Focusing on building balance sheet strength
- 9M23 revenue of £28.5m was in line, at 73% of our FY23F forecast.
- High portfolio occupancy sustained while gearing ratio improved.
- Reiterate Add with an unchanged TP of £0.49.
9M23 update highlights
Elite Commercial REIT (ECR) posted a 2% yoy increase in 9M23 revenue to £28.5m, thanks to 13.1% inflation-linked rental escalation for 136 of its 155 assets effective from Apr 2023, partly offset by income vacuum from eight vacant assets. However, net property income was up a higher 20.4% to £32.5m with the inclusion of dilapidation settlements for nine assets. Income available for distribution fell 25.1% yoy to £13.6m as earnings were eroded by higher interest expenses. 9M23 DPU declined 25.6% to 2.82 pence (2.53 pence based on a 90% payout ratio), 25.6% lower yoy.
Maintaining high portfolio occupancy
Portfolio occupancy stood at 92.1% at end-9M23, with 100% of rent for the period Oct 23 to Dec 23 collected in advance. Weighted average lease expiry stood at 4.3 years at end3Q23, providing strong income visibility, in our view. With the bulk 94.8% of its leases expiring in FY28F, ECR has started early dialogues with tenants to extend and diversify these lease expiries. As at Oct 23, the REIT had concluded dilapidation settlements for nine assets, and divested five of these properties for a total of £3.4m (12.2% above valuation). Of the remaining seven vacant buildings, three of the properties, valued at £2.085m, have been earmarked for sale and the remaining are in various stages of asset management evaluation including re-leasing, asset enhancement, redevelopment or divestments. We believe these initiatives would enable the trust to reduce holding costs of the vacated properties or pare down debt to lower its gearing and strengthen balance sheet in the near term.
De-gearing through capital recycling
The divestment proceeds were mainly utilised to pare down debt and lower gearing to 45.8% at end-3Q23 (45.4% at Oct 23). ECR aims to further reduce gearing through strategic capital recycling and asset enhancement strategies to maximise portfolio value. ECR’s funding cost rose qoq to 5.3% at end-3Q23. An estimated 62% of its interest rates are hedged on fixed rates. ECR has no near-term debt maturity until 4Q24. In terms of sensitivity, management guided that for every £5m debt repayment, gearing will reduce by c.60bp and every 100bp rise in funding cost will impact DPU by 5%.
Reiterate Add rating
We keep our FY23-25F DPU estimates unchanged and maintain our DDM-based TP at £0.49. At the current price, ECR offers an attractive FY23F dividend yield of 15.8%. We like ECR’s stable income portfolio, with inbuilt growth through its inflation-linked rental structure. Potential re-rating catalysts could come from an improvement in the UK macroeconomic outlook. Downside risks include tenant concentration exposure to the Department for Work & Pensions (DWP), and high inflation in the UK which could put pressure on interest rates and funding costs.
