Derwent London full-year results: Wednesday 28 February

Shares in Derwent London are down by a quarter over the past year (and more than half from their pre-pandemic high of early 2020) as real estate stocks – or at least landlords that specialise in office space – remain deeply out of favour with investors.

The Real Estate Investment Trust (REIT) trades at a 43% discount to its last stated net asset value per share figure of £34.44 and there can be no clearer sign of the market’s loss of faith in the long-term value of real estate, even in London. This is due to a combination of factors, including:

• The rise of working from home, or least hybrid working, and its impact on demand for office space
• The relentless onslaught that brick-and-mortar retailers face from online rivals
• The UK’s gradual slide into recession

A further handicap for REITs’ share prices are higher interest rates and bond yields. They drive up interest costs for indebted property developers and owners, drive down net asset valuations (thanks to how future cash flows from rents are valued using a higher discount rate) and make the dividend yield available from REITs look relatively less attractive when compared to the returns on assets such as cash and bonds, which are also, in theory, lower risk. Consensus analysts’ forecasts for a dividend payment of 79.96p for 2023 suggest Derwent London offers a 4% yield – less than the Bank of England base rate and also the ten-year gilt yield of 4.11%.

NAV is therefore the first number to which analysts will turn when they assess these full-year results. At the first-half stage, Derwent London’s portfolio carried a valuation of £5.2 billion, equivalent to that £34.44 per share figure, but this has been trending down for some time. Analysts are, however, looking for a further decline in NAV to 920p a share, thanks partly to increases in interest rates.

Source: Company accounts

This despite a broad spread in the portfolio across fourteen parts of London and also by client. Media, business services, online leisure, fintech and financials were the five largest tenant industries at 64% of the rent roll in 2022, while the largest individual tenants (out of 379) were Expedia, G-Research, the public sector (at 5%), Burberry and Boston Consulting Group. Between them, they came to around one quarter of total rental income.

Analysts and shareholders will look to the performance of each area and client industry and how they contribute to the total. The vacancy rate at the first-half stage was 4.5%, an improvement relative to December 2022’s 6.4%, helped by a big jump in new lettings to £19.3 million.

Source: Company accounts

However, net rental income fell by 3% year-on-year to £90.9 million in the first half and analysts will be looking for improved momentum here in the second period (even if 2022 represented an all-time high for rental income, which hardly sits easily alongside the plunge in the share price).

Source: Company accounts

Like many REITs, Derwent London is looking to recycle its portfolio by selling assets and using that cash to upgrade existing properties or develop new ones. The company plans to start work on 50 Baker Street later this year, just before 25 Baker Street reaches completion and two more projects in W1, called Network and Holden House, are due to go into development next year. Major refurbishments are also underway in EC1 (Farringdon Road and Oliver’s Yard), W1 (Stephen Street) and SW1.

Derwent London is helped in this respect by how it carries relatively little debt at £1.3 billion. Interest cover is good, and the loan-to-value ratio is also relatively low, although this is creeping up as the valuation of the property assets ebbs.

Source: Company accounts

Ultimately, it is rental income that pays the interest bills and funds dividend payments (a REIT must pay out at least 90% of taxable income to maintain its tax status). Derwent London has an excellent history of dividend increases which chief executive Paul Williams and team will doubtless be looking to extend in 2023. The REIT increased its first-half dividend payment by 2.1% and analysts are expecting a similar rate of growth in the full-year payment for 2023 to 79.96p a share.

Source: Company accounts, Marketscreener, consensus analysts’ forecasts

These articles are for information purposes only and are not a personal recommendation or advice.