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LondonMetric Property Plc is a UK£1.4b small-cap, real estate investment trust (REIT) based in London, United Kingdom. REITs are basically a portfolio of income-producing real estate investments, which are owned and operated by management of that trust company. They have to meet certain requirements in order to become a REIT, meaning they should be analyzed a different way. I’ll take you through some of the key metrics you should use in order to properly assess LMP.
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Funds from Operations (FFO) is a higher quality measure of LMP's earnings compared to net income. This term is very common in the REIT investing world as it provides a cleaner look at its cash flow from daily operations by excluding impact of one-off activities or non-cash items such as depreciation. For LMP, its FFO of UK£52m makes up 58% of its gross profit, which means the majority of its earnings are high-quality and recurring.
Robust financial health can be measured using a common metric in the REIT investing world, FFO-to-debt. The calculation roughly estimates how long it will take for LMP to repay debt on its balance sheet, which gives us insight into how much risk is associated with having that level of debt on its books. With a ratio of 8.1%, the credit rating agency Standard & Poor would consider this as aggressive risk. This would take LMP 12.37 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 LMP'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 3.43x, it’s safe to say LMP is generating an appropriate amount of cash from its borrowings.
I also use FFO to look at LMP'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 LMP’s case its P/FFO is 27.68x, compared to the long-term industry average of 16.5x, meaning that it is overvalued.