Although I’m hugely sceptical about Russia politically – let’s agree not to talk about the activities of their spy agencies – I am slightly more optimistic about prospects for the Russian economy. The oil price is much higher than we all expected and the Russian state is actually fairly conservative in its finances – debt levels are falling and the poor old Russian consumer has started spending a bit more in the last year or so. There are of course all the usual caveats that have to be put in place (where do we start!) but for the contrarian amongst you, betting on the Russian consumer doesn’t seem a bad place to start.
One way into this big narrative is via Raven Russia, a London listed Russian property fund that invests in high-grade logistics warehouses in key Russian cities – with Moscow dominating at 70% of lettable area) along with St Petersburg (18% of portfolio). The management of this UK firm are well respected Russian veterans who clearly know a thing or two about surviving in the local property scene and it strikes me that this is a classic public to private markets trade – at some point. The UK market will never properly value this business as it can’t quite its head around the obvious policy and execution risk – investors also fret about the high levels of debt. As of December 31st the business had total debt of $847m on a LTV of 53%, with the average weighted cost running at 7.62% and an average maturity of 4.5 years. No matter how well the fund does, these fears will not subside and the discount – currently at around 22% – probably won’t budge much. That, in turn, makes Raven a quite attractive private equity target for the right buyer – who understands Russia and all the obvious risks.
In the meantime, Raven sticks to its knitting – and produces decent results. Recent full-year numbers (to 31 December 2017) show a 10% increase in net operating income and a 13% increase in NAv – to 77 cents or 55p. If we include the proposed tender offer, that NAV increases by 17%. According to analysts at Numis Raven Russia added four new assets in two transactions, for an aggregate consideration of $209m, representing attractive pricing relative to replacement cost. These were part funded by the issue of convertible preference shares in July 2017, raising $126m. Occupancy levels currently stand at 81% (78% in Moscow, 90% in St Petersburg, 84% Regions). “As at 31 December, the investment portfolio was valued at $1.57bn and comprised 1.8m sq m of Warehouse (94%) and Office space which generated $145m of Net Operating Income. Moscow assets (70% portfolio by lettable area) now yield between 11.25-12.5% (down from 12-13% in 2016), and both St Petersburg (18% portfolio) and regional assets (12% portfolio) now yield 12.5%, down 75bps from 13.25% a year ago.”
These numbers tell us the story about Raven in a quick snapshot. Most other logistics park based funds trade at substantial premiums to NAV, with underlying property yields probably not running that much over 7% pa (at a push). With Raven, net yields are in the low double digits, and the trade here is obvious – as Russia becomes more mainstream (!?), those yields will pull back into the single digits, realising more NAV gains. in the meantime, Raven needs to find more local debt to keep rolling out new developments and focus on generating enough cash to pay for its existing dollar-denominated debt.
As for investors, there’s a complicated structure to deal with. Here’s a summary from Edison (who provide paid for research to Raven):
“The ordinary shares receive variable distributions and would benefit fully from any growth in NAV or discount narrowing (c 27% currently). The 4p distribution declared for 2017 represents a yield of 9.3% on the ordinary shares. We believe this partly reflects the non-recurring gains at Raven Mount and we assume a lower distribution for 2018 and 2019 of 3p per share in each year, a yield of 7.0%. Our assumed distribution is relatively high compared with forecast earnings, more so in 2019, but as noted above, a full deployment of cash resources on cash-generative acquisitions has the potential to substantially lift earnings and cash flow above the forecast levels. The convertible preference shares (RUSC) rank ahead of other share classes in terms of dividend payments and receive a cumulative 6.5% preferential dividend on the subscription amount of 100p, a yield of 5.4% on the current price of 120.5p. The convertible preference shares can be converted into ordinary shares at any time up to July 2026, currently at a rate of 1.779 (equivalent to 67.7p per ordinary share at the current price).”
The dividend yield is largely through the frequent tenders to investors – the current one is in effect distributing the equivalent of 4p for each share which equates to a technical yield of 9.3%. Most analysts expect that to decline to 3p in the future, implying a 7% yield. My own slight preference is for the convertible preference shares where you get a cash distribution which is equivalent to a 5.4% yield, and you also get any upside in the equity price if the shares trade (or exit) above 67p a share. If we assume another two to three years of strong 15 to 20% NAV uplifts, we could see a NAV per share of $1 by 2020. That, in turn, could drag the share price up to around 70 to 80p, which would could in turn, kick in a share price uplift for the convertibles.