Superior income visibility not priced in
- Markets mispricing positive outcome from recent lease restructuring (critical factor)
- c.79% of total portfolio by GRI now with straight leases through to 2028, offering six years of income visibility, the longest amongst S-REITs
- Committed to invest GBP12.5m in asset enhancement work over three years to drive ESG initiatives
- Maintain BUY and unchanged TP of GBP0.80
Investment Thesis
Maintain BUY and TP of GBP0.80, implying a 24% potential upside, with attractive yields of 7.5%/7.8% for FY22F/FY23F. Elite Commercial REIT (ECR)’s portfolio of 155 properties boasts of full occupancy and a long WALE of six years, with over 99% leased to the AA-rated UK Government. As the lease break option in 2023 was removed for almost half of the portfolio, 79% of the portfolio now has straight leases through to 2028 without lease break options. The strong income visibility is a key positive for the REIT.
Revaluation gains ahead to drive share price re-rating. We believe that ECR will likely see a lift in valuations with the removal of lease break options for 100 out of 117 properties leased to DWP. The remaining 17 properties have lease break options undecided by DWP as of now, but notice will have to be served by the end of this month, otherwise the leases will continue to run till 2028, generating further upside to valuations. The weighted average lease to break (WALB) is now at its longest ever at c.5 years, which will be a critical factor for the stock to re-rate; historically P/NAV was at 1.2x when WALB was at its longest at c.4.5 years, and the stock is currently trading at just 1x P/NAV with potential revaluation gains ahead.
Greater incentive for DWP to continue its leases beyond 2028. With the government’s aim to achieve sustainability goals such as net zero carbon emissions by 2050, this sustainability collaboration by ECR and DWP is timely. Achieving higher Energy Performance Certificate (EPC) ratings for the properties in the portfolio can provide a greater incentive for DWP to stay as a tenant beyond 2028, future-proofing the REIT.
Valuation:
Our target price of GBP0.80 is based on a DCF valuation with a WACC of 5.8% and terminal growth rate of 1.00%.
Where we differ:
We are slightly more conservative on the inflation-linked rental uplift in 2023.
Key Risks to Our View:
Tenant risks, country risks, interest rate risks, and regulatory risks.