Is Civitas Social Housing PLC (LON:CSH) A Healthy REIT?

Civitas Social Housing PLC is a UK£500m small-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 CSH is unique and it has to adhere to different requirements compared to other non-REIT stocks. I’ll take you through some of the key metrics you should use in order to properly assess CSH.

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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 CSH’s daily operations. For CSH, its FFO of UK£23m makes up 65% of its gross profit, which means the majority of its earnings are high-quality and recurring.

LSE:CSH Historical Debt, August 7th 2019
LSE:CSH Historical Debt, August 7th 2019

In order to understand whether CSH 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 CSH to pay off its debt using its income from its main business activities, and gives us an insight into CSH’s ability to service its borrowings. With a ratio of 11%, the credit rating agency Standard & Poor would consider this as aggressive risk. This would take CSH 9 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.

I also look at CSH's interest coverage ratio, which demonstrates how many times its earnings can cover its yearly interest expense. This is similar to the concept above, but looks at the upcoming obligations. The ratio is typically calculated using EBIT, but for a REIT stock, it's better to use FFO divided by net interest. With an interest coverage ratio of 6.2x, it’s safe to say CSH is generating an appropriate amount of cash from its borrowings.

I also use FFO to look at CSH'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 CSH’s case its P/FFO is 21.42x, compared to the long-term industry average of 16.5x, meaning that it is overvalued.

Next Steps:

In this article, I've taken a look at Funds from Operations using various metrics, but it is certainly not sufficient to derive an investment decision based on this value alone. Civitas Social Housing can bring about diversification for your portfolio, but before you decide to invest, take a look at the other aspects you must consider before investing:

  1. Future Outlook: What are well-informed industry analysts predicting for CSH’s future growth? Take a look at our free research report of analyst consensus for CSH’s outlook.

  2. Valuation: What is CSH 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 CSH 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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