With the stock market still sliding downhill, bargains in the FTSE 250 aren’t exactly hard to find today. But there’s one business in particular that looks so oversold that I couldn’t help but add some shares to my portfolio earlier this week.
The stock is Warehouse REIT (LSE:WHR), and it only joined the index in September before tumbling by 25%! Let’s explore what happened and why I think a fantastic buying opportunity has emerged.
A new bargain in the FTSE 250 index
Warehouse REIT is quite a young enterprise, with its IPO dating back to 2017. As the name suggests, the group is a warehouse operator that focuses on serving primarily the e-commerce fulfilment industry.
The business model is simple:
- Buy a well-positioned dilapidated property at a low price
- Renovate and lease the space to businesses
- Sell the property for a profit when no longer needed
- Repeat
The group has acquired 8.5 million sq ft of premium leasable space, generating £44m in annualised contracted rent.
The drop in consumer spending has undoubtedly impacted the online retail space. Yet despite this, the firm’s occupancy rate remains strong at 93.7%, with an average lease term of 5.6 years. Half a decade is relatively short compared to some of its peers that boast 10+ years of lease agreements. However, as Warehouse REIT’s client portfolio consists mainly of small- and medium-sized enterprises, this isn’t too alarming.
With long-term demand for e-commerce unlikely to disappear, the need for the group’s logistical solutions isn’t going anywhere. At least, that’s what I think. And with a five-year consecutive track record of raising dividends, this FTSE 250 stock looks like an excellent addition to my income portfolio. Even more so now that its market capitalisation is lower than its net asset value!
Understanding the risk
Following the chaos surrounding the announcement of the new UK government’s mini-budget, Warehouse REIT’s share price plummeted. Why?
Economists predicted that the proposed tax cuts would lead to higher inflation. And the Bank of England responded by saying they would raise interest rates to whatever level necessary to get inflation under control.
This turn of events understandably created concern among real estate investors. After all, buying property isn’t cheap, and debt is often the tool of choice to finance such transactions. If interest rates rise, it puts more pressure on profit margins and, in turn, dividends. That’s why shares of this FTSE 250 company were hit hard, along with its peers.
Yet, upon closer inspection, I believe investors have overreacted. Warehouse REIT has around £283m in debt on its balance sheet. When comparing the interest rates on its loans to operating rental income, the group has solid coverage of more than five times. This creates a robust buffer to absorb the impact of future potential rate hikes.
However, getting further into the weeds reveals the group’s interest rates on its loans are fixed at a maximum of 1.75% until November 2023. And with inflation already starting to fall and the government performing a U-turn on some of its tax cuts, I don’t believe the impact on Warehouse REIT will be as severe as most are assuming.
That’s why, despite the risk, I’ve just added this FTSE 250 stock to my portfolio.