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How Should You Analyze REIT Stock Picton Property Income Limited (LON:PCTN)?

Simply Wall St

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Picton Property Income Limited is a UK£517m small-cap, real estate investment trust (REIT) based in Saint Peter Port, Guernsey. REITs own and operate income-generating property and adhere to a different set of regulations. This impacts how PCTN’s business operates and also how we should analyse its stock. In this commentary, I'll take you through some of the things I look at when assessing PCTN.

View our latest analysis for Picton Property Income

REIT investors should be familiar with the term Fund from Operations (FFO) – a REIT’s main source of cash flow from its day-to-day business activities. FFO is a higher quality measure of earnings because it takes out the impact of non-recurring sales and non-cash items such as depreciation. These items can distort the bottom line and not necessarily reflective of PCTN’s daily operations. For PCTN, its FFO of UK£25m makes up 66% of its gross profit, which means the majority of its earnings are high-quality and recurring.

LSE:PCTN Historical Debt, July 15th 2019

In order to understand whether PCTN has a healthy balance sheet, we have to look at a metric called FFO-to-total debt. This tells us how long it will take PCTN to pay off its debt using its income from its main business activities, and gives us an insight into PCTN’s ability to service its borrowings. With a ratio of 13%, the credit rating agency Standard & Poor would consider this as significantly high risk. This would take PCTN 8 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 PCTN’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 2.77x, PCTN is not generating an appropriate amount of cash from its borrowings. Typically, a ratio of greater than 3x is seen as safe.

In terms of valuing PCTN, FFO can also be used as a form of relative valuation. Instead of the P/E ratio, P/FFO is used instead, which is very common for REIT stocks. PCTN's price-to-FFO is 20.46x, compared to the long-term industry average of 16.5x, meaning that it is overvalued.

Next Steps:

As a REIT, Picton Property Income offers some unique characteristics which could help diversify your portfolio. However, before you decide on whether or not to invest in PCTN, I highly recommend taking a look at other aspects of the stock to consider:

  1. Valuation: What is PCTN 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 PCTN is currently mispriced by the market.
  2. Management: Who are the people running the company? Experienced management and board are important for setting the right strategy during a volatile market. Take a look at information on PCTN's executive and directors here.
  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.