Watkin Jones plc. Onwards and upwards. No change to winning mentality. Untapped structural demand for BTR. Growth in UK Build-to-rent market

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1 plc Onwards and upwards 22nd May, 2018 Success breeds success is a crucial, yet under-appreciated, concept when it comes to investing. You see, great companies devote substantial amounts of time/resource nurturing and maintaining high-performance cultures. Management obviously plays an enormous part walking the talk, motivating employees, recruiting the right people and challenging the status quo. A philosophy embraced by plc, who under the tutelage of CEO Mark Watkin Jones since 2003, has been transformed from regional Welsh housebuilder to become one of the UK s leading developers of purpose built student accommodation (PBSA) and Build-to-Rent (BTR) properties. No change to winning mentality The good news for shareholders is that this X-factor is set to continue. The company announcing last Friday that it had appointed another accomplished leader to take over the helm - with Richard Simpson (42), previously Unite s Property Director, set to join on 2 January Chairman Grenville Turner adding "Richard [is a] highly recognised industry figure with an immense track record and credibility. He is well known to the Board having worked closely with the business on several occasions." Company Data EPIC AIM:WJG Price (last close) 208p 52 week Hi/Lo 249p/175p Market cap 531m ED valuation/share 230p Daily volume 450k Share Price (p) 270p 250p 230p 210p 190p 170p 150p 130p 110p 90p 70p Source: Web Financial Untapped structural demand for BTR In the interim, Mr will stay for as long as needed, and ensure an orderly handover. With the key aims of further bolstering the firm s strengths in PBSA, and rapidly expanding the fledgling BTR division to take advantage of the buoyant conditions (see below). Growth in UK Build-to-rent market Company Description provides the end-to-end development and management of large scale, multi occupancy accommodation, focusing on purpose built student accommodation (PBSA) and residential build to rent (BTR). Both are expanding areas with strong fundamentals enabling the firm to leverage its reputation and industry expertise, along with operating a forward sale, low risk, cashflow positive and capital light model. Residential property and agency lettings (Fresh brand) are also set to be longterm growth engines. Next news: Pre-close trading update in October. Source: Glenigan, Molior, BPF Paul Hill (Analyst) paul.hill@equitydevelopment.co.uk Please refer to the important disclosures shown on the back page and note that this information is Non-independent and categorised as Marketing Material

2 plc 22nd May, 2018 According to the British Property Federation, the aggregate BTR housing stock (either completed, under-construction or in planning) at the end of Mar 18 jumped 30% YoY to 117.8k units. Jacqui Daly (Savills Director) predicting at this rate, we expect [the industry] could double to 200,000 within the next two years. New 68.5m BTR scheme secured Indeed, only last Friday the company disclosed that it had been selected by M&G Real Estate and Lochailort, to develop a new 68.5m BTR project in Reading, entailing 315 apartments (studio, 1, 2 or 3 bed). Work will commence shortly with completion slated for Meaning that WJG today has a consented pipeline of >1,000, and is well on the way to hitting its 2023 target of delivering >1,500 units. Altogether WJG is in control of 5 BTR sites (excluding Reading), and is presently negotiating on several others. 3 already have planning permission, with another in Uxbridge understood to be progressing well (270 units), while Sutton (165) is being re-assessed in light of the Affordable Housing Guidance issued by the Mayor of London in August We reiterate FY18 forecasts after in line H1 Additionally, nestled within today s strong H1 results where adjusted PBT came in at 23.6m (+11.9%) on turnover up 18.4% to 158.3m - was news that the Board is exploring ways to establish a new BTR investment vehicle. Here, we suspect that WJG would retain a minority stake, but could nonetheless generate attractive returns, acting as either the fund manager and/or lettings agent. The Newco would also provide a logical final home and forward funding source for WJG s BTR projects, to be agreed on an arms length basis. Current year EBIT margins vs sector peers Telford (B4 capitalised interest) Gleeson Homes 9.4% 17.4% 24.0% 22.3% 14.3% 12.5% 13.6% 21.5% 18.0% 19.7% 14.7% 17.3% 12.3% 16.0% 17.5% 28.3% 0.0% 5.0% 10.0% 15.0% 20.0% 25.0% 30.0% Source: Equity Development, various sites 2

3 22nd May, 2018 plc CY asset turns vs peers Telford Homes Gleeson Source: Equity Development, various sites BTR Newco could create more alpha for shareholders To us, this strategy makes sense and would be a tried & tested way of leveraging WJG s expertise in largescale multi-occupancy accommodation within the BTR space. Especially as the Government (subject to limits on affordable housing) appears supportive, acknowledging the industry s critical role in meeting its ambitious goal of delivering 300k homes annually by the mid-2020s. The Minister of State for Housing, Dominic Raab, saying The 45% increase in completed BTR homes [to almost 21,000] is good news, but we re restless to do more. In terms of who is set to benefit from the associated construction volumes, then it falls squarely on the shoulders of the UK housebuilders (eg Telford Homes, Cala), contractors (eg Balfour Beatty) and property developers like WJG. Organisations benefitting from BTR construction 3% 11% Local developer 27% UK housebuilder 16% Major UK developer Contractor Registered provider 20% 23% Major international Source: Glenigan, Molior, BPF 3

4 plc 22nd May, 2018 London dominates but regions (49%) are catching up Historically most of the BTR sites have been located in heavily populated city centres, particularly where there exists a vibrant rental market, young workforce and relatively expensive property prices vs 1 st time buyer incomes, such as in London (51% of total see below). Recently though, there has been a marked pickup in the regions, with 62% of all Q1 BTR homes under construction located outside of the Capital. More than half of BTR schemes are located in the Capital Wales Northern Ireland North East East East Midlands South West Scotland Yorkshire and The Humber West Midlands ,059 1,244 1,500 1,511 3,365 5,131 6,378 North West 29,600 South East 7,101 London 60, ,000 20,000 30,000 40,000 50,000 60,000 70,000 Source: Glenigan, Molior, BPF BTR can revolutionise the UK renting landscape So what s driving this unprecedented growth? Well first and foremost, households are slowly coming to terms with renting, with 6m expected to do so (see below) by Rental sector forecast to double in <20 years Source: Hamptons International 4

5 22nd May, 2018 plc Next, institutional money is pouring into the sector, attracted by the reliable income streams and positive real Net Initial Yields (NIY), which are also higher than returns on investment grade credit, such as corporate debt or gilts (see below). The traditional go-to asset classes for pension funds wishing to match their long term obligations. PBSA and BTR generating positive real-returns 6.0% 5.0% 4.8% 5.0% 4.0% 3.0% 2.0% 1.0% 1.5% 3.8% 1.0% 2.0% 2.0% 3.2% 2.5% 0.0% Source: Bank of England, CBRE and JLL. NIY = Net initial yield (post running costs) Student accommodation keeps powering ahead But that s not all. The company s more established PBSA division continues to go from strength to strength. Revenues rose 23.5% to 142.2m, reflecting good progress on its forward sold developments, which are set for delivery this year and next. In turn generating healthy H1 18 gross margins of 20.7% (vs 21.7% LY), with the slight decline simply down to stretching comparatives. Looking ahead, the pipeline comprises 25 sites, representing >10,300 beds worth 900m (vs 11,200 beds and 920m LY). All developments ear-marked for FY18 have been sold (3,415 beds). Likewise 4 (2,245 beds) out of the 6 (2,723 beds) planned for FY19 have exchanged contracts, with another 7 (3,000 beds) scheduled for FY20. Thus offering excellent earnings visibility. Outlook for PBSA remains positive More broadly, we think the outlook for the student accommodation remains positive, with structural demand underpinned by the UK s world-renowned University sector, the internationalisation of higher education and the shortage of good quality housing. Indeed, the UK continues to be the 2nd most popular destination for international students and has 12 out of the world's top 100, and 59 of Europe's top 200 universities. 5

6 plc 22nd May, 2018 Breakdown of overseas (non EU) students in higher education 19% US UK Australia 43% France 10% Germany Russia Japan 6% Canada Other 6% 3% 3% 3% 5% Source: Education at a Glance 2016, OECD For the 2017/18 academic year, total student numbers again reached record levels at >1.8m (see below), of which over 1m live in 3 rd party rented accommodation. So regardless of the slight 3% dip in applications (Re EU students, demographics and changes in the funding of some medical degrees), universities were nevertheless still able to fill most (if not all) their courses, since demand far out-stripped places available by 166k (or 31%). Demand for degrees continues to exceed supply 2,000 1,800 1,710 1,728 1,730 1,771 1,819 1,837 1,600 1,400 1,200 1, / / / / / /18 Full time students Applicants Acceptances 1st Year & overseas PBSA beds Source: UCAS, HESA, Unite estimates WJG well placed to reap the rewards Moreover, there are presently 580k PBSA beds in the UK - split 300k university and 280k corporately owned - compared to 717k 1st year and international students. Approx. another 25k units are scheduled to come on stream this year and a further 18k in FY19/

7 22nd May, 2018 plc In our view this extra volume will be readily absorbed given there is an increasing proportion of 2nd and 3rd year undergrads now also opting for PBSA in preference to traditional student digs. Hence, although the Brexit negotiations and political landscape creates some background noise, we believe these strong fundamentals position WJG well for the foreseeable future. Strong institutional demand for both PBSA and BTR 2018 UK house prices (JLL) 0.0% 1.0% 2.0% Provincial Major Provincial Central London BTR NIY (CBRE) 3.3% 4.3% 4.5% PBSA NIY (CRBE) 4.3% 5.0% 5.5% 0.0% 1.0% 2.0% 3.0% 4.0% 5.0% 6.0% Source: CBRE and JLL Refreshing the lettings business Elsewhere, both Fresh lettings and residential housing (28 vs 31 sales) made solid progress too, with the latter expecting a much stronger H2 (67 legally exchanged or reserved for completion) in line with normal seasonality. In H1 18, Fresh s (FPG) gross margins ticked up to 65.3% (vs 63.2%) as further economies of scale kicked in, following a 25.7% leap in turnover to 3.7m, augmented by recent contract wins. Consequently, despite the sale of 14 student schemes by the Curlew Student Trust (5,124 beds), FPG is today contracted to manage 14,821 student beds across 52 schemes from the start of the 2018/19 academic year. This is set to climb to 17,053 by FY21 vs 16,185 across 53 schemes at the start of FY18 and 12,117 beds 12 months earlier. 7

8 plc 22nd May, 2018 Breakdown of key players in UK PBSA lettings market Chapter Collegiate Hello Host Student housing Co. Sanctuary CLV Homes for students 2018 Fresh Student (ex Curlew) FY17 Fresh Student Derwent CRM Liberty Living Vero group (IQ) UPP Unite Student 4,562 5,318 5,778 6,187 6,281 10,722 12,129 13,966 14,821 16,185 22,403 22,974 23,700 27,524 32,874 49, ,000 20,000 30,000 40,000 50,000 60,000 Source: CBRE and JLL The number of BTR lettings under management is similarly anticipated to advance from 532 to 806 by FY21, after winning a bid in Manchester on a 274 unit scheme. Valuation nudges up to 230p (vs 225p before) With regards to the numbers, we make no change to our FY18 estimates, supported by circa 80% GP cover (ED estimate). What s more WJG closed March with a pristine balance sheet sporting 38.4m of net cash, and declared a 12.3% bump in the dividend to 2.47p. To us, the stock is worth 230p/share - representing a deserved premium to peers (see below), thanks to its superior growth, RoE, asset turns, lower risk profile, robust cashflows and exposure to numerous secular trends. Current year Return on Equity (RoE) vs peers Telford Homes Gleeson 17.5% 18.0% 20.5% 10.2% 16.3% 19.9% 18.8% 20.6% 12.3% 14.9% 15.8% 13.1% 15.8% 17.5% 23.2% 25.8% 0.0% 5.0% 10.0% 15.0% 20.0% 25.0% 30.0% Source: Equity Development (RoE defined as EPS/NA), various sites 8

9 22nd May, 2018 plc CY Price: net tangible assets (NTA) vs peers Telford Homes Gleeson Source: Equity Development, various sites CY PER vs peers Telford Homes Gleeson Source: Equity Development, various sites CY EV/EBIT vs peers Telford Homes Gleeson Source: Equity Development, various sites 9

10 plc 22nd May, 2018 CY Dividend yield Telford Homes Gleeson 2.3% 4.6% 4.1% 4.1% 4.1% 3.9% 3.6% 3.9% 4.6% 3.3% 3.8% 2.9% 5.8% 7.2% 7.5% 7.4% 0.0% 1.0% 2.0% 3.0% 4.0% 5.0% 6.0% 7.0% 8.0% Source: Equity Development, various sites Compelling proposition CEO Mark concluding We are delighted to report strong growth in revenue and profits in H1 [which] were in line with our expectations, reflecting good build progress on forward sold student accommodation developments. We are continuing to see strong demand from institutional investors, keen to acquire scale in this maturing asset class. We have an excellent development pipeline and we are excited about several other opportunities expected to be added in H2. The fundamentals for each of our business segments remain positive and the market dynamics strongly support the Group s forward sale model, providing us with good future visibility on earnings and cashflows. The Board is confident in the outlook. 10

11 22nd May, 2018 plc Summary financial projections (continuing) 2015 Act 2016 Est 2017 Act 2018 Est 2019 Est 2020 Est 2021 Est 2022 Est 2023 Est 2024 Est (Sept yearend) 'ms 'ms 'ms 'ms 'ms 'ms 'ms 'ms 'ms 'ms Turnover Student (PBSA) accommodation Build to Rent (BTR) Residential development Fresh property management Other / construction Total Group revenue growth % YoY 73.5% 9.3% 13.1% 13.6% 13.7% 11.0% 10.6% 10.6% 8.7% 8.0% Student (PBSA) accommodation 3.9% 8.0% 9.3% 1.8% 3.5% 1.7% 0.0% 0.0% 0.0% Build to Rent (BTR) % 200.0% 50.0% 38.9% 36.0% 23.5% 19.0% Residential development -12.6% 65.3% -31.3% 99.2% 5.6% 5.3% 12.5% 11.1% 10.0% 9.1% Fresh property management 116.6% 14.3% 0.0% 15.0% 10.0% 10.0% 10.0% 10.0% Student (PBSA) accommodation Build to Rent (BTR) Residential development Fresh property management Other Group gross profit Group % margin 18.0% 20.2% 21.0% 19.9% 19.3% 18.4% 17.7% 17.4% 17.1% 17.0% Student (PBSA) accommodation 18.2% 20.5% 22.1% 20.0% 19.5% 18.7% 18.0% 18.0% 18.0% 18.0% Build to Rent (BTR) 56.3% 13.0% 13.0% 13.0% 13.0% 13.0% 13.0% 13.0% Residential development 16.6% 11.5% 3.8% 15.0% 20.0% 20.0% 20.0% 20.0% 20.0% 20.0% Fresh property management 58.9% 49.4% 60.0% 60.0% 60.0% 60.0% 60.0% 60.0% 60.0% Admin Distribution / other Adjusted EBIT % margin 13.3% 14.2% 14.1% 13.6% 13.3% 12.6% 12.2% 12.2% 12.2% 12.2% EBITDA (incl JV profits) % margin 13.8% 15.6% 15.0% 14.1% 13.6% 13.0% 12.5% 12.5% 12.5% 12.5% Profit from JVs Net interest Adj profit before Tax (Ex JVs) Effective tax rate -19.1% -20.5% -17.3% -19.0% -19.0% -18.0% -17.0% -17.0% -17.0% -17.0% Adjusted EPS (pence) EPS growth rate 138.5% 19.2% 13.1% 4.0% 10.9% 7.1% 8.2% 10.6% 8.9% 8.3% Net tangible assets per share (p) Dividend (p) Valuation benchmarks P/E ratio Price/Tangible book P/NTAV (adjusted for sector average NTA turns) Return on equity (EPS/NA) 23.5% 30.8% 28.4% 25.8% 25.0% 23.6% 22.7% 22.3% 21.7% 21.0% Dividend yield 1.9% 3.2% 3.6% 3.9% 4.2% 4.5% 5.0% 5.4% 5.9% Net cash/(debt) Sharecount (Ks) 255, , , , , , , , , ,869 Shareprice 208 Source: Company historic data, Equity Development estimates. 11

12 plc 22nd May, 2018 Key risks Impact of a substantial jump in UK interest rates and/or a recession. This seems unlikely though, given that even the most pessimistic economic forecasts are for >1.5% GDP growth through to Similarly, November s 0.25% rate rise by the BoE has already been factored into our modelling. Protracted delays in obtaining planning consent, which traditionally has plagued the whole sector. Availability of skilled labour and associated resources at desired cost levels. Foreign exchange fluctuations could impact demand from international investors, from say Singapore, Hong Kong and China. Being relatively small in, could get squeezed by larger rivals, partners and customers, particularly with regards to residential, BTR and profit margins. Future access to funding at commercial rates, perhaps in the unlikely event of another banking crisis. Generic risks of retention/recruitment of key staff, etc. Acquiring land at affordable rates. Withdrawal of government support for house-building (eg H2B, FTBs, stamp duty, etc). Brexit, and other possible legislative changes, say concerning building regulations, affordable housing, ground rents, etc Less demand from institutional money, say if bond/gilt yields were to rise materially. 12

13 Head of Corporate Gilbert Ellacombe Direct: Tel: Investor Access Hannah Crowe Felix Grant-Rennick Direct: Direct: Tel: Tel: Equity Development Limited is regulated by the Financial Conduct Authority Equity Development Limited ( ED ) is retained to act as financial adviser for various clients, some or all of whom may now or in the future have an interest in the contents of this document and/or in the Company. In the preparation of this report ED has taken professional efforts to ensure that the facts stated herein are clear, fair and not misleading, but make no guarantee as to the accuracy or completeness of the information or opinions contained herein. This document has not been approved for the purposes of Section 21(2) of the Financial Services & Markets Act 2000 of the United Kingdom ( FSMA ). Any person who is not a relevant person under this section should not act or rely on this document or any of its contents. Research on its client companies produced and distributed by ED is normally commissioned and paid for by those companies themselves ( issuer financed research ) and as such is not deemed to be independent, as defined by the FCA, but is objective in that the authors are stating their own opinions. This document is prepared for clients under UK law. In the UK, companies quoted on AIM are subject to lighter due diligence than shares quoted on the main market and are therefore more likely to carry a higher degree of risk than main market companies. This report is being provided to relevant persons by ED to provide background information about plc. This document does not constitute, nor form part of, and should not be construed as, any offer for sale or purchase of (or solicitation of, or invitation to make any offer to buy or sell) any Securities (which may rise and fall in value). Nor shall it, or any part of it, form the basis of, or be relied on in connection with, any contract or commitment whatsoever. Self-certification by investors can be completed free of charge at ED may in the future provide, or may have in the past provided, investment banking services to the Company. ED, its Directors or persons connected may have in the future, or have had in the past, a material investment in the Company. More information is available on our website Equity Development, 15 Eldon Street, London, EC2M 7LD. Contact: info@equitydevelopment.co.uk