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The meteoric rise of Palace Capital’s (LON:PCA) share price since the start of November has caught many investors by surprise. We look at whether the stock can continue to resist Omicron variant drag, or if its bullish run is set to come to an end.

Who is Palace Capital?

Palace Capital is an internally managed UK real estate investment company focused on commercial properties in major towns and cities across the UK, but excluding London. Founded in 2005, the company has grown to own 48 buildings across the main commercial property sectors, generating capital growth through strategic refurbishment and development of these assets. As of 31st March 2021, Palace Capital’s property portfolio was valued at £282.8m.

Stock price history and recent upsurge

The 2007-08 Global Financial Crisis triggered severe slumps throughout the real estate sector, and Palace Capital was no exception. After falling by over 90% during the crisis, the company’s share price remained unchanged for several years, hovering around the 300 GBX mark.

In early 2020 however, at the onset of the Covid-19 pandemic, things took a turn for the worst. In just under three months from mid-January to late March, shares fell from 340 to 178 GBX. It was not until a whole year later in February 2021 that Palace Capital’s stock price started to pick up again.

Recently, Palace Capital’s shares have experienced a miraculous rise. In the one-month period between 10th November and 9th December, the stock price soared by a remarkable 22%. With the emergence of the Omicron variant during this period, many investors would have expected the real estate firm to follow its property peers and suffer significant losses in valuation. Clearly though, this prediction has not materialised.

Current financial condition

Although Palace Capital’s ability to shake off Omicron’s negative effects has undoubtedly caught investors by surprise, a deep dive into the company’s financials reveals that it was fundamentally ready for robust growth.

Perhaps the most obvious indicator of Palace Capital’s strong financial condition is its low Price to Net Asset Value (P/NAV) figure. P/NAV is a financial ratio comparing a company’s current market value to its book value and is used to identify whether a company is trading below or close to the difference between its assets and liabilities. With a P/NAV of 0.5 in 2020 and 0.8 in the current fiscal year, Palace Capital is trading at a discount to its NAV. More crucially, this figure is considerably lower than its real estate sector peers, estimated to be trading at a P/NAV of around 8.0, which implies the firm is critically undervalued.

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Another striking statistic regards the fact that, even amid the Covid-19 crisis, Palace Capital has been able to record all-time-high total revenue (£21.15m) and operating income (£13.7m) figures in 2020. Whilst 2021 did not achieve the same success, income figures were still up at very respectable levels suggesting the company’s inflows are, to a large extent, resistant to external factors.

Exciting projects ahead

Together with strong financial and operational improvements, Palace Capital is continuing to expand its property portfolio. At the forefront of this expansion is the flagship Hudson Quarter (HQ) development in York, which was completed in April 2021. HQ is an extremely large project by Palace Capital’s standards, with the gross development value representing two-thirds of the company’s total market capitalisation. According to Edison Research, HQ has the potential to crystalise sales profits, recognise development gains and earn recurring income, while significantly reducing the risk attached to its property portfolio. This could mean an additional £10m of total trading gains (by the end of FY23) and £0.9m of annualised rental income is generated.

Could sectoral and macroeconomic sensitivities threaten Palace Capital’s profitability?

Historically, the commercial property market has exhibited substantial swings in valuation through cycles. As a longstanding listing on the London Stock Exchange, Palace Capital has demonstrated that it is no exception to this rule, periodically experiencing sharp upturns and downturns. Even though revenue through income returns has proved to be significantly more stable in the real estate sector, these inflows also tend to be heavily dependent on external variable factors such as tenant demand and rent terms.

Regarding the sensitivities specific to Palace Capital, there are certainly increased risks and uncertainties attached to the business’ recent property portfolio expansion, including its development of HQ. This includes planning permissions, timing issues and construction risks, as well as the long lead times to completion and eventual occupation of properties.

Aside from these, the company also faces multiple macroeconomic risks which could impact its profitability and revenue-generating capacity in the near future, the most prominent of which concerns the Covid-19 crisis status. With the increasing threat of further restrictive measures being imposed, the pandemic continues to create financial uncertainty within the real estate market as demand for rental properties is likely to fall if the country is put into another lockdown.

The UK’s economic condition will also play a pivotal role in determining Palace Capital’s financial performance in the months ahead. GDP growth rates and currently low interest rates are supporting strong commercial property returns, but the threat of rising inflation and stubborn unemployment rates may offset this profitability. Actions of the government and the central bank will therefore be key in this regard.

Investment prospects

Considering the strong financial condition Palace Capital finds itself in, the company appears to be very well positioned to maintain strong growth into 2022. Its recent and upcoming real estate projects provide further reason to believe that Palace Capital’s share price will continue to shake off Omicron fears and rise in the coming months. However, as with all businesses at this moment in time, the price action of its stock will be largely determined by how the situation surrounding the Covid-19 pandemic develops. Either way, Palace Capital is certainly a company to keep an eye on.

Related

Please note this article does not constitute investment advice. Investors are encouraged to do their own research beforehand or consult a professional advisor.

Adel Ahmed

Adel Ahmed

Adel Ahmed is a reporter with The Armchair Trader based in London. He covers a broad range of financial markets and asset classes. He has completed the Bloomberg Markets Concepts course and is the President of the SOAS Investment Management Society.

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