Terrace Hill Group - Property Development Play

http://www.terracehill.co.uk/

Terrace Hill Group Logo

The 'Real Estate Investment & Services' sector is not one that I have covered before on the site - Terrace Hill Group (LSE:THG) marks the first company that I'm looking at. Terrace Hill is a UK property development company that has undergone a major restructuring in recent years that has put it on a sounder footing. Despite that, a strong run up prior to FY 2013 results led to profit taking upon release, and combined with a tip to bank profits from an investors magazine, the shares have retreated substantially. Having reached highs above 35p before results, the shares have slumped to a current price of 23.88p. With roughly 212m shares in issue, the market is currently valuing Terrace Hill at £50.6m. I reckon there is scope for a rise from this level as the market realises (again) that the fundamental outlook is much improved.


The charting outlook for Terrace Hill is currently unclear. Having fallen from heights above 35p, first on the back of profit taking, and then due to an Investors Chronicle sell tip, the shares have stabilised within the 22-24p band. There is good support at this level, although confidence in the shares seems to have been shot as there hasn't been any real traction since - the Investors Chronicle magazine has a large readership so it is not surprising that the fall was extended downwards. Positively, the share price managed to stay above 22p, which was the minor low right before the Q4 2013 price rally. If the share price can regain 24.50p, the chances are that 25p and then 27.50p will be broken. I don't foresee a huge amount of downside from this level (potentially to 22p). Whilst the moving averages have formed a 'death cross', that has been on the back of the sell tip, which I don't regard as having changed the fundamental position of the company, hence can be disregarded in this case. It is unlikely that the share price will regain the red support line (now resistance), but I expect it to trade above 25p on a medium-term timescale.

Shares in Terrace Hill are tightly held by directors and institutions. Executive Chairman Robert Adair holds 62.7% of the share capital with other board members (including CEO Philip Leech) holding a further 1.63%. As I tend to say, these large director holdings are something of a double-edged sword as it can deter institutions and create illiquidity, and if they decide to sell-out there can be a tidal wave of selling pressure. In this instance, the Executive Chairman is extremely rich so I don't imagine he will be in any rush to convert his holding. Liquidity is good as well, with the spread currently only a couple of percent wide. Whilst the high holding will inevitably deter some institutions, Caledonia Investments holds over 8% of the stock.

Terrace Hill is a commercial property development company, having changed its strategy last year through disposing of 901 residential properties to RSL Places for People for £68m. The sale was completed pretty much at the carrying value of the assets and enabled Terrace Hill to pay down a large portion of its debts, which has led to a much improved balance sheet and to it becoming an all-round better investment proposition. The restructuring has made the company a simpler investment opportunity and that was initially shown as the share price doubled by mid-December. The residential section was highly geared as well and the fact that it was sold very close to the carrying value is important as it gives confidence that the value of the property assets are not been overstated on the books. The past "12 months have been transformational for the group".

The company has offices around the UK, in London, Teesside, Manchester, Bristol and Glasgow, from which it services a number of projects. Terrace Hill has 3 divisions; Foodstores, London Offices and Regional Opportunities. These divisions focus on different areas of property development. As the name suggests, the foodstores division helps develop foodstore projects such as the Sainsbury's store at Sedgefield shown on the right. Across the 3 divisions the group has over 15 sites that are either in pre-planning, planning or the construction stage and these projects aggregately carry gross development values in excess of £600m.

The group limits risk by entering into conditional site purchases, pre-letting agreements and forward funded/Joint-venture projects. That risk limitation is important as it can reduce the costs of writing-down unsuccessful projects which is important considering that it had to write down two separate projects last year. These were St Austell (planning consent was not granted) and Prestwich (occupier requirements changed). It's worth pointing out now that planning grants/rejections can be major movers of the share price, and that is ultimately an investing risk. Nevertheless, they historically have a very good record with regards to obtaining planning consent.

Taking foodstores as an example, Terrace Hill's role typically starts when it conditionally acquires a land plot. Terrace Hill will then seek pre-let agreements with food retailers and attempt to get planning consent. Thereafter it will enter a forward-funding agreement with investors (who seek the reliable income streams that the leases generate). There has been a slight deviation within the London offices division amid an influx of foreign capital into the sector, which has increased competition. The focus has thus turned towards office refurbishment opportunities (e.g. offices -> hotels). The regional developments pipeline remains robust with demand seen from various sources including several universities who are looking to build new accommodation and replace old accommodation. One of Terrace's more recent university projects was to complete Mayflower Halls in Southampton, which was a 1100 room complex. The last of the 3 buildings for this was completed early in 2013 and the project is expected to be passed over to the university ahead the next academic year in September. In this instance Legal & General Property forward funded the project.

Terrace has numerous developments in the pipeline that should provide it sufficient work for the next few years, especially in light of an improving economic climate. For example, project construction in Middlesbrough and Kent (Herne Bay) are expected to commence before Q3 2014, although the latter is still awaiting planning consent (Terrace and 'confident' of obtaining it). The Middlesbrough development is for a 125,000 square foot foodstore and retail development project. Consent is also being awaited at the project in Midsomer Norton (Somerset), whilst a project in Stokesley is still in the discussions phase.

Terrace is also acting as development manager for an office and retail development on Conduit Street in Mayfair. Construction has started at this project and already office and retail rents are showing a considerable improvement with the company noting that returns are likely to exceed expectations. More recently, planning consent was received for a project in Darlington where an old bus station is set to be transformed into an area with a cinema, hotel and restaurant. Work is set to start in mid-2014 and complete in Autumn 2015. Whilst there are numerous other developments, these are a taster of the sort of projects that Terrace is involved in.

The value in Terrace is really in the figures. Below is a chart showing how the underlying financials of the company have changed over the past few years, and what ballpark market expectations are for the next financial year.


Just describing the historic data above, whilst revenues have fallen over the past couple of years, it is worth recognising that revenue volatility is typical of the property development sector. Almost the entirety of revenues are derived from site sales with only a small amount from rental income and other sources, so they are prone to revenue swings and that is what can be seen as above. The company's EPRA Triple Net Asset Value has been flatlining, although importantly, net debt has declined rapidly (in light of the residential property sale, the proceeds of which were used to repay debt). Diluted EPS has also been rising which means that Terrace has been becoming more of a value play, and the large debt cloud that has been hanging over it has subsided.

Looking at the figures from the last FY set of results released a few months back, these were the key points:
- EPRA NAV rose to 28.8p. The more useful NAV (EPRA Triple) rose to 27.7p
- Balance sheet gearing slashed to 28.6%. Net debt reduced by 62.9% to £17.5m
- Revenue of £48.5m (vs. £65.9m)
- Gross margin of 25.9% (vs. 21.5%)
- Administrative expenses £1.3m higher
- Pre-tax profits of £5.6m (vs. £7.5m)
- Post-tax profits improved at £4.34m from continuing operations
- Diluted EPS of 2.05p

As always with results, the implied figures and less obvious details are equally as important as the big picture details. Terrace is currently trading on a PE ratio of 11.6 which I would argue is fair value given the debt pile is still high, there is no dividend and the historic revenue trend is volatile. That revenue volatility actually means the whole sector trades on a low PE (generally between 10 and 14). Combined with the NAV of 28.8p coming in slightly below market expectations (due to prolonged waits for planning consent at a couple of projects) and debt rising from the £10.4m half-year figure, the market's reaction was to sell off the shares, and this created the initial price spike back below 30p. It's therefore worth understanding these points. Ultimately, the NAV will adjust higher if the planning consent is granted so that is not a major point, and the debt rise was on the back of a historic deal with Terrace Hill Residential (previously an associate company) which saw Terrace Hill Group buy up residential properties owned by THR. That is complete now so that debt rise is not an accurate reflection of the underlying group performance.

Looking further into the detail, the company is currently trading on a ~17% discount to EPRA NAV or a ~14% discount to the lower EPRA Triple NAV. The EPRA Triple NAV is a more useful figure as it strips out possible goodwill and tax payments. The results were impacted by a £0.9m write-off on certain properties (including St Austell and Prestwich as noted earlier). The debt position is actually much better as well. Whilst net debt stands at £17.5m, only 28% of the debt is current (i.e. repayable within 1 year), and the company was pleased to note that there was a "significant increase in the appetite of banks to lend to development groups" that are focused on pre-let/sale projects with low Loan-To-Value ratios. Terrace Hill fits the bill in this respect. Current assets are also more than 2x the value of total liabilities, which is reassuring, especially since the assets are tangible. There were also net receivables on the balance sheet of £5.6m and cash flows remained strong, and this ultimately means lower future interest repayments as the debt continues to be paid down.

The catch with regard to the debt is that a hike in the base rate would adversely impact the company - that is always a risk you take when looking at companies with large debt piles (£26.1m is large for Terrace). The risk is made more real if a company has not hedged against a rate rise, and Terrace hasn't. Despite that, there are no strong hints of an imminent rate rise from the Bank of England, although there are hints that there could be one in H1 2015. I would expect Terrace to hedge ahead of then just in case a rate hike does take place - until then, debt will continue to be repaid. This is an example though of how the current economic recovery is not built on the most secure base - there are many companies still holding large amounts of debt on their balance sheet and a rate rise can have a very material effect upon their financial performance, especially if the rate rise is too steep. Regardless, the company must be happy with their position given that they "expect shortly to recommence payment of dividends". That should act as a share price boost when announced, and by the sounds of it, it should be this financial year.

The administrative expenses rise was largely the result of a near doubling in director remuneration and that is usually a red flag. However, in this case, the turnaround of the business has been strong and the additional payments were in the form of bonuses rather than a rise in the base salary so I deem it acceptable. More and more often though it seems to be the case that directors are giving themselves options with excessively distant expiry dates and with uninspiring exercise prices. Unfortunately that is the case with Terrace Hill, but given that is it now almost common practice I'm starting to overlook it in some circumstances.

With all that said, it is the 2014 results that really look interesting, and looking back at the graph above, it is easy to see why. Revenues are predicted to soar to just short of £90m on the back of increase site sales, EPRA Triple NAV is estimated to rise towards 33p, net debt is predicted to fall to just £5.6m and EPS is predicted to rise to above 4.2p. If those figures are achieved, then the shares start to look very good value at the current price. Debt becomes a minor problem, the forward PE Ratio is just 5.7 (taking 4.2p EPS) and the shares are potentially trading on a ~28% discount to EPRA Triple NAV. Furthermore, 2015 estimates are for revenues in excess of £100m, EPS closer to 4.6p, EPRA Triple NAV closer to 35p and net cash of £1.8m. For each of these years, dividends are predicted to be 0.50p (this would cost around £1.05m). Even assuming that these figures are not fully reached, the shares still look good value. Considering the debt position of the company, it is best to keep a conservative PE ratio in mind, so a PER of 10 at 4.2p EPS would lead to a share price of 42p, which is substantially above the current price. Of course, there are all sorts of risks, which could mean that won't be achieved, but even 3.0p EPS and a lower than estimated NAV of 30p give plenty of upside headroom.

A quick comparison with two larger competitors also looks good. St Modwen (LSE:SMP) is trading on a 2013 diluted PER of 12 and has substantial net borrowings. It is also trading at a 33% premium to EPRA NAV, only has a 1% trailing dividend yield and has advanced by ~59% over the past year. On the other hand, Helical Bar (LSE:HLCL) is trading on a trailing PER of 45, or an estimated 2014 PER of 9.9. Once again, they have substantial net debt and they are trading at a 30.5% premium to their last EPRA NAV reading. With a trailing dividend of 1.5% and 1-year price movement of +61%, Helical is also valued at a much higher level that Terrace.

Compared to these peers, plus others, Terrace is modestly priced and I fully expect the share price to re-rate higher if it can deliver on the expected figures (or at least the bulk of them). The shares have tumbled in light of profit taking and a magazine tip, yet the fundamentals are certainly better than last year, and even more so compared to previous years. Revenues are set to rise again and the development pipeline that Terrace holds looks promising. The large debt pile does mean that Terrace simply has to be labelled as high risk at the current point in time, yet it is substantially lower risk than at most points in its past, and it has a transformed value creation strategy. With the commercial property market going from strength to strength, and an economic recovery continuing to take hold, Terrace Hill seems a logical choice if looking for a property development play. I have therefore put a Buy tag on Terrace Hill at 23.88p.

UPDATE (23/05/14) - I have moved Terrace Hill Group from Buy to No Rating at the equivalent of 26.35p after the company completed a reverse takeover of Urban & Civic. The scale of the change means that the investment case needs to be reviewed before holding further

5 comments:

  1. To put the IC 'adventure' in context: they were tipped around 18p when they were obviously severely undervalued and in the run up to the recent results, there was clearly over-exuberance in the price so the fall started as soon as the results were released and were exacerbated by the IC 'sell' which was based on the relationship between NAV and price. I rather suspect that if the price were to fall another couple of pence so that the relationship to predicted NAV rose to the region of 25% discount, that IC would again say 'buy'. I am a holder in anticipation of that happening.

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  2. Great article el1te. Terrace Hill has a development near where I live and the plans for it look good

    CraigJ

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  3. very good informative site. bookmarked

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  4. I get concensus eps of 3.4p for 2014 (admittedly on Stockopedia). Where do you get 4.2p as that is quite an upgrade?

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    1. I understand that different websites give different figures and that financial website figures can be quite inaccurate - broker reports tend to be much closer to the mark. Digitallook gives 3.91p, but a report from Broker Profile (which was independently commissioned) gave 4.4p EPS as the 2014 estimate on similar revenue figures. A full financial breakdown is included in that, which looks sensible. Given that I haven't seen any figures from Oriel, an area around 4.4p is probably the most accurate figure to take. It's worth looking over the financial breakdown they have provided - the report is probably locatable on Google.

      El1te

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