Editing Custodian Property Income REIT plc: Interim Results

* Custodian Property Income REIT plc, the UK-focused commercial real estate investment company, has made two announcements since we last reported on the company on 28th November 2022 (i.e. less than three weeks ago).
*For us, the key highlight of the announcements is that the company has grown its dividends in the six months ended 30th September 2022, relative to the comparable period a year earlier, in-line with our expectations (of 10%).
*Accordingly, we have maintained our forecasts. 
*With the shares currently trading at 91.70p per share, we estimate that the expected return of an investment in Custodian Property Income REIT Plc over the next five-years is 62%, which equates to an annual return of 10.2%. In other words, an £100,000 investment in the company is expected to return £162,000 in five-years from now.
*Assuming that a suitable return level in the five years is 50%, then an investment in the company is considered to be a 'suitable' one.
== Interims ==
On 14th December 2022, the company announced its 2022 interim results.<ref>https://www.investegate.co.uk/custodian-property-income-reit/eqs/interim-results/20221214070021EKITI/</ref>

For the six months ended 30th September 2022, revenue increased by 10.64% to £22.30mm (H1 FY21: £20.15mm), driven by income that is rechargeable to tenants. Adjusting for the rechargeable income, revenue increased by 1.67% to £19.59mm (H1 FY21: £19.27mm), entirely generated from rental income from the company's investment properties. As a result of a revaluation of investment property, the company swung to a net loss of £14.09mm (H1 FY21: positive £48.07mm).

Mainly driven by new investments, cash decreased by 59% to £4.77mm from six months earlier (FY21: £11.62mm). Following the investment acquisitions, net current liabilities decreased by 67% to £7.58mm (FY21: £23.10mm) and net debt increased by 37% to £171.83mm from six months earlier (FY21: £124.99mm). All-in-all, net assets decreased by 4.97% to £501.43mm (FY21: £527.64mm).

After adjusting for investment property revaluations (£62.39mm), net cash flows from operating activities decreased by 22% to £12.08mm (H1 FY21: £15.56mm). Mainly due to the purchase of investment properties (£52.82mm vs. £12.21mm), net cash flows from investing activities moved to negative £46.61mm (H1 FY21: positive £22.79mm). Net cash flows from financing activities moved to £27.68mm (H1 FY21: negative £5.13mm), driven by increased borrowings (the net borrowing difference between the periods is £32.87mm).
*

In comparison to the same period a year earlier, dividend increased by 10% to 2.75p per share (H1 FY21: 2.5p), and we note that they are fully covered by earnings (103%). The company reiterated that its target dividend amount for the financial year (i.e. 12-months ending 31 March 2023) is 5.5p or more.

EPRA earnings, which is intended to provide a common baseline measure for performance that is relevant to investors in investment property companies<ref>EPRA Earnings is a measure of the underlying operating performance of an investment property company excluding fair value gains, investment property disposals and limited other items that are not considered to be part of the core activity of an investment property company. It has its basis firmly in IFRS earnings (operational earnings) with limited specific adjustments. It therefore does provide a measure of recurring income, but does not, for example, exclude ‘exceptional’ items that are part of IFRS earnings. EPRA Earnings is intended to provide a common baseline measure for performance that is relevant to investors in investment property companies. To ensure that all adjustments reflect the net result to the parent company’s shareholders taxes and minority interests in respect of all adjustments are also taken out.</ref>, decreased by 6.7% to 2.8p per share (H1 2021: 3.0p), mainly due to administrative cost inflation, rising interest rates and additional ESG compliance costs.

Fixed rate agreed debt facilities increased from 61% to 74%, significantly mitigating interest rate risk. The company's loan-to-value (LTV) increased to 25.5% as at 30th September 2022, and decreased by 1.5 percentage points to 24.0% post period end. We note that the LTV is in-line with that the targets detailed in the company's investment policy, which is maximum value of no more than 35% and medium-term net gearing target of 25%. The weighted average term of drawn debt is 6.3 years, the average cost of debt is 3.5% and there is no debt facilities maturing until September 2024.

== Name change ==
On the 7th December 2022, the company announced that to better reflect the main objective/mission of the company, it has changed its name to Custodian Property Income REIT plc, from Custodian REIT plc.<ref>https://www.investegate.co.uk/custodian-reit-plc--crei-/eqs/change-of-name/20221207070007ERINE/</ref>

The objective of the company is to generate income returns for shareholders.

== Financials ==
In light of the announcements, we have maintained our forecasts, which can be found by clicking [https://www.proactiveinvestors.co.uk/companies/news/999566/custodian-reit-plc-the-6-yield-and-nav-discount-is-an-opportunity-999566.html here].

== Risks ==
As with any investment, investing in Custodian Property Income REIT carries a level of risk. Overall, based on the company's market beta<ref>Research shows that an investment has two main types of risks: 1) non-systematic and 2) systematic. Systematic risk is the risk related to the overall market, and non-systematic risk is the risk that's specific to an individual investment. Evidence shows that taking on non-systematic risk is inefficient, and it's, therefore, best to eliminate it; and in most cases, elimination is fairy easy to do [by holding a diversified portfolio of investments (i.e. around 15 investments)]. Accordingly, when assessing the riskiness of an investment, it’s best to look at the systematic risk only (i.e. ignore the non-systematic risk). A key measure of systematic risk is beta, and a main way to determine the riskiness of an investment is to compare the beta of the investment with the beta of the market, which is 1.</ref> (i.e. 0.426), the degree of risk associated with an investment in Custodian Property Income REIT is relatively 'low'.

Here, to estimate the adjusted beta, we used the iShares MSCI World ETF to represent the market portfolio; and in terms of the time period and frequency of observations, we used five years of monthly data (i.e. 60 observations in total), which is supported by a study and is the most common choice. The beta value in a future period has been found to be on average closer to the mean value of 1.0, and because valuation is forward looking, it is logical to adjust the raw beta so it more accurately predicts a future beta. In addition, here, we have assumed that for an investment to be considered 'low' risk, it must have a beta value of 0.5 or less. Further information about the beta ratings can be found in the appendix section of this report.

For us, currently, the biggest risk to the valuation of the company relates to macro-economic factors, in particular unexpected and sudden changes in inﬂation and interest rates movements.

== Valuation ==
Research suggests that in terms of estimating the expected return of an investment over a period of 12-months or more, the approach that is more/most accurate is the absolute valuation approach, so that's the approach that we suggest using to determine the estimated value of the company.

==== What's the expected return of an investment in Custodian Property Income REIT using the absolute valuation approach? ====
Accordingly, we estimate that the expected return of an investment in Custodian Property Income REIT Plc over the next five-years is 62%, which equates to an annual return of 10.2%. In other words, an £100,000 investment in the company is expected to return £162,000 in five-years from now. The assumptions used to estimate the return figure can be found in the table below.

Assuming that a suitable return level in the five years is 60% and Custodian Property Income REIT Plc achieves its expected return level (of 62%), then an investment in the company is considered to be a 'suitable' one.

==== What are the assumptions used to estimate the return figure? ====
{| class="wikitable"
|+Key inputs
!Description
!Value
!Commentary
|-
|Which valuation model do you want to use?
|Discounted cash flow
|Research suggests that in terms of estimating the expected return of an investment over a period of 12-months or more, the approach that is more/most accurate is the absolute valuation approach<ref>Demirakos et al., 2010; Gleason et al., 2013.</ref>, so that's the approach that we suggest using to determine the estimated value of the company.
|-
|Which type of discounted cash flow model do you want to use?
|Dividend discount model
|As a UK real estate investment trust (REIT), the company is legally required to distribute 90% of its income to shareholders (within 12-months of the end of the accounting period).<ref>https://www.pwc.co.uk/services/tax/insights/uk-reits-attractive-vehicle-uk-property-investment/reit-conditions.html#distribution</ref><ref>However, neither exempt gains, nor profits from the residual business income have to be distributed.</ref> Accordingly, we suggest using the dividend discount model (DDM), which is one of the most common discounted cash flow models.
|-
|How many distinct stage of growth do you want to use?
|One stage
|For simplicity, we have used the one stage pattern here.
|-
|What is the expected lifespan of the business?
|Perpetual
|Again, for simplicity, we have assumed that the business continues forever.
|-
|What is the expected constant growth rate in dividends?
|1.57%
|We note that the gross domestic product (GDP) growth rate in the last 20 years (2001 to 2022) is around 3% per year for the global economy, and around 2.25% for the United Kingdom. Since the company's inception (i.e. eight years ago), the median dividend of the company is 1.57%. Further information about the company's dividend pay-outs can be found in the appendix section of this report.
|-
|Which financial forecasts to use?
|Proactive Investors
|Here, we have used the forecasts of Proactive Investors.
|-
|What is the required return on equity?
|5.73%
|For estimating the required return on equity, we used the Capital Asset Pricing Model (CAPM), which provides an economically grounded and relatively objective procedure for required return estimation, and, therefore, it has been widely used in valuation. The calculation of the required return on equity (and the reasons behind the calculation) can be found in the table below.
|-
|What's the current value of the company?
|91.70 pence per share
|As at 16th December 2022, the current value of Custodian Property Income REIT plc is 97.70p per share.<ref>https://www.londonstockexchange.com/stock/CREI/custodian-property-income-reit-plc/company-page</ref>
|-
|Which time period do you want to use to estimate the expected return?
|Between now and five years time
|Research suggests that following a market crash, the average amount of time it takes for the price of a stock market to return to its pre-crash level (i.e. the recovery period) is at least three years.<ref>https://www.newyorkfed.org/mediabrary/media/medialibrary/media/research/staff_reports/research_papers/9809.pdf</ref> Accordingly, we suggest that to account for general market cyclicity, it's best to estimate the expected return of the company between now and five years time.
|}
{| class="wikitable"
|+Cost of equity (%)
!Input
!Input value
!Additional information
|-
|Risk-free rate (%)
|3.488%
|Here, the risk free rate is the US 30 year treasury bond, and is calculated as at 16th December 2022.<ref>https://www.marketwatch.com/investing/bond/tmubmusd30y?countrycode=bx</ref> Research suggests that for the risk-free rate, it's best to use one that has the same or similar maturity to the estimated remaining lifespan of the company. Here, we have assumed that the estimated lifespan of the company is perpetual, so we have used the longest maturity, which is 30 years.
|-
|Beta
|0.426
|Here, to estimate the adjusted beta, we used the iShares MSCI World ETF to represent the market portfolio; and in terms of the time period and frequency of observations, we used five years of monthly data (i.e. 60 observations in total), which is supported by a study and is the most common choice. The beta value in a future period has been found to be on average closer to the mean value of 1.0, and because valuation is forward looking, it is logical to adjust the raw beta so it more accurately predicts a future beta.
|-
|Equity risk premium (%)
|5.26
|Here, the equity risk premium is in relation to the global region, and is calculated as at 1st January 2022.<ref>https://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/ctryprem.html</ref> Research suggests that for the region of equity risk premium, it's best to use one that is the same or similar to the region of the beta market portfolio. Here, the region of the beta market portfolio is the world/global, so we have used the world/global region for the equity risk premium.
|-
|Cost of equity (%)
|5.73%
|Cost of equity = Risk-free rate + Beta x Equity risk premium.
|}

== Sensitive analysis ==
The three main inputs that result in the greatest change in the expected return of the Custodian Property Income REIT Plc investment are, in order of importance (from highest to lowest):

# The discount rate (the default multiple is 5.73%);
#The 12-month ahead dividend per share forecast (the default forecast is 5.56 pence per share); and
# The dividend growth rate (the default multiple is 1.57%).

The impact of a 30% change in those main inputs to the expected return of the Custodian Property Income REIT Plc investment is shown in the table below.
{| class="wikitable sortable"
|+Custodian Property Income REIT investment expected return sensitive analysis
!Main input
!30% worse
!Unchanged
!30% better
|-
|Discount rate
|15%
|62%
|177%
|-
|Dividend per share
|14%
|62%
|111%
|-
|Growth rate
|46%
|62%
|83%
|}

== Appendix ==

=== Peers ===
The peers have been determined by Bloomberg's algorithm, and fall into the 'ccc' classification and 'ccc' industry. We note that Custodian Property Income REIT plc's yield and interest cover are in-line with its peers (6.02% vs. 6.02% and 5.12x vs. 5.12x). The company's debt-to-capital amount is around 5.25 percentage points lower than its peers (20.57% vs. 25.82%).
{| class="wikitable"
|+Peers
!Company name
!Primary exchange
!Market capitalisation (USD)
!BF P/FFO
!Yield (%)
!Interest cover (x)
!Total debt/total capital
!Adjusted beta
|-
|Custodian Property Income REIT plc
|United Kingdom
|495.07M
|<nowiki>--</nowiki>
|6.02%
|5.12
|20.57%
|0.4230
|-
|Prs Reit Plc/The
|United Kingdom
|577.62M
|<nowiki>--</nowiki>
|4.67%
| --
|35.16%
|0.598
|-
|Regional Reit Ltd
|United Kingdom
|381.88M
|<nowiki>--</nowiki>
|11.05%
| --
|44.34%
|0.838
|-
|Triple Point Social Housing
|United Kingdom
|325.50M
|<nowiki>--</nowiki>
|8.21%
| --
|37.23%
|0.633
|-
|Abrdn Property Income Trust
|United Kingdom
|273.84M
|<nowiki>--</nowiki>
|6.85%
| --
|21.63%
|0.478
|-
|Schroder Real Estate Investment Trust
|United Kingdom
|268.02M
|<nowiki>--</nowiki>
|7.12%
| --
|30.56%
|0.700
|-
|Uk Commercial Property Reit
|United Kingdom
|973.35M
|<nowiki>--</nowiki>
|8.49%
|41.73
|0.00%
|0.562
|-
|Workspace Group Plc
|United Kingdom
|1.01B
|<nowiki>--</nowiki>
|4.99%
|2.98
|25.82%
|1.006
|-
|Lxi Reit Plc
|United Kingdom
|2.49B
|<nowiki>--</nowiki>
|5.21%
| --
|15.58%
|0.615
|-
|Derwent London Plc
|United Kingdom
|3.32B
|19.4x
|3.22%
|3.79
|21.95%
|0.814
|}

=== Dividends ===
Since the company's inception (i.e. eight years ago), the median dividend of the company is 1.57%, and the mean is 0.78%. We note that if the dividend grows in the current financial year (i.e. the year ending 31st March 2023) in-line with our forecast (i.e. 4.76%), then the median will increase to 1.59% and the mean to 1.28%. We note that if the company had grown its dividend at a constant/fixed rate during that period, then the rate would be 3.64%. 
{| class="wikitable"
|+Declared Custodian Property Income REIT plc dividends
!
!Q1
!Q2
!Q3
!Q4
!
!Total
!Growth (%)
|-
|2023
|1.375
|1.375
|
|
|
|2.75
|
|-
|2022
|1.25
|1.25
|1.375
|1.375
|
|5.25
|5.00%
|-
|2021
|0.95
|1.05
|1.25
|1.25
|0.50
|5
| -24.81%
|-
|2020
|1.6625
|1.6625
|1.6625
|1.6625
|
|6.65
|1.53%
|-
|2019
|1.6375
|1.6375
|1.6375
|1.6375
|
|6.55
|1.55%
|-
|2018
|1.6125
|1.6125
|1.6125
|1.6125
|
|6.45
|1.57%
|-
|2017
|1.5875
|1.5875
|1.5875
|1.5875
|
|6.35
|1.60%
|-
|2016
|1.50
|1.50
|1.5875
|1.6625
|
|6.25
|19.05%
|-
|2015
|1.25
|1.25
|1.25
|1.5
|
|5.25
|
|}

=== Financial statements ===
{| class="wikitable"
|+Condensed consolidated statement of comprehensive income
!
!Unaudited 6 months to 30th September 2022
!Unaudited 6 months to 30th September 2021
!Audited 12 months to 31st March 2022
|-
|
|£000
|£000
|£000
|-
|'''Revenue'''
|'''22,296'''
|'''20,152'''
|'''39,891'''
|-
|Investment management fee
|(2,086)
|(1,788)
|(3,854)
|-
|Operating expenses of rental property rechargeable to tenants
|
(2,704)
|
(882)
|(852)
|-
|Operating expenses of rental property directly incurred
|(1,127)
|(1,708)
|(3,422)
|-
|Professional fees
|(428)
|(262)
|(617)
|-
|Directors’ fees
|(167)
|(145)
|(291)
|-
|Administrative expenses
|(460)
|(356)
|(776)
|-
|Expenses
|(6,972)
|(5,141)
|(9,812)
|-
|'''Operating profit before financing and revaluation of investment property'''
|
'''15,324'''
|
'''15,011'''
|
'''30,079'''
|-
|Unrealised (losses)/gains on revaluation of investment property: relating to gross property revaluations
|
(27,742)
|
32,310
|
93,977
|-
|Unrealised (losses)/gains on revaluation of investment property: relating to acquisition costs
|(3,404)
|(1,069)
|(2,273)
|-
|Net valuation (decrease)/increase
|(31,146)
|31,241
|91,704
|-
|Profit on disposal of investment property
|4,695
|4,165
|5,369
|-
|Net (losses)/profit on investment property
|(26,451)
|35,406
|97,073
|-
|'''Operating (loss)/profit before financing'''
|'''(11,127)'''
|'''50,417'''
|'''127,152'''
|-
|Finance income
|<nowiki>-</nowiki>
|<nowiki>-</nowiki>
|<nowiki>-</nowiki>
|-
|Finance costs
|(2,960)
|(2,347)
|(4,827)
|-
|Net finance costs
|(2,960)
|(2,347)
|(4,827)
|-
|'''(Loss)/profit before tax'''
|'''(14,087)'''
|'''48,070'''
|'''122,325'''
|-
|Income tax
|<nowiki>-</nowiki>
|<nowiki>-</nowiki>
|<nowiki>-</nowiki>
|-
|'''(Loss)/profit and total comprehensive (expense)/income for the Period, net of tax'''
|
'''(14,087)'''
|
'''48,070'''
|
'''122,325'''
|-
|Attributable to:
|
|
|
|-
|Owners of the Company
|(14,087)
|48,070
|122,325
|-
|Earnings per ordinary share:
|
|
|
|-
|Basic and diluted (p)
|(3.2)
|11.4
|28.5
|-
|EPRA (p)
|2.8
|3.0
|5.9
|}

{| class="wikitable"
|+Condensed consolidated statement of financial position
!
!Unaudited 30th September 2022
!Unaudited 30th September 2021
!Audited 31st March 2022
|-
|
|£000
|£000
|£000
|-
|Non–current assets
|
|
|
|-
|Investment property
|685,423
|565,279
|665,186
|-
|Property, plant and equipment
|747
|<nowiki>-</nowiki>
|<nowiki>-</nowiki>
|-
|'''Total non-current assets'''
|'''686,170'''
|'''565,279'''
|'''665,186'''
|-
|Current assets
|
|
|
|-
|Trade and other receivables
|6,019
|6,452
|5,201
|-
|Cash and cash equivalents
|4,765
|37,139
|11,624
|-
|'''Total current assets'''
|'''10,784'''
|'''43,591'''
|'''16,825'''
|-
|'''Total assets'''
|'''696,954'''
|'''608,870'''
|'''682,011'''
|-
|Equity
|
|
|
|-
|Issued capital
|4,409
|4,206
|4,409
|-
|Share premium
|250,970
|251,015
|250,970
|-
|Merger reserve
|18,931
|<nowiki>-</nowiki>
|18,931
|-
|Retained earnings
|227,116
|190,648
|253,330
|-
|'''Total equity attributable to equity holders of the Company'''
|
'''501,426'''
|
'''445,869'''
|
'''527,640'''
|-
|Non-current liabilities
|
|
|
|-
|Borrowings
|176,596
|145,713
|113,883
|-
|Other payables
|570
|571
|570
|-
|'''Total non-current liabilities'''
|'''177,166'''
|'''146,284'''
|'''114,453'''
|-
|Current liabilities
|
|
|
|-
|Borrowings
|<nowiki>-</nowiki>
|<nowiki>-</nowiki>
|22,727
|-
|Trade and other payables
|10,702
|10,098
|9,783
|-
|Deferred income
|7,660
|6,619
|7,408
|-
|'''Total current liabilities'''
|'''18,362'''
|'''16,717'''
|'''39,918'''
|-
|'''Total liabilities'''
|'''195,528'''
|'''163,001'''
|'''154,371'''
|-
|Total equity and liabilities
|696,954
|608,870
|682,011
|}
{| class="wikitable"
|+Condensed consolidated statement of cash flows
!
!Unaudited 6 months to 30th September 2022
!Unaudited 6 months to 30th September 2021
!Audited 12 months to 31st March 2022
|-
|
|£000
|£000
|£000
|-
|Operating activities
|
|
|
|-
|(Loss)/profit for the Period
|(14,087)
|48,070
|122,325
|-
|Net finance costs
|2,960
|2,347
|4,827
|-
|Net revaluation loss/(profit)
|31,146
|(31,241)
|(91,704)
|-
|Profit on disposal of investment property
|(4,695)
|(4,165)
|(5,369)
|-
|Impact of lease incentives
|(832)
|(741)
|(1,112)
|-
|Amortisation
|4
|4
|7
|-
|Depreciation
|8
|<nowiki>-</nowiki>
|<nowiki>-</nowiki>
|-
|Cash flows from operating activities before changes in working capital and provisions
|
14,504
|
14,274
|
28,974
|-
|(Increase)/decrease in trade and other receivables
|(818)
|(451)
|1,923
|-
|Increase in trade and other payables
|1,169
|3,913
|1,702
|-
|Cash generated from operations
|351
|3,462
|35,299
|-
|Interest and other finance charges
|(2,777)
|(2,176)
|(4,463)
|-
|
'''Net cash flows from operating activities'''
|'''12,078'''
|'''15,560'''
|
'''28,136'''
|-
|Investing activities
|
|
|
|-
|Purchase of investment property
|(52,818)
|(12,217)
|(21,529)
|-
|Purchase of property, plant and equipment
|(755)
|<nowiki>-</nowiki>
|<nowiki>-</nowiki>
|-
|Capital expenditure
|(4,455)
|(1,803)
|(3,515)
|-
|Acquisition costs
|(3,404)
|(1,069)
|(2,272)
|-
|Proceeds from the disposal of investment property
|14,899
|38,299
|54,403
|-
|Costs of disposal of investment property
|(80)
|(424)
|(479)
|-
|'''Net cash flows from/(used in) investing activities'''
|'''(46,613)'''
|'''22,786'''
|'''26,608'''
|-
|Financing activities
|
|
|
|-
|Proceeds from the issue of share capital
|<nowiki>-</nowiki>
|558
|558
|-
|Costs of the issue of share capital
|<nowiki>-</nowiki>
|(5)
|(51)
|-
|New borrowings
|63,000
|7,000
|<nowiki>-</nowiki>
|-
|New borrowings origination costs
|(437)
|(62)
|<nowiki>-</nowiki>
|-
|Repayment of borrowings
|(22,760)
|<nowiki>-</nowiki>
|(25,057)
|-
|Dividends paid
|(12,127)
|(12,618)
|(24,191)
|-
|'''Net cash flows (used in)/from financing activities'''
|'''27,676'''
|'''(5,127)'''
|'''(48,874)'''
|-
|
Net (decrease)/increase in cash and cash equivalents
|(6,859)
|33,219
|
6,003
|-
|Cash acquired through the acquisition of DRUM REIT
|<nowiki>-</nowiki>
|<nowiki>-</nowiki>
|
1,701
|-
|Cash and cash equivalents at start of the Period
|11,624
|3,920
|3,920
|-
|Cash and cash equivalents at end of the Period
|4,765
|37,139
|11,624
|}

== Risk rating ==

{| class="wikitable"
|+ Risk rating
|-
! Rating !! Beta 
|-
| style="background: green; color: white;" |Low || style="background: green; color: white;" |Equal to or below 0.5 
|-
| style="background: orange; color: white;" |Medium || style="background: orange; color: white;" |Between 0.5 and 1.5 
|-
| style="background: red; color: white;" |High || style="background: red; color: white;" |Equal to or above 1.5 
|}

== References and notes ==