The real estate investment trust (REIT) sector saw a major merger agreed on Wednesday. Shopping centre operators Intu (LSE: INTU) and Hammerson(LSE: HMSO) will combine to create a significant player in the sector. Together they will have a £21bn portfolio of high-quality retail and leisure destination which stretches across the UK and Europe. Could this be the start of a period of consolidation across the sector?
The right deal?
The merger of the two companies will take place via an all-share transaction. Shareholders in Intu will receive 0.475 New Hammerson shares for each share they currently own. This places a premium of 27.6% on the Intu share price as at close of business on 5 December 2017. This may appear to be a generous deal for the company's investors - especially given the uncertainty in the UK retail sector at present.
However, it could also be argued that the deal undervalues the company. In fact, the £3.4bn purchase price for Intu is just 67% of its net asset value of £5.05bn. This suggests that there may be significant upside potential ahead for investors in the merged entity if the new strategy is able to gain traction and is welcomed by the stock market.
Clearly, a merger of this scale is set to have significant synergies. Already £2bn of asset disposals are being highlighted by the companies. In addition, cost savings seem likely, while a focus on higher-growth regions such as Ireland and Spain could bring increasing earnings and dividend growth in future. It may also bring additional sources of capital which allow the combined entity to expand its Premium Outlets Platform.
Therefore, the merger seems to be a logical step for the two companies to take, with it having the potential to drive improved operational, financial and share price performance in the long run.
The REIT sector seems to be somewhat undervalued at the present time. When combined with an uncertain outlook driven by Brexit, this could lead to further consolidation across the sector. Two companies which appear to offer good value for money at present are Big Yellow(LSE: BYG) and Londonmetric(LSE: LMP).
Big Yellow has a price-to-book (P/B) ratio of just 1.5, which appears to be relatively low given its profit growth potential. The company has a dominant position in the UK storage sector and this could help to protect it to some degree from the potential headwinds within the economy.
The company is forecast to grow its bottom line by 8% next year, which suggests that it offers a degree of defensive characteristics. As well as this, a dividend yield of 3.6% which is due to rise to 3.9% next year, indicates that it offers strong income potential. With a sound strategy that has delivered earnings which have risen 3.3 times over the last four years, Big Yellow could be a potential bid target in future.
Similarly, Londonmetric appears to be cheap at the present time. It trades on a P/B ratio of 1.2, which is relatively low given its forecast growth rate of 5% per annum during the next two financial years. The company also has a strong income outlook. It has a dividend yield of 4.5% forecast for the next financial year, which could help its investors to overcome the threat of inflation. And with a strategy that has delivered four years of consecutive earnings growth, it appears to offer stability at a time when the outlook for the wider economy is uncertain.
Clearly, it's difficult to select which companies could become bid targets. However, Big Yellow Group and Londonmetric both offer impressive investment outlooks and, with such low valuations, they could be attractive to a number of sector peers.
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Peter Stephens owns shares of Big Yellow. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.