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Double Figure Yield - Public Service Properties Investment (PSPI)
20/5/2010
(119264)
Double Figure Yield
A prospective dividend yield of near-enough 10% suggests that some must have doubts about Public Service Properties Investments (PSPI), but the company certainly puts up a strong case for pushing them aside. The mood is unmistakably confident, and market caution appears overdone.
PSPI has been recommended here for about a year. In that period, the share price has risen from 55.25p to 70p (after touching 80p), and holders have enjoyed a dividend yield in excess of 11%. Not bad – and there are strong chances of at least as good a performance in the year ahead.
At a presentation by Ralph Beney, finance director of the company’s asset managers and PSPI chairman Patrick Hall, there was a suggestion that PSPI lacked support because investors could not decide whether it was in healthcare or in property. In truth, it is a property company which owns care homes – but does not operate those homes.
That makes it a property company with a unique flavour. Values tend not to fluctuate as sharply as the average property, but there is a real worry that cuts in Government spending will press harder on care homes and undermine the ability of the tenants of PSPI’s properties to make money and honour their leases.
This concern is the more acute at PSPI because all of the UK properties are let to one operator, European Care Group. UK generated net rental income in 2009 of £11.5m, with £3.6m from German care homes, £700,000 from a home in Switzerland, and £1.3m from 140 post offices in the USA. Switzerland and the US would be sold should a suitable opportunity arise.
The health of European Care is clearly crucial to PSPI. Dealing with just one operator, though the companies are independent, allows PSPI to keep close tabs on what is happening, and to consult over expansion decisions. The company sees it as an advantage, others worry about over-dependence. As a result, much of the presentation was diverted into discussion of European Care.
A private, long-established company, it declared a loss in the last filed accounts, but only after heavy group overheads. PSPI feels European Care is a sound operator, planning to expand by 25% over the next two years.
In fact, PSPI supplies 1,730 UK beds to European Home which also has 3,000 beds itself, and is the fifth largest such company in the UK. Operating profits cover rents comfortably, and it is reckoned that European Care needs about 80% occupancy to break even, and is achieving 92%. About 75% of European Home’s income is ultimately funded by local authorities. There is a shift towards catering for those who require more demanding care, with complex dementia becoming the fastest-growing source of patients. Spending cuts may be focused lower down the care chain.
There is a squeeze on care home operators, and several groups have suffered. Southern Cross, the industry leader with more than 36,000 beds, has seen profits ease, but has just announced a £50m re-financing.
Should there be a major problem, PSPI retains ownership of the homes and the business which goes with them. Though unwelcome, it would be possible to bring in other operators. Medium to long term there is a shortage of good quality care homes in the UK.
Working with European Care, PSPI is looking to spend perhaps £20m of the £24m raised by a recent open offer at 70p on improving the size and quality of the homes in the UK portfolio over the next couple of years. This is done on the basis of an 8% return on spending, and that effectively enhances the asset value.
PSPI has a fully let portfolio and a weighted average unexpired lease term of 22 years. It is relatively modestly geared at 53% (total borrowings as a percentage of total non current assets, excluding goodwill and loan receivable). It comfortably meets all debt covenant tests.
After the open offer and Euros18m of new senior debt raised against the German properties (let to three different companies) , the pro forma net asset value is 121p a share (as diluted by the share issue). There is, however, £27.5m of deferred tax on fair value gains and such, and much of this might never be payable. Adding that back would take net asset value to 147.9p a share. The real figure is probably somewhere between the two.
Various extensions are under way, raising prospective income and asset value, and there will be savings from re-financing some debt. All UK rents are indexed to retail price index, up to 5%. The running yield has been valued by Colliers CRE at an average 6.3%.
There is no profits forecast for the current year, but a dividend (up 8.3% to 6.5p for 2009) of 7p was forecast with the open offer, projecting a yield of 10% at the current share price of about 70p. That will be covered by cash earnings, the company says.
The open offer was underwritten free of charge by Elliott International, a substantial US specialist fund manager with funds of maybe $15bn. Elliott now holds 45.66%, but has agreed that the chairman and a majority of the PSPI board will remain independent.
Elliott’s readiness to take the whole of the open offer, had that been necessary, suggests that it is comfortable with the outlook for PSPI and the relationship with European Care. It is safe to assume that Elliott will have inspected European Car far more closely than the average investor, so it is sensible to draw real comfort from that.
The PSPI management is well aware of the need to improve the share rating, though it holds out no promise of spectacular rapid growth. It considers the company offers a solid, long-term growth prospect. For many, of course, the lure of a 10% yield will be more than enough in these uneasy times.
At present, that 10% return can only be sheltered from tax inside a SIPP. The board is well aware that, as an AIM stock, it cannot be tax-sheltered in an ISA. Thediectors continue to consider the possibility of moving to a full listing, but there is nothing in sight as yet.
Some 80% of the shares are held by big investors, and the company is especially keen to gain a greater following among individuals. Though the relationship with European Care will deter some, it looks well worth tucking PSPI away for the high return and steady growth prospects. A re-rating merely to a generous 8% yield would suggest a price of 87p.
I have a holding in PSPI.
Ends
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