for occupiers High footfall locations Desirable and profitable trading opportunities for tenants Cater to ageing population with greater spending power
NewRiver FoundationNewRiver was formed by David Lockhart and Allan Lockhart, an experienced father and son combination. David founded Halladale as a real estate management and development company in 1991. Halladale was listed on AIM in 2001 for approx. £10m and was sold to Stockland Corporation, an Australian company in April 2007 for £171m (having raised £60m of additional equity and convertible unsecured loan capital. Over its life, Halladale grew third party AUM from £116m to approx. £1.5bn and generated a 440% Total Shareholder Return (TSR). Allan Lockhart advised major property companies and institutions on retail investment and development at Strutt & Parker for 13 years and joined Halladale in 2002.
NewRiver Retail Ltd was formed as a specialist commercial property investment and asset management company and listed on AIM in September 2009 to exploit opportunities in the UK retail market. It raised £25m gross proceeds in an initial offering of 10m shares. Management was well aligned, investing £5m in aggregate. At foundation, NRR targeted returns greater than 15% per annum, seeking opportunities where rental income is derived from tenants operating mainly in the value, aspirational and food retailing sectors. Specifically, it focused on: The food sector within retail given positive sales growth and retailers keen to acquire space
across a range of store formats and good tenant covenants available. It sought to anchor shopping centres with a food retailer as an anchor.
Towns which are demographically balanced, with lower occupation costs and where there is limited competition from both out-of-town retailing and competing town centres, which should attract a broad range of retailers, thus leading to rental growth.
Targeted borrowings were between 50% and 65% of the gross asset value of the property.
NRR PortfolioNRR - £1.4bn portfolio comprising two segments-Retail Property and Pubs.
Shopping Centres 58%, Retail Warehouses 13%, High Street 2%, Development sites 7% High level of retail occupancy at 95.5% Highly diversified by tenants
o 895 individual occupiers in retail portfolio;o Top 10 retailers account for only 15% of total rental incomeo Top occupiers -Poundland, wilko, b&m, Boots, Superdrug, Primark, Co-Opo Low department store exposure
High affordability is defensive- average retail rent of £12.37/sq. ft, lowest in listed retail sector Low average shopping centre lot sizes (£24m) provide in-built liquidity High shopping centre yields 7.4% relative to peers.
Pub portfolio Pub portfolio has grown to 22% of assets, now has in-house management team of 45 people. Pub occupancy at 98.9%. More than 600 individual pub tenants 671 pubs of which 95% operate under leased and tenanted model, with the remainder operating
under managed or franchised model Predominantly wet-led Many pubs have excess adjacent land available for development into c-stores or residential
Gearing – lower than peers
Portfolio Valuation The portfolio is valued independently by Knight Frank and Colliers International The valuation is determined using an income capitalisation method, which involves applying
a yield to rental income streams. Inputs include yield, current rent and the Estimated Rental Value (ERV).
Pubs are valued by applying a multiple to maintainable income, rather than a yield. So, for example a pub valued off a multiple of 8x, is equivalent to a net initial yield of 12%.
Development properties are valued using a residual method, which involves valuing the completed investment property using an investment method and deducting estimated costs to complete, then applying an appropriate discount rate.
In respect of the pub portfolio the valuer makes judgements on whether to use residual value or a higher value to include development potential where appropriate.
Inputs for pub valuations are:o Rental value- total rental value per annum.o Equivalent yield- the discount rate of the perpetual cash flow to produce a present
value of zero assuming a purchase at the valuation.o EBITDA multiples and maintainable earnings from each pub.
Portfolio has a yield of 8.2% (Sept 2018) vs. cost of debt of 3.2%. NRR assets are higher yielding with smaller lot sizes; portfolio yield is 350bps more than the
All Property Index yield. This reflects shorter lease lengths for Retail. Pub yields high as there are fewer buyers due to past issues with over leveraging and
financial engineering. Company Voluntary Arrangements (CVAs) or administrations had limited impact on NRR
Retail Portfolio NRR was impacted by the administration of Poundworld and the CVAs of Homebase and Office Deport which had represented £1.9m, or 1.9% of NRR annual net rental income at the start of the period.
Balance sheet is strong BBB debt rating No looming maturities of debt Dry powder of £100m based on reaching 40% LTV
NAV declined from 292p per share at end March 2018 to 284p due to a £24m or 1.8% markdown in property valuation in 1H FY 19. Most of the markdown is in the Shopping Centres portfolio.
NAV NRR trades at a 23% discount to the September 30, 2018 NAV vs a 10% average. Its discount
however is lower than other retail REIT the more on line resistant and defensive portfolio.
The NAV will most likely be lower in March 2019 reflecting negative capital growth in the UK retail sector as Brexit uncertainties and structural changes continue. Retail property capital value returns in Q4 18 were -1%. Assuming Q119 values fell another 1%, I estimate that NRR’s NAV would have fallen 2% since September to March; the NAV estimate at end March 2019 is 277p, 2.1% lower (Liberum estimates 271.6p and Barclays estimates 276p).
Assuming retention of a 23% discount to the March 2108, the near-term price would be 213p. The current share price already anticipates the likely fall in NAV.
A lifting of the negative Brexit sentiment could reduce the discount to NAV; assuming the discount narrows to the historical average 10%, upside to 249p price is 14%.
Further markdowns in the retail sectors may hurt NAV more than 2%. Meanwhile, NRR yields ~9% although the dividend is uncovered.
Simplified Cash Flow Model for NRRA simplified model for NRR’s cash flow generation model is as follows:
Administration costs 1.3%Financing 1.4%Net margin (cash) 3.6%Distributable cash flow (on £1.3bn assets) ~£47mDividend payment at 21.6p per share on 305m shares
~£65m
Dividend cover ~72%
Net Income NRR has gross income of close to £100m and net income after property expenses of £87m which is stable and growing due to the long-dated lease contracts.
Since 30 September 2018, NRR has shown its business in two segments-the retail property and pubs, as shown in the half year statements for 2018 and 2017. This was done after the acquisition of Hawthorn Leisure, a portfolio of 281 pubs that include a management team.
The Operating Income from the pubs is about 24% of the total. The income from the pubs is largely made up of rental income plus sales of drinks (the
difference between the price charged to the customer and the cost at which NRR supplies) plus a share of machine profits. This means the income will be dependent on sales volumes.
Pubs have a higher income yield after operating expenses than retail property (1% more over a year). This needs monitoring to see if it persists.
The acquisition of Hawthorne Leisure in July 2018 has increased administrative expenses in the 1H period to £11.8m from £7.2m. This was due to professional fees of £2.8 that would be non-recurring and £1.9m of an increase in administration expenses related to the Hawthorn’s management team.
FFO and Dividend CoverOne possible concern for investors is that the FFO cover for the dividend has fallen below 100% to 76% subsequent to the additional £225m capital raised in July 2017. Capital was not fully deployed in anticipation of future acquisition opportunities.
30-Sep-17
£ mExisting portfolio
Hawthorn Leisure Total Group JV
Proportionally Consolidated
Gross Income 48.3 11.4 59.7 49.6 103,333 3,675 107,008 Property operating expenses -10.6 -5.9 -16.5 -9.8 19,229- 636- 19,865- Net property income 37.7 5.5 43.2 40.1 84,104 3,039 87,143 Administrative expenses -5.8 -1.9 -7.7 -6.1 14,855- 294- 15,149- Net finance costs -9.4 -7.3 14,605- 650- 15,255- (Loss)/Profit on disposal of investment properties -0.3 0.4 4,893 114- 4,779 Taxation -0.5 -0.6 1,200- 1,200- Funds From Operations 25.3 26.5 58337 1981 60,318 Weighted average # of shares 303.8 266.5 286,105 FFO/share 8.3 9.9 21.08 Dividend/Share 10.8 10.5 21 Adjusted FFO 24.9 26.2 59,581 Admin cost ratio 12.90% 11.40% 15%
30-Sep-18 31 March 2018
Management expects the dividend cover to rehabilitate to 100% by 2020 as shown below.
Canvey Island is a 62,000 sq ft retail part development in Essex with the scheme 75% pre-let to M&S Foodhall, B&M, Sports Direct and Costa. These stores are set to open in early 2019 and once fully let the scheme will deliver £1m of annualised rental income.
Adjusted FFO (AFFO) adjusts the FFO to reflect maintenance capex incurred during the period (the element considered to be non-accretive and which cannot be recovered from occupiers through the service charge). Maintenance capex is low, 0.03% of portfolio value.
Management IncentivisationManagement is incentivised through three elements:
A shareholding requirement
Executive Directors are expected to build up a shareholding within 5 years of appointment worth 200% of base salary of the CEO and 100% of base salary for other Executive Directors. At March 2018, value of CEOs holding was 170% of 2018/19 salary and CFO held 100% of salary
Performance Share Plan
The 2017 plan has two performance conditions (50% weight each) over a three year period
Total Shareholder Return vs FTSE All Share Index TAR vs. Peer Group. TAR is annualised return over three years based on change in EPRA
NAV/share and DPS.
Range % of award vesting
< 100% of index 0
=100% of index 25
>100% < 125% of index Between 25 and 75 on straight line basis
>125% < 150% Between 75 and 100 on a straight line basis
>=150% of the index 100%
Bonus
Bonus up to 125% of salary on the basis of achieving Growth Based, Financial Compliance and Personal targets. 80% of the bonus paid on the basis of corporate targets and 20% on the basis of personal performance.
On-Target performance would result in 60% of maximum bonus (75% of salary). Threshold
performance would result in bonus of 20% of maximum bonus ((25% of salary). Growth based measures are:
o Total return vs IPD All Retail Threshold-At Index (12.5% of salary); OnTarget-10% ahead (31.25% of salary); Stretch-20% ahead (50% of salary)
2018 Actual Result 8.2% vs. 6.2%; FY 17 6.8%o Earnings yield (FFO)-comparative to peers-Threshold-AT Index (7.5% of salary); On
Target-Top Quartile (18.75% of salary); Stretch-Top 5 (30% of salary) 2018 Actual Result Top 5
Performance
Total Accounting Return has fallen off in the last two years post the Referendum and the fall in retail sector valuations.
Total Accounting Return
FY14 10.8%
FY15 15.7%
FY16 18.1%
FY17 5.7%
FY18 8.1%
Over the last three year, NRR has underperformed the FTSE 350 REIT sector and the FTSE All Share
Since inception, NRR has underperformed the FTSE REIT 350 and the FTSE All Share
Growth NRR has a risk-controlled development pipeline which total 1.8m sq ft (1.4m sq ft near term)
including Retail (1.6m sq. ft) and Pubs (0.2m sq. ft).o The risk-controlled approach means that NRR will not commit to a new development
unless 70% by area has been pre-let or pre-sold.
The development strategy includes:o Regeneration of existing space (e.g. Abbey Centre, Belfast)o Development of sites acquired in portfolio acquisitions (e.g. Canvey Island Retail
Park, Essex)o Capitalising on opportunities with ownership above or adjacent to assets (e.g.
Cowley, Oxford)o Complete redevelopment of existing assets (e.g. Burgess Hill, c-store pub
conversions) Development costs are phased mostly arising in FY2020
• NRR has potential to deliver up to £140m of development profits from residential development over next 5-10 years.
Why I have bought, and would buy? Attractive dividend yield of 10%; with narrowing of discount to 10%, the upside is 15%-total
return of 25%. Note NRR traded at a 5% premium in 2016. This is the no-growth case; further upside from the development pipeline.
The dividend is sustainable given that NRR has high yielding properties and a pipeline of new developments that generate a like return.
The NAV should hold up better than the market due to the online resistant and defensive characteristics
Occupancy to remain high as low exposure to more vulnerable parts of the sector -low CVA risk- and affordability.
Management is well aligned, not strongly aligned due to relative performance measures.
Risks Income from pubs is reliant on spending and margins on drinks. Valuation adjustment is more severe than expected, LTV covenant breach. Occupancy drops or CVAs appear.
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