Value stocks are seemingly everywhere right now. The stock market is still mending from the damage caused by the recent correction, so plenty of businesses continue to trade at discounted valuations. This seems to be especially true in the real estate sector, where the uncertainty surrounding interest rates has investors spooked.
While there is some cause for concern, not every enterprise is in jeopardy. And one from my portfolio that I’m tempted to start adding more to is LondonMetric Property (LSE:LMP), especially since it may soon be joining the ranks of the FTSE 100.
Let’s take a closer look.
Commercial real estate empire
LondonMetric operates as a real estate investment trust (REIT). Its business model is fairly straightforward. It purchases a bunch of commercial properties across the country and then lease them to businesses, using the rental income to cover its own mortgages as well as pay shareholders a handsome dividend.
Looking at its asset portfolio, most of the group is concentrated in infrastructure related to logistics and warehousing. This has proved to be a smart managerial decision, given the rapidly rising level of demand being driven by the adoption of e-commerce.
With rental rates increasing in line with demand, the firm has been fairly consistent in expanding its cash flow. And so it’s not surprising to see that dividends have been hiked for eight years in a row.
The share price has been on a rollercoaster ride these past 18 months, due to rising interest rates. With inflation showing signs of cooling last October, the valuation enjoyed a bit of a rally. But since December, they’ve resumed a downward trajectory despite the underlying business continuing to thrive. What’s going on?
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Becoming an industry titan
The cost of debt has risen drastically, and using equity isn’t ideal either, with depressed valuations. As such, it seems management is turning towards a mergers and acquisitions strategy to secure growth in 2024. In fact, the firm has recently announced it’s in early-stage acquisition talks with LXi – a rival real estate manager.
Assuming this transaction is successful, LondonMetric Property would become the second-largest generalist REIT on the London Stock Exchange. It would be just behind the FTSE 100’s Land Securities Group. The resulting real estate portfolio would be worth an estimated £6.4bn. And it would consist of warehouses, supermarkets, hotels, retail outlets, and logistics centres.
Taking a step back
Becoming a new leader in the British real estate sector undoubtedly sounds terrific on the surface. But the process isn’t exactly straightforward. Ignoring all the challenges relating to regulatory approval of such a large takeover, integrating acquisitions of this scale can be problematic.
Should LXi’s assets fail to live up to expectations, the balance sheet may become compromised. After all, if the majority of the firm’s cash flow goes to paying off loans, that leaves little room for dividends. That’s likely why shares have slumped in recent weeks.
However, in my opinion, this risk may be worth taking. The company has a long and largely successful track record of executing acquisitions. Therefore, I’m tempted to drip-feed more money into my existing position. I’d want to capitalise on the long-term potential of this business at today’s discount.
