an employee in action at Lok n store

Buy: Lok’nStore (LOK)

The secured pipeline will increase available space by a third in a market significantly under supplied, writes Jonas Crosland.

Growing demand for self-storage space helped to lift profits at Lok’nStore in the year to July, boosted additionally by the opening of three new stores. And there are three more stores opening in the current financial year, with a further five sites secured.

Growing customer awareness has also helped to shorten the time for a new store to fill, with the latest opening filling up the fastest of all. Of the 29 stores open, over half were trading above 70 per cent occupancy, with a third of revenue coming from businesses and two-thirds from household customers.

Lok’nStore prefers to own the freehold on its stores but around one-third of its trading space is leasehold, with an average unexpired lease term of just over 11 years. Margins are lower on leasehold property because of the rent payable, but the return on capital is higher than on freehold because the latter require much greater expenditure on buying the land and building.

The group also manages a growing number of stores for third-party owners. The investor provides all the capital for the project and pays operating expenses out of the revenue earned. For Lok’nStore, there are no costs and no capital at risk, and the managed stores are operated under the Lok’nStore banner.

Analysts at house broker finnCap are forecasting adjusted pre-tax profit for the year to July 2019 of £4.9m and earnings per share of 13.4p (from £4.7m and 13.1p in 2018).

Hold: Warpaint (W7L)

Shares lost nearly half their value on the day the latest update was announced, and now trade at about 12 times revised forward earnings.

Warpaint may be making progress in its international expansion plans, but so far it hasn’t been enough to make up for trouble at home. The cosmetics company warned that retailers in the UK have been cutting their stock levels and reducing Christmas orders, presenting a big problem for Warpaint since holiday trading is key. Full-year sales are now expected to be in the range of £48m-£52m, with pre-tax profits excluding exceptional items around £8.5m-£10m. But profitability for 2018 will be dependent on the precise product and geographical mix of sales. Before this update, analysts at Stockdale had expected £55.3m in sales and pre-tax profits of £12.7m.

Progress in Warpaint’s international markets has so far failed to compensate for the problems in the UK, but has improved in recent months. As of the end of September, US sales were up 60 per cent compared with last year, and sales in the EU (excluding the UK) were up 13 per cent year on year. The newly established Chinese subsidiary recently made its first sales, and the company has also moved into Russia.

Shares are currently at a discount to the cosmetics company’s historical valuation, but we’re taking a step back from our buy recommendation. The UK weakness stems from tough trading in UK department stores such as Debenhams and House of Fraser, which doesn’t look likely to improve soon.

Buy: RDI Reit (RDI)

With its generous dividend and 23 per cent discount to forecast net asset value, we are sticking with RDI for now, writes Jonas Crosland.

RDI Reit has set out to be the UK’s leading income-focused real estate investment trust, and with a forecast dividend yield for 2019 of 8.6 per cent fully covered by earnings, it is one of the top payers in the sector.

Trading in the year to August 2018 saw a further shift towards the London serviced office market, where the group’s current 7 per cent share of London office stock is forecast to rise to nearly a third by 2030.

This is part of a strategy to move into areas of investment that offer greater growth potential.

To finance further acquisitions, RDI raised £255.7m through disposals at an average 9 per cent premium to book value.

This included the sale of the German supermarket portfolio at a 10.8 per cent premium to book value, and regional offices in the UK where it considered there to be less opportunity for rental growth.

The group’s retail division faced a much tougher year, as several companies folded while others began paying less rent.

Overall, this reduced annualised gross rental income by 0.7 per cent. However, outside Greater London the shopping centre portfolio is focused on food, discount and convenience retailing to local communities, and occupancy rates remained high at 96.4 per cent.

Analysts at Peel Hunt are forecasting adjusted net asset value at the August 2019 year-end of 43p (from 42.8p in 2018).

Chris Dillow: Housing crash holds dangers

The UK’s housing market is in the doldrums. This week’s figures showed that mortgage approvals have flatlined for five years; the Halifax is likely to say next week that prices are falling in real terms; and the Royal Institution of Chartered Surveyors is expected to report that estate agents expect demand and prices to remain weak. Does this matter for the wider economy?

Some say not. Willem Buiter, chief economist at Citigroup, has argued that housing is not net wealth for people in aggregate. Yes, homeowners lose from falling prices — especially those planning on trading down or using home equity release schemes. But those who don’t own a home gain, either by needing to save less for a deposit or because rents will eventually fall.

And, in fact, high housing costs are in many ways an economic menace. They are associated with high household debt, which tends to depress growth and increase instability. They divert spending away from innovative and dynamic sectors towards a low-productivity one. They encourage energetic people into “property development” rather than more innovative forms of entrepreneurship. And they compel workers to commute long distances which increases stress and decreases productivity.

And this is not to mention their cultural and political damage: the loss of bohemian arts scenes and the alienation that young people feel in being unable to afford property.

Nevertheless we should be a little disquieted by the weakness of the housing market.

One reason for this is that housing is collateral. It is used to finance some consumer spending via second mortgage or home equity release schemes as well as many small business start-ups. Through this channel, falling prices do depress spending.

Also even if house prices don’t matter, transactions do. There’s a close link between the number of house purchases and spending on housing-related items such as furniture and carpets. In fact, there’s also a link to spending more generally via a framing effect. If we’ve just spent £500,000 on a house, a few hundred pounds seems a smaller sum than it otherwise would, so we are more likely to spend.

For these reasons, there is a strong correlation, with a lag of a few months, between mortgage approvals and retail sales. Recent weakness in approvals therefore suggests that the recovery in high street spending we saw in the third quarter won’t be sustained. And with no sign of any pick-up in the housing market soon, this is a reason for longer-term caution about consumer spending.

I’m not sure all this is as contradictory as it seems. There’s widespread agreement that a healthy economy requires reform of the housing market — through changes to planning laws or taxation, for example. What we don’t need is long-lasting stagnation.

Chris Dillow is an economics commentator for Investors Chronicle

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