Some people buy value stocks for the potential for long-term capital appreciation. This isn’t a bad idea, but it can also be combined with the ability to source good income shares as well. That way, someone could get paid a generous yield while waiting for the share price to rally. Here’s one stock that could tick both boxes.
A trip to Europe
I’m talking about the Schroder European Real Estate Investment Trust (LSE:SREI). Over the past year, the stock has fallen by 9%, but it has a dividend yield of 8.58%.
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At its core, the trust invests in commercial real estate across Europe (as the name suggests). If we’re being a bit more specific, it’s offices and logistics hubs in countries such as Germany and France. The aim is to buy properties, collect rent, improve the buildings over time, and ultimately grow both rental income and asset values.
That rental income is the main source of the trust’s income. On top of that, the managers hope that properties will appreciate over time, boosting the portfolio’s net asset value (NAV). Talking about the NAV, the share price currently trades at a 42% discount to it. Given that the portfolio of properties should closely match the NAV, this could indicate the stock is undervalued. Over the coming years, this discount could narrow, which is why some see it as a value stock right now.
The dividend outlook
Aside from the potential share price gains, the dividend yield is exceptionally attractive. The trust typically pays a quarterly dividend, with the dividend cover of 1.2. This means that the earnings per share easily cover the dividend, which is a good sign that things are sustainable.
Looking ahead, a big factor (and one that has driven most of the stock’s decline over the past year) is interest rates. Interest rates staying higher for longer have negatively impacted trust, as investors had to readjust their expectations. Further, with the energy price shock, there’s the potential for interest rates in Europe to rise this summer. This makes borrowing more expensive for real estate purchases, reducing profits and future growth potential.
Even though that’s a risk going forward, it could be easily resolved if the conflict in the Middle East ends in the coming months. Not only would this ease pressure to raise interest rates, but it could also improve sentiment on corporates committing to longer leases on sites, as the business outlook would be more stable.
The bottom line
It’s true that the discount to the NAV could remain for several years. Yet during this period, the dividend payments more than compensate for this. It’s not a low-risk stock by any means, but I think it’s worthy of consideration for investors who are aware of the risks.
Jon Smith has no positions in the shares mentioned.
