Why Are KPG Trading Below NTA? Part II

In Part I of this article, I considered how I might value KPG, which is a REIT that is currently trading below NTA. I concluded that the value should essentially be based around dividend, so tonight I’m going to have a gander through the financials to look for anything odd and to see whether the dividend is sustainable and if there is any reason to believe that the NTA could drop (which may give concern that the share price might fall in line).

Looking through the May 2021 results announcement, concerns of dropping property values are abated (assuming that enough time has passed to be sure that working from home and online ordering of goods will not be the new normal, which I think is a fair assumption given the amount of time that’s passed). KPGs property portfolio value increased by 3.1% over the last year.

With a market cap of $1,868m and an NPAT of $196.5m (PE of 9.5), it looks like even the historic annual dividend of 5.9% will likely be affordable going forward.

In other forward looking aspects, low interest rates seem to be and will likely benefit KPG in the future.

KPG have a good variety of property types and a good selection of customers, the largest being government, banks, and other large businesses, with a near 100% occupancy rate. They also have a good spread of lease renewals, 43% of which have a renewal date on or after FY25. All this information is listed in their Property Compendium, so I won’t republish it here.

Looking through the financials, I’m a little worried how much employee costs are growing. I vaguely remember reading that they have 150 employees and a quick Google search supports this memory as it seems 130 were reported in 2015.

Looking a little deeper into the financials, removing asset appreciation from profits leaves (what I will call) an Underlying NPAT of $96.7m and an Underlying PE of 19.3. That supports a dividend of 5.18% at most (100 / 19.3). That’s a lot less exciting that the previous numbers. Add to this, the fact that Profit before other income/(expenses) and tax (profit without asset appreciation and tax) has been following a downward trajectory over the past 5 years (excluding this last year, which I’m tempted to write of as anomalous due to COVID19), and the dividend outlook doesn’t look that exciting at all to me.

That said, their Adjusted (non GAAP) numbers look great, as does their financial position (which could just be a timing thing?). I think I might need an accountant to better explain these numbers to me because it looks to me like they’re hiding a falling profit by marking some properties as for sale this year, and borrowing more money each year (keeping the debt to asset ratio the same as asset values rise) to pay an increasing dividend. If I’ve understood the model correctly (and it’s entirely possible that I haven’t), it looks like the investment proposition is to get paid a dividend from debt covered by rising property valuations and it doesn’t look sustainable without rising property valuations.

It’s quite late as I write this and I have an early morning, so I might come back to finish my analysis off and have a re-read of the accounts to try to get my head around what’s going on another day. For now, I’m going to mark it as not a buy for me because I need to be convinced that the dividend is at least sustainable.

At least I think I’ve uncovered why they’re trading below NTA: because the Underlying PE doesn’t support a dividend higher than 5.2% and without selling properties (or clever cheap financing – which is entirely possible in KPG’s arsenal) I can’t see how they can sustainably grow that dividend. On top of this, there’s talk of interest rates going up in future, so this might also be a factor at play against the investment case for KPG (though I personally suspect any meaningful increase will be years away).

KPG are probably fairly priced currently, in my view. This is due to the dividend return as explained in the paragraph above, but also because they can’t trade too far below NTA without becoming a buyout target (though being NZ’s largest REIT I don’t know who would buy them out) – or perhaps more likely a partial buy out (selling properties) to return value to shareholders. The discrepancy between the NTA and share price is about what you’d want for an annual return for such trading activities with a good dividend as compensation if sales were not to occur.

Finally, I am left feeling that the management are pretty smart with finances to run this business in a way that returns value to shareholders so well… But I’m still not investing due to the afore mentioned reasons. I have my eyes on more interesting targets at the moment.


One reply on “Why Are KPG Trading Below NTA? Part II”

Simply Wall St seems to agree with this analysis. They highlight risks that operating cash flow doesn’t cover debt, which I guess is what you’re aluding to when you talk about the dividend coming from increasing debt levels.

The other risk Simply Wall St highlights its that they predict earnings to fall by an average of 8% per year.

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