The Week In Review: Valuations are looking stretched by Reits march
Saturday 06 January 2007
Ten of Britain's biggest listed commercial property companies officially converted into real estate investment trusts (Reits) this week. Among those that switched to the tax-efficient format were British Land, Land Securities, Slough Estates, Liberty International, Great Portland Estates and Hammerson.
Property groups have to pay a one-off charge equivalent to 2 per cent of the value of their portfolio to the Treasury. For British Land, this is about £300m, equal to one year's corporation tax bill. From here on in, British Land is free to expand its property interests with little hindrance from the tax authorities as long as it distributes 90 per cent of its income to investors as dividends.
Its shares, like the rest, remain listed on the London market as before. But, valuations across the sector, which soared ahead of conversion, are now beginning to look stretched. Whereas historically companies traded at a discount to their net asset value, they now trade at a premium.
On average, the likes of British Land, Land Securities, Hammerson and Slough Estates trade at a 10 per cent premium to net asset value - a building worth £10m on its own is worth £11m to the stock market in the form of a Reit.
Although these valuations may seem excessive, they are conservative when compared to those abroad. European-listed Reits trade at a premium of between 25 and 30 per cent to their assets, and Australian Reits at up to 40 per cent.
Clearly, commercial property is in fashion in a big way at the moment. The investment community is in love with assets that can deliver predictable cashflows and property fits the profile perfectly. The introduction of Reits has greatly fuelled this ardour. But with the sector offering a dividend yield of less than 3 per cent even after raising its payout to take account of the new Reit regulations, now is the time for readers to take the bulk of their chips off the table.
SECTORS TO WATCH
Which sectors are likely to perform best in 2007? The consensus in the City is that economic growth will slow over the next 12 months, which in turn will moderate earnings growth. This means cyclical industries such as engineering, consumer and electrical goods and so-called general industrials are best avoided.
However, the insurance sector, which did well last year, should continue to perform strongly. It has consistently beaten analysts' expectations for nearly two years and there is little to suggest this trend is about to change. Meanwhile, insurers trade at a discount to the wider stock market.
The oil sector also looks set to do well. BP shares lost ground last year, while Shell finished flat. The oil sector is valued at a historically low multiple of earnings; in fact, so low is the sector's valuation that it implies a crude price of about $40 a barrel compared with the going rate of $60.
Healthcare is another example of a sector de-rated by investors because it is unlikely that many of its major players will ever be taken over. Analysts now point out that the sector trades at a multiple of earnings so low that it has not been seen since the early 1990s. Healthcare stocks are a great bet when the wider economy is starting to slow.
Finally, readers would do well to have a look at the technology sector in 2007. In Europe, it has suffered because of persistent downgrades to earnings. But the story in the US has been very different. There, earnings estimates have been on the up, prompting a solid performance by technology stocks since the summer. Many analysts expect Europe to follow suit in the months ahead.
The biotech company SR Pharma is a key player in a hot new area of gene-based drugs called RNA Interference (RNAi) therapeutics. This technology, which blocks or "silences" genes, is expected to play a pivotal role in the development of treatments for diseases such as cancer, Aids and blindness. The scientists behind the discovery - Dr Andrew Fire and Dr Craig Mello - were awarded the Nobel Prize for medicine last year. The technology moved further into the spotlight in October after Merck acquired the US biotech specialist Sirna Therapeutics, another leader in the field, for $1.1bn (£50m). And this week, SR Pharma was granted a patent by the European Patent Office for its core RNAi compound. Buy.
Worthington Nicholls is the UK's leading installer and maintainer of air-conditioning units for hotels and shops. The Manchester-based company has unveiled its first European contract, which will see it install new and replacement air-conditioning systems for Grand City Hotels & Resorts at the Park Hotel, Amsterdam. The deal should be complete by the summer and is worth €350,000, but, more importantly, it could lead to significantly larger contracts with the hotel group in the future. Hold
CABLE & WIRELESS
Cable & Wireless shares have risen by nearly 30 per cent since we tipped them at the end of the summer. This week, they gained further ground because the telecoms group was heard to have made a bullish presentation to one of the City's leading sector analysts. However, the stock's strong gains over the past four months have left it trading at a massive 36 times forward earnings and yielding around 3 per cent. This is a significant premium to its European rivals. With headwinds gathering for the group's international operations, this could be the time to take profits.
Aggregates group Ennstone has continued its US expansion with the purchase of Handyman Concrete for £4.6m. Ennstone has been building up its American operations for some years and given the strength of the pound against the dollar now is a perfect time to do such a deal. Ennstone's impressive asset backing is probably its most exciting feature. Although the stock looks fully priced at its present rating of 17 times forward earnings, note that it trades well below the levels at which Aggregate Industries and RMC were bought at. Buy
EBT MOBILE CHINA
EBT Mobile China has raised £7.7m from a placing of new shares at 22p. The cash will be used to strengthen the retailer's position in the local market. It plans to extend its relationship with the country's biggest operator, China Mobile, commence a national expansion in partnership with a leading international retailer and set up and run kiosks selling mobile phones in malls and hypermarkets. There is probably no more exciting place in the world to be selling mobile phones than China, but don't expect an instant return from EBT. This is a stock to tuck away for the long-term.
These recommendations are taken from the daily Investment Column
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