Palace Capital has published strong FY17 results, with rental income of £14.3m feeding through to adjusted EPRA earnings of 22.2p per share (FY16: 18.9p). EPRA NAV of 443p per share was 3.5% ahead of our forecast (431p) and 7% higher than at 31 March 2016 (414p), driven by asset management initiatives, selective disposals at above book value and modest yield contraction. The regional occupier market is reported to be healthy and we continue to expect Palace’s geographic and sector focus, as well as the relatively high yields on the portfolio, to provide some protection from macroeconomic headwinds, including the effects of Brexit, when compared with property in London.
As explained in our previous notes, management has taken steps to add value by refurbishing, releasing and in some cases repositioning assets in the portfolio, and by disposing of non-core properties where an attractive price can be struck. The success of this strategy is evident in the results: property sales have generated a gross uplift in value of c 14p per share, while revaluation gains on the retained portfolio have added another c 12p per share. At the same time, Palace has assembled a stable core portfolio generating recurring rental income of £12.7m, expected to rise as new acquisitions are made and new leases signed for the existing portfolio.
The board proposes to pay a final dividend for FY17 of 9.5p, taking the total for the year to 18.5p, a 5.0% yield on the current price and equivalent to 87% of EPRA earnings, a similar payout ratio to a REIT. Allowing for a slight dip in rents as Hudson House in York is redeveloped and for a lag before a new acquisition replaces income from properties sold in FY17, we forecast that the higher dividend will be sustained and remain fully covered in FY18 and FY19.
As the company had indicated in its update in May, reported NAV is well above market expectations and means that Palace now trades at a discount of c 16% to EPRA NAV, despite having recurring rental income expected to rise to c £13.5m once the announced acquisition of a £20m asset is complete. Our forecast EPRA EPS fully cover a prospective dividend yield of c 5%, which we would argue justifies a narrower discount, in line with regional property peers, averaging close to NAV.