We first recommended Rubicon Europe Trust last September, after which time the Trust performed well. However, back in March, Rubicon Europe decided to extend its activities into mortgage financing, and this resulted in a sharp share price reversal as investors re-assessed the Trust's risk profile.
| "... while its assets may be sound, the high loan-to-valuation ratio on these assets increases their risk." |
The move into the high yield mortgage financing segment was accomplished by a substantial debt and equity raising. At the time, we recommended Members not to take up the offer, as we were concerned about the altered risk characteristics.
Following the capital raising, we thought that the rapid share price decline had factored in most of the increased risk, and that a healthy dividend yield should provide support, so we continued to hold.
However, changes in the market environment now warrant greater caution. In light of current credit market conditions, we believe that investors will continue to shun the Trust, given that the new financing arm exposes it to a higher level of uncertainty.
We make the point that the assets supporting the loan book are not of the sub-prime variety. Most represent secure, low vacancy assets in the UK and Europe, including retirement homes and prime location hotels.
However, while its assets may be sound, the high loan-to-valuation ratio on these assets increases their risk.
The Trust's asset structure has weakened with the high-yield loans now accounting for 27 percent of total assets. Having said this, other metrics remain robust, with a prospective yield of 10.2 percent, a price to book ratio of 0.81 times and a price to earnings ratio of 9.3 times.
While these metrics paint a picture of a 'cheap' security, we believe the Trust could remain cheap for some time, given the risks involved.
Furthermore, as we have seen in the last week, the investing crowd has become more risk-averse. We therefore do not see REU achieving a re-rating anytime soon. Keeping opportunity costs in mind, we believe investors would be better off selling out of REU and re-deploying capital elsewhere.
Consensus Valuation Estimates
|
2007 |
2008 |
| Price to earnings ratio |
9.3 |
9.5 |
| Net dividend yield |
10.2% |
10.5% |
| Price to book value |
0.8 |
0.8 |
| Return on Equity |
10.0% |
8.6% |
Bloomberg
The charting outlook supports our cautious fundamental view. The price softness of the past six months is clearly dominating the near-term outlook. And although support at 95 cents has held twice this month, persistent downward momentum threatens a break below here in the months ahead.
Given the limited upside and the opportunity cost of continuing to hold, we recommend Members sell REU around 98 cents.
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