Argues Tom Winnifrith of t1ps.com

Top tipster
Tom Winnifrith recommended shares in Close High Income Properties to t1ps.com members only two weeks ago at 13.5p.
Investors who followed his advice are now standing on gains of 37%! To get access to 20 tips per year, including Tom's newest tip posted yesterday, click here.

Close High Income Properties PLC is such a complex beast most folks don't understand it
Or they just ignore it

Or they don't like property

Or they are put off by recent problems with its banks

Still reading? At 18.5p with a three year target of 40-75p

And Here is why….

Via a structure which is too complicated to go into – involving a number of separate vehicles but at least since Christmas only involving one class of share – Close High Income Properties (CHI) but lets call it CHIP owns a portfolio of industrial and secondary office properties across the UK. The portfolio is actively managed by a team at Close Asset Management who do know what they are doing.

Having said that
the team came a bit unstuck during the credit crunch and on found its borrowings
of GBP80 million had left it ( as a result of asset writedowns) in breach of its
banking covenants. The shares hit 3p as the City bet that the company was bust.
But you know that old saying that if you owe the bank a quid you are in trouble,
if you owe the bank a million quid the bank is in trouble? The point is that the
properties are mainly let so CHIP can not only cover its interest bills but can
actually hope to pay down its debt.

So what does CHIP own?

It is a mix of office space and industrial units outside the capital but usually close to main roads. The ten largest investments are:



Ikon Trading Estate, Hartlebury

Webb Ellis Industrial Park, Rugby

Stephenson Court, Bedford

Groundwell Farm Industrial Estate,Swindon

Farthing Road Industrial Estate, Ipswich

Churchfield Court, Barnsley

St. James Mill Business Park, Northampton

Faraday Court, Burton

Watermark Way, Hertford

Warwick House, Solihull


Some of these properties were bought individually while others were
bought as part of packages. CHIP is heavily biased towards industrial rather than office space where tennants tend to stay for ages (it is a pain to move machinery) and so as a result voids are rare. And the yield on its portfolio is just over double figures – that is what you get for such properties.

So what are the financials?

Well it is pretty simple. My numbers are very approximate as the company is in its closed period so cannot be specific and rough so assume a margin of error either way but here goes.. Assume a yield of just over 10% so income is cGBP12 million. Interest is fixed at just under 6% so EBTDA is GBP7 million. Staff and other costs (including hiring letting agents to "work" empty space) are around GBP3 million which leaves the company with about GBP3 million a year going free post tax of GBP1 million.



The property portfolio is today worth cGBP110 million. Debt (all at fixed rates of interest) is just north of GBP80 million. So net assets are just under GBP30 million – lets be prudent and call it c30p per share – it might be more but I assume a worst case margin of error in my numbers. Now let's move forward three years… Assume that all free cashflow is used to clear debt. In three years time we therefore have debt down at GBP70 million. Now what do we assume for property prices? My belief is that we will start to see some inflation this year so I give you a number of scenarios about an annual increase in prices, compound that over three years and then arrive at a three year out gross asset value figure, a net asset figure based on GBP70 million of debt and a NAV per share (based on 84 million shares in issue)

Now the 8% scenario is not impossible and if it happens my guess is that the banks will relax the covenants and allow CHIP to do as it once did – and pay a dividend. On a 1/3 payout policy you would (if you bought the shares today) be looking at a
high single digit yield. That would be a bonus.

Valuation

My guess is that property inflation will be 3-5% over the next three years. Right now the discount to NAV is more than 50% which tells you that the market is still discounting the possibility that the banks might pull the plug. That might happen and be aware you could lose everything here. But – as I explained above – I do not think it will. If I am right, as that becomes clearer the shares will instantly be re-rated and as property does start to increase in value (it is already doing so as it happens) then the discount to NAV will narrow sharply. But as the table above shows, the NAV will also start to increase sharply.

I am not setting a target price here but a range which is based on a discount to each of my possible three year estimated NAVs. My own belief is that the NAV in three years will be 60p plus in which case the shares are likely to be at least 50p. In a worst case scenario (I do not see yields on CHIP's portfolio heading much above the current low teens so worst case is no AV growth) a NAV of 47.6p should see a share price in the high thirties. In a best case (8%) scenario you could plausibly see a 75p share price and you have a multibagger. You know the risk is with the banks in which case you lose everything. So do not bet the ranch on this one but as a risk reward play I think it very attractive. CHIP is
a BUY at 18.5p with a three year target of 40-75p.

Key Data

EPIC: CHI

Market: AIM

Spread: 17p - 20p (15%)



Tom Winnifrith edits

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