Watkin Jones plc Graduating with honours 2 June, 2017 Watkin Jones has reported a robust set of interim results with PBT, EPS and DPS coming in ahead of our expectations. This company operates in two of the hottest areas of residential real estate, namely purpose-built student accommodation (PBSA) and build to rent sector (BTR) and it operates a lower risk model. Therefore we believe it should trade at a bigger premium to other housebuilders. H1 result statement The company produced another strong set of results during H1. Despite an expected 8.4% decline in H1 revenues, significant margin gains drove a 23.8% increase in gross profits. Adjusted PBT rose 26.6% to 21.1m; EPS +28.8% to 6.7p. The company reported an interim DPS of 2.2p. PBSA development The company's largest division reported strong profit growth H1 with a significant increase in gross margins. Visibility of sales and earnings is very high in this division. It is set to have a very good second half with growth in revenues and margins YOY. PBSA management Fresh Student Living continues to grow its number of beds under management. It currently has 12,117 beds under management and this is set to grow to 19,532 by 2020. BTR development Company Data EPIC AIM:WJG Price (last close) 187p 52 week Hi/Lo 187p/100p Market cap 477m Share Price, p 200 180 160 140 120 100 80 May/16 Sep/16 Jan/17 May/ Source: ADVFN Description Watkin Jones provides an end-to-end solution in developing large scale, multi occupancy accommodation projects, with a primary focus on the student accommodation market. The company completed its first BTR development in Leeds in the period. With a site with planning secured in Sutton and two further sites progressing through planning, we believe the medium term opportunity within this space is significant. BTR management The newest part of the group, Five Nine manages the Leeds scheme and currently has 535 BTR units under management. Valuation Watkin Jones shares trade on 14.1x PER for September 2017 with a 3.5% dividend yield. For the following year the PER falls to 12.9x and a yield of 3.8%. This appears undemanding given the group s consistent long term record of' growth, its strong cash generation, and its excellent medium term prospects as a leading developer within the growing UK student accommodation market. 14.1x represents a 35% premium to the Housebuilding sector on PER, but we would argue that this is too small a premium at this stage of the cycle. We conclude that Watkin Jones offers considerably better medium term visibility and growth than the average Housebuilder and should therefore trade at a 30-50% PER premium to the sector. Mark Hughes (Analyst) 0207 065 2690 mark@equitydevelopment.co.uk Hannah Crowe 0207 065 2692 hannah@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
Watkin Jones plc 2 June, 2017 Established for over 200 years, Watkin Jones is one of the UK s leading property development companies involved in two of the hottest areas of residential real estate, namely the purpose-built student accommodation (PBSA) and build to rent (BTR) segments. The fundamentals for both markets are positive and Watkin Jones is very well positioned to grow market share and profits despite operating a very low risk and working capital light business model. H1 results H1 revenues were in line with management's expectations, down 8.4% on H1 2016. This was due to the timing of forward sales and some one-off inventory sales of completed apartments in H1 2016. Management expect revenues to be stronger in H2. The company enjoyed significant increases in gross margins during H1. Indeed compared to H1 2016 gross margins increased by 570 bps to 21.8%. This was due to the location and quality of many of its student accommodation schemes on the development side, as well as a full half-year contribution from fresh student living which was acquired part way through H1 2016. Gross profits increased by 23.8% to 29.1m (versus 23.5m in H1 2016). Overheads were 9.7m compare to 6.5m in H1 2016, the increase reflecting the additional personnel required to support the growth of the business, the full six months overhead for Fresh Student Living and additional costs associated with being a listed company. Some operational gearing was experienced with both EBITDA and adjusted PBT increasing 26.6%. Adjusted PBT came in at 21.1m. Adjusted basic EPS rose 28.8% to 6.7p (from 5.2p in H1 2016). The company has a progressive dividend policy and therefore it has announced a 10% increase in the interim dividend to 2.2p per share compared to an annualised equivalent 2.0p per share and H1 2016. The company had 11.7m of net cash at the end of H1. PBSA development The long term fundamentals for the purpose-built student accommodation sector are very positive with growing student numbers, strong demand for quality accommodation and institutional investors hungry for exposure. In PBSA, Watkin Jones enjoys excellent visibility of revenues, profits and cashflow through a combination of a strong development pipeline and a forward sales model. Forward sales also reduces development risk. It also has an exceptionally good delivery track record of gaining planning consents. Since 1999, Watkin Jones has delivered more than 31,800 beds across 98 sites in this space, making it the leading provider of purpose-built student accommodation. It has a reputation for high quality and on-time delivery. The company has very strong institutional relationships. Its clients are leading institutions such as CBRE Global, AIG, M&G, UBS, UPP, Brookfield, Arlington, GSA and L&G' amongst others. Revenues from student accommodation developments were 115.2m, down slightly on H1 2016 as expected. That said the value of development to progress for completion is currently higher than for the prior period and therefore we expect a strong second-half. Gross margins rose significantly in the PBSA development business with H1 2016's 17.9% margin rising to 21.7% for the period. 2 www.equitydevelopment.co.uk
2 June, 2017 Watkin Jones plc Since 1 October, the company has sold 216m development value of seven student accommodation developments (2,580 beds). This includes one operational asset (590 beds). In addition it has 292m development value in legal negotiations for forward sale of nine further student accommodation developments. This equates to 3649 beds. The student accommodation development pipeline equates to 31 sites or 11,200 beds with a gross development value (GDV) of 920m. Many of these are already forward sold. These developments will be delivered over three years and most have planning consent. PBSA management The company's Fresh Student Living business (Fresh) is one of the leading independent PBSA managers in the UK. It offers vertical integration for the company within the student accommodation market and offers an end-to-end solution for institutional investors. The revenue growth opportunity, long-term nature of contracts and high margins within this business are very attractive. The company operates across 25 UK towns and cities and offers lettings and management services for a range of clients on contracts that range between 3-7 years. In H1 2017 beds under management rose from 8310 beds to 12,117 beds, across 43 schemes. The company is contracted to manage 19,532 beds for FY2020. These figures exclude the beds from the company s own development pipeline where the asset has not yet been sold and the engagement of Fresh has not yet been confirmed. For H1 2017, revenues were 3m and the gross profit was 1.9m (63.2% gross margin). Fresh's current annual contracted fee income is 4.6m and this should rise to 6.0m over the next two years. The business achieves a very attractive gross margin of circa 60% and we see this as sustainable. Fresh requires little working capital. Watkin Jones' strategy is to continue to grow the number of beds under management by Fresh. Operationally, Fresh has the capacity to expand to 30,000 beds under management without the need for any further significant investment in its operating platform. BTR development BTR is an attractive market in our opinion. Interest in the sector is driven by a significant supply demand imbalance in UK housing, a lack of affordability in some areas of the UK, and institutional investor demand for residential exposure. The business is very well positioned to take advantage of continued rising demand for developments within the build to rent sector. The company aims to operate along the same lines as its PBSA business, by developing a strong pipeline and forward selling to institutions. The growth opportunity could be significant in the medium term. BTR is a key part of Watkin Jones' overall growth strategy. Its first 322 unit development completed in the period. The BTR development pipeline is growing. One site secured with planning in Sutton (132 units) and two further secured sites are progressing through planning in Belfast and Leicester. Three further sites are in negotiation for development (subject to planning). All of these six schemes are currently targeted for delivery between 2019 and 2021. www.equitydevelopment.co.uk 3
Watkin Jones plc 2 June, 2017 As with student accommodation, the forward funding of schemes by institutional investors is significantly positive from a cash flow and working capital perspective. Therefore working capital requirements are minimal, ROCE is excellent and visibility is ensured. It also makes the division very scalable as again, cash can be rolled into other BTR development opportunities. The company intends to progressively grow within the BTR market by leveraging its expertise in PBSA in order to capitalise on the similarities between the two markets. It will use the expertise of its residential development teams and engage with its existing institutional investors with a view to forward funding and de-risking these BTR projects. BTR management The recently established BTR asset management business, Five Nine Living aims to manage both Watkin Jones developed schemes and external portfolios. Indeed it is seeing strong interest from other developers to manage assets. A lot of this potential business is driven by existing relationships at the Fresh Student Living asset management business. Five Nine manages and operates the Leeds BTR development. Again, the medium term growth opportunity in this space is significant. It is currently contracted to manage 535 units. Residential Revenues for the residential development business were 6.3m, down from 16.4m in H1 2016. The gross margin improved by 1010bps to 17.5% reflecting the impact of nil margin sales in the prior year from a legacy development site near Chester. The 2017-2019 development programme All 10 developments for completion in 2017 have planning consent and are forward sold, and therefore 2017 offers very high visibility. This equates to 3314 beds. The company has also secured all development sites for 2018. It is looking to complete 10 schemes in that financial year and all 10 sites (3,415 beds) have planning consent. Five sites or 1,854 beds are presold and an additional five sites or 1,561 beds are in legal negotiation for sale. At present nine student developments or 3,545 beds are scheduled for delivery in 2019. Eight sites (3,191 beds) are secured. There is one remaining site in legal negotiation to purchase. Six sites have planning (2,676 beds) with three remaining sites progressing through planning. At present one development is forward sold (511 beds) and four developments (2,088 beds) are in legal negotiation for sale. Some of the company's larger 2019 schemes will also contribute to FY 2017 and 2018 performance, in particular the 511 bed scheme in Stratford for the University of London, which in terms of development value is Watkin Jones' largest ever project by development value. For 2020, two sites have been secured and one is in legal negotiations to purchase. A number of additional site acquisitions are also progressing. Therefore, at present the company has a total of 20 developments due for completion by FY2018, of which 15 are already forward sold and 5 are in legal negotiation for sale. Current demand remains strong with seven student accommodation developments (2,580 beds) being sold since is 1 October 2016. In addition to this, nine are in legal negotiation (3,649 beds) with a total development value of 292m. This is more than double the value of sites forward sold or entered into legal negotiations in the equivalent period in 2016. 4 www.equitydevelopment.co.uk
2 June, 2017 Watkin Jones plc Summary All of the fundamental drivers for Watkin Jones are positive in our opinion. From an asset perspective institutional demand for both student accommodation and BTR is strong. From an asset management perspective, Fresh and Five Nine offer the group the benefits of annuity style management income. When we look at demand from a consumer perspective, demand for quality accommodation from students and renters is also positive. Couple these drivers with the fact that the company has an excellent management team and a strong balance sheet, it could be argued that the stock looks inexpensive given the growth opportunity. Valuation The company's model is such that, in our opinion, a PER and Dividend Yield based valuation technique is logical. This also helps us take account of the fact that it has a strong forward sold position and asset management divisions. The stock trades on a September 2017 PER of 14.1x falling to 12.9x with a 2017 dividend yield of 3.5%. For investors who bought at the IPO price of 100p the current dividend yield on acquisition is 6.6%. At present, the housebuilding sector trades on an average PER for 2017 of 10.5x. The sector enjoys reasonable visibility, but not the same degree of visibility that Watkin Jones enjoys, and this company has the added growth opportunities within property management and the build to rent sector. Whilst some traditional Housebuilders also have BTR opportunities, it represents a smaller opportunity relative to the overall size of the business. Watkin Jones currently trades at a 35% premium to the sector on PER but we would argue that it could justify a larger premium at this stage of the cycle. We conclude that Watkin Jones offers better medium term visibility and growth than the average Housebuilder and should therefore trade at a 30-50% PER premium to the Housebuilding sector. www.equitydevelopment.co.uk 5
Watkin Jones plc 2 June, 2017 Income Statement m, Y/E 30 September 2015 2016 2017E 2018E 2019E Revenues Student Accommodation 228.2 237.2 243.4 260.8 276.1 % change 9% 3.9% 2.6% 7.2% 5.9% Fresh (Student Living) 0 2.8 5.8 7.2 7.8 % change 0.0% 0.0% 107.0% 24.0% 8.0% Residential & Other 16.1 27.0 23.0 25.8 28.8 % change -12% 67.7% -15.0% 12.5% 11.5% Total Revenue 244.3 267.0 272.1 293.8 312.6 % change 5% 9.3% 1.9% 8.0% 6.4% Gross profit 44 53.8 60.4 65.1 68.4 % margin 18.0% 20.1% 22.2% 22.2% 21.9% Gross Profit Student Accommodation 41.5 48.6 53.3 56.6 59.1 margin % 18% 21% 22% 22% 21% Fresh (Student Living) 0 1.7 3.5 4.3 4.7 margin % 0.0% 59% 60.0% 60.0% 60.0% Residential & Other 2.5 3.6 3.6 4.2 4.7 margin % 16% 13% 16% 16% 16% Central Overheads -11.1-15.3-18.5-19.7-20.0 Depreciation & Amortisation -0.5-0.6-1.0-1.0-1.0 Operating Profit 32.5 37.9 40.9 44.4 47.4 % margin 13.3% 14.2% 15.0% 15.1% 15.2% Interest -0.7-1.0-1.0-0.7-0.7 JV's 1.2 3.0 2.6 2.8 3.0 Exceptionals 0-26.6 0.0 0.0 0.0 Reported PBT 32.9 13.2 42.5 46.5 49.7 PBT 32.9 39.8 42.5 46.5 49.7 Tax -6.3-8.2-8.5-9.57-10.0 Tax rate % 19.1% 20.6% 20.0% 20.0% 20.0% Reported PAT 26.6 5.0 34.0 36.9 39.7 PAT 26.6 31.6 34.0 36.9 39.7 Number of shares (diluted) m 255 255.0 255.3 255.3 255.3 EPS, p 10.4 12.4 13.3 14.5 15.6 % change 141% 18.8% 7.5% 8.5% 7.6% Share price p 187 Market cap m 477.2 Source: Company historic data and ED forecasts 6 www.equitydevelopment.co.uk
2 June, 2017 Watkin Jones plc Dividends Our dividend forecasts are set out in the following table: Dividends Y/E 30 September 2015 2016 2017E 2018E 2019E DPS p 0 4.0 6.6 7.2 7.9 DPS growth rate 64.9% 8.5% 9.7% Dividend Yield 2.1% 3.5% 3.8% 4.2% Dividend Cover x 3.1 2.0 2.0 2.0 Source: Company historic data and ED forecasts www.equitydevelopment.co.uk 7
Watkin Jones plc 2 June, 2017 Cash Flow m, Y/E 30 September 2015 2016 2017E 2018E 2019E Operating Profit 32.5 37.9 40.9 44.4 47.4 Depreciation & Amortisation 0.5 0.6 1 1 1 EBITDA 33.0 38.5 41.9 45.4 48.4 Working Capital -0.2 13.4 5.2-6.5-15.6 Other -2.1-1 0 0 0 Operating Cash Flow 30.7 50.9 47.1 38.9 32.8 Net interest -0.8-1.0-1.0-0.7-0.6 JV Income 2.6 3 2.9 2.8 3 Tax -2.8-8.5-8 -8.7-9.3 Net Operating Cash Flow 29.7 44.4 41.0 32.3 25.9 Investments -0.4 5.8 0 0 0 Capex 0 0-0.4-0.4-0.5 Free Cash Flow 29.3 50.2 40.6 31.9 25.4 Acquisitions / Disposals 0-14.5 0 0 0 Cash Flow before Financing 29.3 35.7 40.6 31.9 25.4 Equity 0 0 0 0 0 Borrowings 4.3-4.8 0.6 0.3 0 Dividends 0-3.4-12.4-17.0-18.8 Pre-IPO Dividend 0-39.3 0 0 0 Net Finance Lease -0.4-0.3 0 0 0 Cash Flow 33.2-12 28.8 15.2 7.0 Cash at start of year 25.9 59.2 47.2 76.0 91.2 Cash Flow 33.2-12 28.8 15.2 7.0 Cash at end of year 59.2 47.2 76.0 91.2 98.2 Total Debt (Incl finance leases) -20.2-15 -15.6-15.9-15.9 Net (Debt) / Cash 39.0 32.2 60.4 75.3 82.0 Source: Company historic data and ED forecasts 8 www.equitydevelopment.co.uk
Head of Corporate Gilbert Ellacombe Direct: 0207 065 2698 Tel: 0207 065 2690 gilbert@equitydevelopment.co.uk Investor Access Hannah Crowe Ben Ferguson Direct: 0207 065 2692 Direct: 0207 065 2693 Tel: 0207 065 2690 Tel: 0207 065 2690 hannah@equitydevelopment.co.uk ben.ferguson@equitydevelopment.co.uk 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 the subject matter of the note. 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 www.fisma.org ED may in the future provide, or may have in the past provided, investment banking services to Watkin Jones. 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 www.equitydevelopment.co.uk Equity Development, 15 Eldon Street, London, EC2M 7LD. Contact: info@equitydevelopment.co.uk 0207 065 2690