Upgrading Segro PLC To A Strong Buy

Dear Landlords,

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Roundtable Discussion With Segro PLC - EPRA ReThink Conference (Strong Buy Upgrade)

Segro PLC (SGRO / ) is our biggest industrial real estate investment in Europe. 

When we invested in it two years ago, we favored it relative to its peers because of five key reasons:

• Great urban assets: Segro is one of the leading industrial REITs in the UK and central Europe. It owns mainly urban facilities that enjoy significant barriers to entry and rapid growth prospects. Moreover, we also think that its rents are deeply below market, which provides a predictable path to growth as its leases gradually expire. Finally, it also owns a large land bank, which should allow it to significantly boost its cash flow as it develops new properties. 

• Alpha-rich strategy: The company is able to develop properties from the ground-up to earn yields of 7-8%, but these properties are really worth a 5% cap rate. As such, it is creating significant value for shareholders instead of simply buying what the market has to offer at low cap rates, which is what most investors are doing. Moreover, the company also has an asset management arm, which allows it to leverage the capital of others to boost its returns by earning additional fees. This typically results in 200 basis point higher initial returns for Segro's capital. They estimate that the yield on new money that they deploy is about 10% at this time.

• Strong balance sheet: The company has little debt with a 20% LTV and its maturities are long at 9 years with no major maturities until 2026. Since then, the value of its assets as dropped a bit due to cap rate expansion, but even then, its LTV is today just 30%. It is also able to consistently sell 1-2% of its assets each year to redeploy it into new higher yielding projects and grow externally without having to tap the public equity market.

• Rapid growth prospects: Its rents are deeply below market, its leases include annual rent escalations, it owns a large land bank, and it has the financial capacity to keep developing new properties at high cap rates all while also earning fees from third party capital management. All in all, we expect this to result in double-digit annual FFO per share growth over the long run. Even in today's tough environment, it has still managed to grow its FFO per share by 7% so far this year. 

• Discounted valuation: when we invested in it two years ago, it was just as cheap as its close peers, despite owning better assets and having less leverage. It then traded at a 42% discount to its net asset value, which was truly exceptional for a REIT of this quality. Finally, we also noted in our thesis that the British Pound was historically cheap, resulting in a 'double discount' for US based investors who could profit from additional currency gains in the following years. 

Since then, Segro has recovered nicely.

It has earned us a 60% total return in just two years as its discount to NAV closed down and the British Pound also recovered: 

Data by YCharts

But what now? Is it still a good investment opportunity? Or is it too late to get involved?

I was hesitant and even considering to downgrade it to a Hold rating. 

But after attending the EPRA ReThink conference and meeting with their team, I have decided to upgrade it to a Strong Buy rating.

I got to participate in a roundtable discussion with Claire Mogford, who is the Head of Investor Relations at Segro, and she helped me discover a new angle to the thesis that I had overlooked so far. 

This angle is that of data centers.