• Initiate BUY with GBP0.31 TP, 24% upside and 11% yield. Elite UK REIT – the only pure-play UK REIT focusing mainly on social infrastructure assets– is on a firm recovery path after addressing key issues of lease renewals, gearing, and debt refinancing. With market conditions turning favourable we see tailwinds from a stable new pro-labour government, increased rate cut odds, and economic growth. We believe this turnaround is yet to be priced in, as Elite offers attractive c.11% yield and trades at >30% discount to book.

• Income certainty till mid-2028, with c.97% of its UK government-backed leases locked in until then. A key investor concern: The concentration risk of government leases and likelihood of lease renewals in 2028. Based on our recent ground visit, and management and tenant discussions, we see a strong likelihood of >90% of such leases being renewed for the longer term before expiry. Management is aware of this overhang, and is proactively working with local authorities and government bodies to de-risk this before end 2026.

• DPU to turn around in FY25. We expect Elite’s DPU to bottom out in FY24 with a 12% YoY decline, mainly due to its enlarged unit base and higher financing costs. With planned disposals of vacant assets by early next year, we expect operational costs to lower significantly and result in higher FY25 net property income (NPI) margins, while financing costs ought to stabilise from anticipated rate cuts, resulting in a sustained earnings turnaround.

• Moving towards c.40% gearing target with good sponsors and major shareholders’ support. Elite raised GBP28m via a preferential offer in January to address its high gearing, thereby bringing net gearing to a comfortable c.42%. We think this offering has substantially de-risked its risk profile and was well supported by its sponsors and key shareholders (Appendix A). Additionally, sponsor Sunway (SWB MK, BUY, TP: MYR5) further subscribed for excess units, which doubled its stake in Elite to 11.2%, underlining its long-term commitment. With planned asset disposals and proceeds from dilapidation income, we see gearing lowering further by FY25.

• Macro conditions turning more favourable. UK inflation cooled to +2% YoY in June, hitting Bank of England’s target range, with the market pricing in 45% odds for rate cuts in August, followed by another before end 2024. This will have a positive effect on Elite’s floating rate loans and could also result in higher asset valuations in FY25, in our view. Additionally, the UK economy in May grew 0.4% MoM, doubling market expectations. The return of a Labour Party-led government is positive for Elite’s social infrastructure assets – it is also likely to provide more regulatory clarity on polices governing the real estate sector. As the 3.1 ESG score is in line with the country median, we ascribe a 0% ESG premium/discount to the TP.

Source: RHB Research - 24 Jul 2024