Investing In Property Through Derwent London Plc (LON:DLN)

By
Simply Wall St
Published
June 09, 2019
LSE:DLN
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Derwent London Plc is a UK£3.6b mid-cap, real estate investment trust (REIT) based in London, United Kingdom. REIT shares give you ownership of the company than owns and manages various income-producing property, whether it be commercial, industrial or residential. The structure of DLN is unique and it has to adhere to different requirements compared to other non-REIT stocks. Below, I'll look at a few important metrics to keep in mind as part of your research on DLN.

View our latest analysis for Derwent London

Funds from Operations (FFO) is a higher quality measure of DLN's earnings compared to net income. This term is very common in the REIT investing world as it provides a cleaner look at its cash flow from daily operations by excluding impact of one-off activities or non-cash items such as depreciation. For DLN, its FFO of UK£115m makes up 62% of its gross profit, which means the majority of its earnings are high-quality and recurring.

LSE:DLN Historical Debt, June 10th 2019
LSE:DLN Historical Debt, June 10th 2019

Robust financial health can be measured using a common metric in the REIT investing world, FFO-to-debt. The calculation roughly estimates how long it will take for DLN to repay debt on its balance sheet, which gives us insight into how much risk is associated with having that level of debt on its books. With a ratio of 12%, the credit rating agency Standard & Poor would consider this as aggressive risk. This would take DLN 8.5 years to pay off using just operating income, which is a long time, and risk increases with time. But realistically, companies have many levers to pull in order to pay back their debt, beyond operating income alone.

Next, interest coverage ratio shows how many times DLN’s earnings can cover its annual interest payments. Usually the ratio is calculated using EBIT, but for REITs, it’s better to use FFO divided by net interest. This is similar to the above concept, but looks at the nearer-term obligations. With an interest coverage ratio of 6x, it’s safe to say DLN is generating an appropriate amount of cash from its borrowings.

I also use FFO to look at DLN's valuation relative to other REITs in United Kingdom by using the price-to-FFO metric. This is conceptually the same as the price-to-earnings (PE) ratio, but as previously mentioned, FFO is more suitable. In DLN’s case its P/FFO is 31.46x, compared to the long-term industry average of 16.5x, meaning that it is overvalued.

Next Steps:

Derwent London can bring diversification into your portfolio due to its unique REIT characteristics. Before you make a decision on the stock today, keep in mind I've only covered one metric in this article, the FFO, which is by no means comprehensive. I'd strongly recommend continuing your research on the following areas I believe are key fundamentals for DLN:

  1. Future Outlook: What are well-informed industry analysts predicting for DLN’s future growth? Take a look at our free research report of analyst consensus for DLN’s outlook.
  2. Valuation: What is DLN worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether DLN is currently mispriced by the market.
  3. Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.

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