Leasing Momentum And Index-Linked Rents Will Support Office Recovery And Income Resilience

Catalysts

About CLS Holdings

CLS Holdings is a diversified office-focused property investment group operating across the U.K., Germany and France.

What are the underlying business or industry changes driving this perspective?

• Accelerating leasing momentum in core urban office markets, combined with employers requiring more space per employee and staff back in the office, should drive down vacancy in London, Germany and France and lift contracted rent and net rental income.
• Execution of the GBP 400 million disposal and degearing program into increasingly active investment markets is expected to lower LTV into the 35% to 45% range, reduce refinancing risk and gradually improve net margins via a lower cost of debt.
• Delivery of major refurbishment and development projects such as Citadel Place, the Brix, the Yellow and Debussy, alongside selective residential conversions, should upgrade portfolio quality, support higher ERVs and enhance earnings growth once schemes are fully let.
• Rising proportion of index-linked and CPI-linked leases, especially with long term government and municipal tenants in Germany and France, is likely to provide embedded rent uplifts that support revenue resilience and protect EPS in a gradually improving macro environment.
• Focused capital allocation into energy efficiency upgrades and higher EPC ratings, aligned with tightening environmental regulation, should future proof assets, sustain occupancy and rents and support valuation recovery, underpinning net tangible assets and long term earnings.

Assumptions

How have these above catalysts been quantified?

• Analysts are assuming CLS Holdings's revenue will decrease by 14.2% annually over the next 3 years.
• Analysts assume that profit margins will increase from -39.0% today to 54.6% in 3 years time.
• Analysts expect earnings to reach £50.4 million (and earnings per share of £0.11) by about December 2028, up from £-56.9 million today.
• In order for the above numbers to justify the price target of the analysts, the company would need to trade at a PE ratio of 9.1x on those 2028 earnings, up from -4.2x today. This future PE is lower than the current PE for the GB Office REITs industry at 9.2x.
• Analysts expect the number of shares outstanding to remain consistent over the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 12.92%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• Office valuations in the U.K., Germany and France may remain under pressure for longer than expected if structural demand for traditional office space weakens again, prolonging the recent 1.6 percent valuation decline and constraining net tangible assets and future earnings growth.
• The deliberate increase in vacancy to reposition assets, such as New Printing House Square and other development or refurbishment projects, may take longer to relet or achieve below expected rents, keeping contracted rent and net rental income depressed while fixed operating and financing costs remain.
• The GBP 400 million disposal and degearing program could crystallize value at discounts in weaker submarkets or during a slow recovery, locking in lower prices and leaving a smaller income producing portfolio, which would weigh on revenue and earnings even if leverage improves.
• Refinancing beyond 2025 might become more expensive or harder to secure if credit conditions tighten again or property values fall further, limiting the benefit from the current 3.75 percent cost of debt and potentially squeezing net margins and EPRA EPS.
• Large, long duration index linked leases with government and municipal tenants provide stability, but if inflation remains structurally lower or public sector budgets tighten, future indexation and expansion demand could be weaker than anticipated, tempering rental growth and slowing any recovery in earnings and dividends.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The analysts have a consensus price target of £0.8 for CLS Holdings based on their expectations of its future earnings growth, profit margins and other risk factors.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of £1.0, and the most bearish reporting a price target of just £0.7.
  
• In order for you to agree with the analysts, you'd need to believe that by 2028, revenues will be £92.3 million, earnings will come to £50.4 million, and it would be trading on a PE ratio of 9.1x, assuming you use a discount rate of 12.9%.
  
• Given the current share price of £0.6, the analyst price target of £0.8 is 25.0% higher.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.