Palace Capital Initiation of coverage

Hardman & Co

Hardman & Co Report Report DownloadsPalace Capital (LON:PCA) has almost doubled NAV since the initial investment in
October 2013. Good income generation is evidenced by the EPRA EPS and the
DPS track record, whilst undertaking incremental refurbishments and
development. The investment portfolio is 90% occupied and generates strong
cashflows: with a focus on regional city centres, offering occupiers value for
money. Development opportunities are optimised. 6% of the portfolio value is in a
recently demolished and cleared two-acre site in the heart of York, due to be
redeveloped, which will generate a step rise in NAV and in group income, once
completed end 2020.

Selective assets: PCA makes opportunistic acquisitions of regional real estate,
enhancing income through active asset management. Average rents of £14 sq.
foot (in the largest sector, offices) underpin the sustainability of cashflows.
There is one major development, in York, commencing early 2019.
Capital recycling: Selected property disposals (typically small portions of
portfolios acquired) provide liquidity. Further, the York development is set to
enhance cashflows, once completed, as is the sale of the residential portfolio
currently available for sale. This latter was part of a portfolio acquisition.
Risks: The £70m equity raise, funding the £68m RT Warren portfolio
acquisition (October 2017), reduced LTV to a conservative 30% (37% prior
year). WAULT of 5.3 years is a mix, with some void risk balanced by asset
management potential. While the office element at York is being developed
speculatively, the local residential market is strong, with the northern market
currently outperforming the south.
Investment case: The existing income portfolio produces 6.6% NIY, providing a
good risk/reward. Importantly, the York development’s anticipated completion
by December 2020 will result in a step-rise in Palace Capital’s ongoing income
as capital is redeployed. We estimate this could add £1.5m p.a. or more,
equating to post tax 2.7p on EPRA EPS, 16% of the 2019E level.
Valuation: The valuation appears below that of comparables even before the
potential from York is taken in to consideration. There is also a 16% income
uplift potential on ERV vs. contracted rent, thus adding to the momentum.

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