Development Securities at a discount

The UK and Irish real estate group Development Securities had a basic NAV per share of 276p at February 2015. The current share price of 242p gives a 12% discount to the net asset value (NAV). This seems unwarranted given the scope for development gains over the next three years.

Development Securities is a real estate developer with a portfolio of mature investment assets. This mix provides cashflow to support the business and potential upside as new projects come through to completion.

However, the real estate development business model is precarious given cyclical demand and the use of debt. When the music stops companies with large unfinished projects are likely to experience financial stress.

Development Securities saw its share price fall from over £7 in early 2007 to £1.22 in mid-2012. The long-term performance has also been weak with the shares at around £4 in 1994 versus only £2.42 today.

However, the shares have performed well when there has been a period of economic growth. The group’s gearing has also been reduced in recent years and property completions are set to be strong over the next three years.

Development Securities’ near-term potential

Real estate developers generate value by taking projects through to completion and then selling them. Works in progress are conservatively valued on the balance sheet and so the sales should generate an increase in book value.

Development Securities expects the next three years to see strong gains from its development portfolio at an average of £56.5m a year. This compares to the £45.7m seen in the year to February 2015 and £27m the year before.

Expectations of gains to be realized across the portfolio

Source: Development Securities investor presentation

In the year to February 2015 the NAV increased from 262p to 276p at the end of the period. This gain is after factoring in the payment of an ordinary dividend for the year of 5.9p for the year and a special dividend at 8p.

Balance sheet improvement

The scope for setbacks in the medium-term has been reduced by a fall in balance sheet gearing. At February 2015 gearing came in at 38.3% versus 48% at the start of the year.

Including joint venture debt and gearing at February 2015 was 48.5% versus 56.8% at February 2014 and 63.9% at February 2013. Interest payments are supported by the income from mature investment assets as well as trading gains.    

Development Securities in focus

Taking a snapshot of the group at February 2015 and 42% of the book value was in investment assets at £211m. The remaining 58% of the portfolio was in development and trading assets at £291m.

The investment portfolio’s focus is to provide a recurring income stream and make a contribution to the NAV growth. Value can be created through lease re-structures, improving the tenant mix and asset management.

In the financial year to February 2015 the investment portfolio generated £13.8m of rental income and saw a 12.2% valuation gain including joint ventures. The group made £60.8m of disposals and £65.7m of acquisitions.

Source: Development Securities investor presentation

Turning to the Development and Trading portfolio and the focus is on short to medium term profit generation. This may only be in land improvement but generally the focus is on taking forward undeveloped real estate sites.

The group realized £45.7m of gains in this area in the year to February 2015 which was the main driver of NAV growth during the year. Six new projects were acquired during the year while a number of recent new deals have been in Dublin.

Source: Development Securities investor presentation

Geographic focus

In terms of the geographic focus and the majority of the investment portfolio is in London and the South East. Over 80% of the investment assets are let to retailers while 57% of the rental income is generated from PLC/nationals.

The Development & Trading portfolio had 44.2% of its “work in progress” assets in Greater London at February 2015. The next largest area was the South East at 16.4% and then the Republic of Ireland was in third place at 15.2%.

Deals since the year-end will have increased the exposure to Ireland and should bode well. This is because Ireland’s unemployment rate is falling back and the rate of economic growth is amongst the highest in Europe.

Management change

Development Securities has seen a leadership change with Michael Marx having stepped down as CEO in July. His replacement is Michael Weiner (43) who has been on the board for 11 years.

The deputy CEO, Richard Upton joined the group acquisition of Cathedral Group in May 2014. He has recently been buying shares in the company and appears to have had a successful track record in the real estate sector.

Summary and valuation

The recovery in the UK and the Irish economies provides a positive backdrop for Development Securities. The Development and Trading portfolio is also set to see strong gains over the next three years.

Against this backdrop the share price discount to the NAV of 276p at February 2015 seems somewhat harsh. The next update will be for the end of August NAV and will be released with the interim results on 21st October.

The Investment Portfolio also provides support with the majority located in the South East and London. Nearly half of the Development and Trading portfolio, meanwhile, is located in Greater London.

Development Securities clearly has a poor long-term track record but the level of financial gearing has been reduced. The company is also clearly confident given the payment of an 8p special dividend (£10m) in the last financial year.

This report was produced by Fat Prophets Senior Analyst, Andrew Latto CFA