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CLS Holdings: don’t be fooled by the share price

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Last month, the UK arm of CLS Holdings (LON:CLI), a FTSE 250 commercial property investment company with a £2.3bn portfolio, reclassified as a REIT on EPRA (the European Public Real Estate Association Index).

The company has stated that its aim is to target a broader range of investors and add liquidity to the shares. But with 50% of its operations based in the UK – 38% Germany and 12% France – one of the reasons to convert to a REIT says CLS is to shield the UK operations from the increase in UK corporation tax from 19% to 25% which is planned to take effect from 1 April 2023. Although this may change as the new Chancellor, Nadhim Zahawi is said to be reviewing this.

Little impact on share price

CLS Holdings estimates that the conversion to a REIT will save between £3-5m annually in UK corporation tax from 2022 onwards. This news and the fact that the EPRA NTA (net tangible assets) increased by 4.5p per share did not have any immediate impact on the share price however. In fact, the share price has since fallen 10% and is now at 202.50p. So what’s going on?

But CLS is an outperformer

Kieran Lee, real estate analyst at Berenberg Bank, told The Armchair Trader: “Shares have underperformed over the long period because CLS has been caught up with the wider malaise of UK REITS. However, it is one of our top picks as it has a long record of outperformance.”

“Essentially the portfolio is misunderstood,” states Lee. “The management team have a knack of identifying and investing in high quality assets in up and coming peripheral locations and capitalising as markets mature. For example, CLS once owned the land upon which the Shard now sits. It also owns a swathe of Vauxhall Gardens, which is situated between the US embassy and London Waterloo station. Similarly, its German portfolio is very similar in quality to Alstria, a Hamburg-based REIT. Alstria was taken private by Brookfield Asset Management at the beginning of 2022, but at a valuation premium. Meanwhile CLS shares are currently trading at a 46% discount to CY 2022E.” Berenberg is maintaining a 330p price target with a Buy rating.

CLS has got potential

CLS has significant inherent organic growth opportunities as well as a secure, growing and geographically diversified income-biased return profile, states a recent research note from Berenberg. Following recent asset recycling activity, CLS’ portfolio has significant potential, with asset management initiatives capable of growing operating income by 17% to FY 2024E and further upside possible as on-site and near-term development progresses.

Dividend payout and future policy

The 2021 dividend totaled 7.70p per share (2020: 7.55p per share). However, in May CLS announced an increased dividend policy and that they are potentially exploring options to return capital to shareholders in order to close the valuation gap. There is no further news on this as yet but the details could be announced after the H1 2022 results on 10 August.

Berenberg’s base-case forecast assumes that circa £40m of cash is returned to shareholders. Due to the prevailing share price discount and using a tender price premium in line with pre-dividend normalisation history, this has the potential to result in NTA accretion of 1.3%, or c5p.

Strong demand for office space but challenges remain

While the environment for the London office market has undoubtedly been challenging, investor appetite for prime buildings has been especially strong and lettings activity remains robust according to Knight Frank. And as there is a lack of prime stock, occupiers are looking further ahead and preleasing office space – 30% of the current pipeline under construction is already pre-let.

This is constraining the pipeline as are supply chain issues, rising construction costs, shortages of materials and labour, both in London and in the EU. For example, in Q2 2021, Savills anticipated a total of 5.2m sq m of new EU office stock would complete during 2021; however, only 3.8m sq m was delivered, with rising numbers of project timeframes pushed out until 2022/23.

Savills now anticipates over 5.7m sq m of space will be completed in 2022 (of which 49% is currently pre-let), with a further 5.1m sq m of space scheduled for 2023 (of which 23% is pre-let). In total over the next two years, this marks a 43% increase p/y on the average level of completions over the previous five years with Berlin and Munich having the highest development pipelines by end 2023.

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This article does not constitute investment advice. Make sure you do your own research or consult a professional advisor.

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