speculative buy

Huntley's Recommendation: Valad Property Group

Recommendation: Speculative Buy

Valad Property Group (VPG) is one of Australia’s newer AREITs, being a stapled security comprising a unit in the trust and a share in the management company. VPG has four interlinked business streams - each based on a ‘value-add’ to investment property - being development and trading, capital services, ownership and funds management, with assets in Australia, Europe and the UK. While rental income and funds management fees form stable earnings for VPG (96% of 1H09 EBITDA), short-term stability is dependent on no losses from the riskier businesses of development, trading and capital services, which will form the medium-term growth drivers. Short-term price volatility is expected to be extreme. VPG is currently high risk and should only be considered by investors willing to speculate on a positive medium-term outlook.

Event03-Jun-2009
Co-founder, Stephen Day, resigns as a director and employee. Bid received for small UK-listed fund managed by VPG. Conditions stabilise with absence of shocks.

Business Impact: Clarification of uncertainty around Stephen Day brings greater stability to senior management. Bid for UK fund offers potential to realise some goodwill for management rights. Confidence in stock increasing.

Forecast Impact: --

Recommendation Impact: Recommendation upgraded from AVOID to SPECULATIVE BUY.

Event Analysis
Confidence in Valad Property Group (VPG) is increasing amid stabilising conditions and an absence of shocks, resolution of senior management issues and the prospect emerging of realising some value from part of the UK property business acquired close to the peak of the boom. So we upgrade our recommendation from AVOID to SPECULATIVE BUY. VPG is unsuitable for risk-averse investors and should only be considered by investors willing to accept high risk and speculate on a positive medium-term outlook. Late last year, VPG co-founder Stephen Day stood aside from his role for health reasons and uncertainty about his future role in the management of VPG has pervaded the stock ever since. VPG have finally announced Day’s resignation as a director and employee of the group with co-founder Peter Hurley becoming sole managing director. Clarification of the structure of the senior management team brings welcome stability during a critical time and resolves a significant ongoing distraction. Close to the peak of the boom in July 2007, VPG spent around $0.7bn acquiring the Scarborough property development and funds management business in the UK and Europe. A large part of the goodwill paid has since been written off, with the book value now around $0.14bn. The entire Scarborough foray has been extremely expensive for VPG unitholders but the current unit price of only around 8.4cpu offers upside in the medium to long term as market conditions improve. Within the Scarborough business, VPG provides fund and asset management services to the UK-listed Teesland Advantage Property Income Trust which received an unsolicited take over bid from a UK investment company. This provides VPG with an opportunity to negotiate a payment for the management rights and therefore recover at least a small portion of the lost goodwill. The last few months were notable for VPG, with an absence of shocks and bad news releases to the market. After an extremely rough time where management credibility was severely damaged, conditions appear to be stabilising and lead us to be more optimistic about the outlook. However, it is still highly speculative. Operating income is at a cyclical but reliable low, being founded on property ownership net rents and fund management fees from 71 secondary quality properties and 20 managed funds across the Asia Pacific and UK/Europe, which are recurrent but low-growth income sources comprising 96% of 1H09 EBITDA. But, challenges continue to exist on the balance sheet though the recent refinancing of debt bought a reasonable breathing space. VPG’s bankers agreed to revise lending terms extending debt facilities by 12 months to September 2011 and to replace group covenants with direct asset security. Debt covenants were renegotiated to 55% and interest cover of 1.5x, with falling property values taking 1H09 gearing to 47% on a balance sheet basis. This may be expected to deteriorate by year end as asset values fall further. While the support of their bankers is a positive, realistically the banks had no more attractive alternatives and the debt problem is deferred rather than resolved. Still, VPG has bought time to undertake asset disposals which its lenders will in turn reward with lower lending rates.