BUY: Big Yellow (BYG)
The self-storage rental company and operator has reported strong results again, but its value has not been recognized by the market, writes Mitchell Labiak.
It’s a sign of the strength of Big Yellow’s margins that the self-storage rental and operator was still able to post a £75.3m pre-tax profit on sales despite a £29.9m valuation decline of £189m in its results for the year ended 31 March.
Other real estate investment trusts (REITs) have not been so lucky. The ‘minimal’ budget-driven interest rate hike reduced buyers’ budgets overnight and led to a painful re-rating for Reits across the board. Most posted pre-tax losses in the months that followed, but not Big Yellow.
Due to the revaluation, the pre-tax value is still well below the previous year’s value, but the prospects for future earnings are good. Pre-valuation operating profit increased 12.6 percent due to a 9 percent increase in net rent per square meter. In other words, even as Big Yellow expands its portfolio, the company is still seeing increasing demand for its services, which it can use to boost rents.
Thanks to increased efficiencies from a larger portfolio, the company has steadily increased its operating margin from an already strong 60.3 percent in full-year 2021 to 63.6 percent in this year’s results. Such high margins will eventually reach their limits, but for now, shareholders are benefiting from the good times and increasing the dividend by another 8 percent.
Such a feat by Big Yellow isn’t new, but historically shareholders have typically paid a hefty premium to net asset value (NAV) for this stock. For now, however, the major real estate calamities mean investors can buy Big Yellow at a modest discount to net asset value. For this and several other reasons, we repeat our appeal.
HOLD: Victorian Plumbing (VIC)
The bathroom supplies retailer is growing. But not fast enough to justify its price, writes Mitchell Labiak.
Victorian Plumbing more than doubled its pre-tax profit for the six months ended March 31. That sounds impressive, but there’s a caveat. The £2.9m increase is not insignificant but needs to be seen in context, particularly given the paltry pre-tax margin of 3.81 per cent.
To some extent, the bathroom retailer’s tight margins are to be expected. The company doesn’t have a public listing until 2021, so it’s in growth mode, which means costs are rising. With the expansion, investors would expect that margin to increase. So far, however, the opposite has happened. The pre-tax margin has shrunk from 11.4 percent in full-year 2020 results to 4.38 percent in last year’s preliminary numbers. The most recent results continue this trend.
The company attributes part of this to inflation. It said staff costs were up 18 percent, which was “slightly higher than expected due to ongoing inflationary pressures and our commitment to attracting and retaining talent.” Meanwhile, it said the 61 percent increase in real estate costs was due to “warehouse capacity becoming more expensive in the short term to support the company’s growth.”
To its credit, the company remains net cash and has zero bank debt, which is a huge advantage at a time of relatively high interest rates. Still, the company’s growth rate and declining margin at a price of 20x earnings doesn’t justify a rating upgrade just yet. We stick to our neutral position.
HOLD: Severn Trent (SVT)
An inflation-indexed dividend is the most attractive feature of the water company, which is struggling with negative headlines, writes Julian Hofmann.
Severn Trent, along with the rest of privatized utilities, has long been viewed as “vital but unloved,” both by investors who await the company for its gilded, inflation-linked dividends, and by activists, consumers, and other politicians who line up regularly , to give the water suppliers a good kick.
For the past two years, the bulk of industry headlines has been about the disposal of raw sewage – a subject that Severn Trent mentioned only three times in his entire statement. Still, a private lawmaker’s bill now going through parliament that would impose binding sanitation targets suggests that political sentiment is sour. To be fair to Severn Trent, the company doesn’t appear to be the worst offender when it comes to unwanted outflows, but the situation underscores that another round of large capital investments by the water industry appears certain.
This was already rising, with cash capex up nearly £100m in these results to £687m, still below the company’s £713m operating cash flow. This was also reflected in a reduction in EBIT (earnings before interest and tax) coverage by 1.4 times the company’s interest charge on its debt, down 0.5 percentage point. Meanwhile, operating profits in Severn’s core water business fell to £468m, offset by a strong performance in business services, where profit was more than 30 per cent higher at £49.2m.
Overall, the dividend is undeniable, but at a price-to-earnings ratio of 32 times consensus forecasts for next year, the company appears fully valued by inflation hunters pushing shares higher.