Palace Capital (PCA) has confirmed that FY19 independent property valuations are marginally up on the prior year, although adjusted earnings will be lower than previously expected. This is due to the deferral of some near-term lettings, as part of its asset management-driven total return strategy. Management has reiterated its commitment to the current level of dividends, expecting these and other asset management initiatives, including the flagship Hudson Quarter development in York, to deliver future income and capital growth.
Palace has held off letting some of its vacant space in order to enhance mediumterm returns through refurbishment and redevelopment. As a result, the company says that FY19 adjusted earnings will be “slightly below expectations”. We have reduced FY19e adjusted EPS by c 9% to 15.9p and while FY20e adjusted earnings increase due to a favourable lease surrender settlement, FY21e is also reduced. We believe our estimates are conservative, capturing little or none of the upside that management expects from asset management initiatives (due to the difficulty in forecasting this and no contribution from the Hudson Quarter development, which is expected to complete by the end of FY21. In view of this upside potential, the strong cash position and comfortable c 33% LTV, management has reiterated its commitment to the current level of DPS.
Palace is not a REIT and while it seeks to generate returns by growing recurring income, it also has a parallel focus on increasing capital values. It has built a strong track record of value creation over several years, primarily driven by corporate acquisitions, which additionally benefit from lower stamp duty and provide the potential to benefit from acquired tax losses and capital allowances. NAV total return in the five years from September 2013 (H114) to the end of H119 is 126.1% – a compound 17.7% pa. Strong reversionary potential and a range of opportunities to further reposition and grow the portfolio are positive indicators for future returns.
The yield is approaching 7% and management has committed to the current level of DPS despite a near-term earnings cover shortfall. The discount to EPRA NAV is c 30%. Asset management initiatives to capture reversionary potential and progress with Hudson Quarter are potential triggers for a re-rating.