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It’s simple:

The business is growing and so are the opportunities coming our way.

Operating Review

Tenanted residential highlights

Operating contribution* increased by 22% to £81.9m

1,031 properties sold for £134.9m, generating a rise in trading profits to £59.1m and profit on disposal of fixed assets of £3.0m

1,042 residential units purchased for £118m

Year end portfolio of 12,041 units, investment value £1,329m, vacant possession value £1,865m

*Profit on ordinary activities before interest and taxation and excluding administration expenses

Tenanted residential

The scale of our tenanted residential activities has increased with the acquisition of the outstanding share of the Bromley joint venture. For the purposes of comparison in this division we have included our share of the results of the joint venture in last year’s tenanted residential performance figures; for statutory reporting purposes, the joint venture results are aggregated as one disclosure item.

Key performance statistics
  2004 2003
Properties sold 1,031 1,414
Sales value £m 134.9 139.4
Trading and fixed asset profits £m 62.1 51.2
Net rental income £m 17.8 14.9

The geographic strength of our portfolio is reflected by the range of growth in vacant possession sales values achieved in comparison to last year’s valuation, London and the South East showed growth levels of 7.7%, while the rest of the country showed 15.7%.

Geographic spread of our portfolio
  Investment value £m % of assets
London 551 41
South east 224 17
South west 79 6
East 91 7
East Midlands 47 3
West Midlands 129 10
Wales 8 1
Yorkshire 47 3
North west 124 9
North east 20 2
Scotland 8 1
Northern Ireland 1 -
  1,329 100

Our portfolio composition also helps dampen the volatility associated with the higher end of the market. The analysis below shows the number and value of properties we own by vacant possession value.

Range of vacant possession values (excluding ‘other interests’)
  No. of properties Vacant
possession
value £m
>£500k 58 38
£250k – £500k 963 320
£175k – £250k 2,593 540
£100k – £175k 4,867 676
<£100k 3,560 256
  12,041 1,830


The analysis of our portfolio by tenure is set out in figure 1, below.

A key feature of the tenure analysis is that the reversionary surplus (the difference between vacant possession and investment values) now amounts to £536m, or £21.61per share.

The average vacant possession value of our residential properties (adjusted to reflect the fact that many of our life tenancy assets are partially owned) at 30 September 2004 was £164,000 compared to last year’s figure of £144,000 (a 13.9% increase) and to the average UK house price of £163,000. Over recent years we have sold many of our lower value properties and, as we have comparatively few very high value properties, this has meant that the price range within our portfolio is tending to consolidate towards the UK average.

Acquisitions in the year totalled £118m. Of particular note were the portfolio purchases of 128 london based units for a consideration of £25m and 308 life tenancy units for £14.2m.

Figure 1 - Analysis of tenanted residential portfolio by tenure
  No. of
properties
Vacant
possession
value £m
Investment
value
£m
% of vacant
possession
value
Regulated 7,941 1,295 939 73
Assured 1,083 154 136 88
Vacant 356 55 49 89
Life tenancies 2,627 320 167 52
Hoteling complex – reviewed apartments 34 6 6 100
Other interests 35 32 91
30 September 2004 12,041 1,865 1,329 71
30 September 2003 12,030 1,648 1,164 71

Development and trading highlights

Operating contribution* increased by 74% to £25.3m

£25m of investment property sold at surplus of £3.5m

12.4 acres sold at Kennel Farm for £14.2m

Net income to date on Pimlico development £7.9m

Sales of 132 units worth £14.7m by Grainger homes, generating profit of £2.1m

*Profit on ordinary activities before interest and taxation and excluding administration expenses

Development and trading

Including profits on sales of fixed assets, net of valuation writedowns, and before administrative expenses this division contributed £25.3m (2003: £14.6m) as follows:

  2004
£m
2003
£m
Trading profits 13.5 10.3
Net profits on sale of fixed assets 3.5 1.9
Net rental income 0.4 1.9
Other income (Pimlico flats) 7.9 0.5
Operating profits 25.3 14.6

During the year we sold 12.4 acres of development land at Kennel Farm, Basingstoke for £14.2m generating profits of £10.7m. This now completes the sale of the major residential land blocks at this site. Since 1999 we have sold 78 acres for total revenues of £76.2m.

The opportunities for further income from Kennel Farm relate to the five acres allocated for business use, the local centre and to smaller residential land parcels totalling approximately seven acres, some of which is allocated for social housing. Given current market conditions and planning status we do not anticipate to benefit from the business use site until the financial year 2005/06.

We have disposed of the majority of our commercial investment portfolio, selling nine properties for £25.0m, representing a surplus of £3.5m over September 2003 values. We have written down the carrying value of our office development at Landmark place, Slough by £1m in the year.

Other income in this division relates principally to the Pimlico development with Network Housing Association. 70 flats have been sold for a total value of £37.3m generating income of £7.9m. a further eight flats remained to be sold and five of these have completed since the year end.

Satisfactory progress is being made on the other major projects in this division. See figure 2, below.

During the year, Grainger Homes sold 132 units for £14.7m at a profit of £2.1m. Activity in this division has increased and we hope to sell in the region of 150 units in 2004/05.

The review highlights that 2003/04 has been something of a one-off year for the development and trading division. Major sales in the commercial portfolio and at Kennel Farm together with the income from Pimlico flats have produced a contribution from the division which is unlikely to be repeated in the short-term.

Figure 2 - development and trading – overview of current projects
Project Description Status Income expected from
west waterlooville option over 640 acres mda masterplan approved by winchester havant and hampshire 2007+
macaulay road,clapham, sw4 110,000 sq. ft. mixed
use scheme
application submitted,decision awaited 2007+
south london hospital,sw4 77 residential units above
new tesco foodstore
construction commenced 2006/07
hornsey road and barnsbury complex, islington public/private partnership mixed use scheme, 350 residential units, 43,000 sq.ft. council office and community use contracts exchanged 2007+

Financial review highlights

Profit before taxation and exceptional interest up to £59.6m from £48.5m, an increase of 23%

Net asset value per share up by 25% to £27.34 from £21.94

Gearing at 103% (2003: 125%)

Refinancing in the year to give increased capacity and greater flexibility

Results

Contributions from the tenanted residential and development and trading divisions have increased by 29.6% to give group profit before interest and taxation of £99.7m (2003: £76.9m).

Administrative expenses

Administrative expenses have increased by 59.6% to £7.5m, largely as a result of the consolidation of the Bromley joint venture for the first time. These expenses represent 3.4% of turnover.

Interest payable

Net interest payable has increased to £40.1m, from £11.5m, again because of the consolidation of Bromley's figures. We also had an exceptional charge of £5.4m relating to interest payments arising on the early repayment of our fixed debt, performed as part of our refinancing exercise. The average interest rate payable in the year has been 5.8% (2003: 5.6%), the increase coming from the general upward movement in borrowing rates in the year: at 30 September 2003 three month libor stood at 3.7% and had increased to 4.9% a year later.

Pre-exceptional interest is covered 2.5 times by profit before interest and tax (2003: 2.7 times).

Taxation

Our annual tax charge is significantly affected by frs19, the accounting standard that prevents the provision of deferred tax on revaluation gains when companies are acquired. This serves to increase our effective tax rate which this year has been 39.1% (2003: 39.4%).

Earnings per share and dividends

Earnings per share before exceptional interest have increased by 25% to 149.7p from 119.8p and dividends by 42%. Dividends are covered 6.5 times by profit after taxation but before exceptional items and minority interest (2003: 7.3 times).

Financial position

General

Most of our properties are held as trading stock and are therefore shown in the balance sheet at cost. This does not reflect the true worth of Grainger assets and we set out in figure 4 below a statement of our net assets with the properties restated to market value.

Fixed assets

Fixed asset properties in the balance sheet comprise £97.0m tenanted residential and £8.4m commercial investment, totalling £105.4m (2003: £84.4m, £23.7m and £108.1m respectively).

Investment and intangible assets

Investments relate to our investment in schroders resput which has increased in value by £0.9m to £9.7m - book cost is £7.0m (2003: £7.0m) and a recent £3.3m investment in a limited liability partnership set up to develop land at smiths dock on tyneside.

The negative intangible asset of £84.8m (2003: £97.2m) principally reflects negative goodwill arising on the acquisition of Bromley. It is being released to the profit and loss account in line with sales from that portfolio.

Trading properties

Statutory balance sheet
  30 sept
2004
£m
30 sept
2003
£m
Tenanted residential 843 807
Development and trading 76 81
Total 919 888


Market value balance sheet
  30 sept
2004
£m
30 sept
2003
£m
Tenanted residential 1,232 1,080
Development and trading 101 106
Total 1,333 1,186

The cost of our tenanted residential stock has increased from £807m to £843m, the movement being stock purchases of £95m, sales, write offs and transfers to development and trading of £63m and capitalised improvement costs of £4m.

The market value figures have risen to £1,232m from £1,080m. Valuation uplifts account for £140m of the increase and the balance of £12m relates to the net effect of sales, acquisitions and transfers. The total market value of all of our tenanted residential properties, including those held as fixed assets, is £1,329m (2003: £1,164m).

The group's development and trading assets held as stock fell in cost terms to £76m and in market terms to £101m (2003: £81m and £106m respectively), principally as a result of sales of commercial properties and plots of land at Kennel Farm. Our investment in this division in the year amounted to £22.6m, of which £14.2m related to Grainger homes and a further £5.0m to projects in the land and regeneration division.

Figure 3 - Group tax charge
  £m
Group profit before tax 54.2
Tax at 30% 16.3
Adjusted for:  
Additional tax on the difference between book and tax value of trading property sales 7.2
Negative goodwill (not taxable) (2.3)
Actual tax charge 21.2


Figure 4 - Proforma net asset statement
  30 sept
2004
£m
30 sept
2003
£m
Properties at market value:    
Tenanted residential 1,329 1,164
Development and trading 109 130
  1,438 1,294
Investments and other assets 16 12
Cash 54 81
Total assets 1,508 1,387
Borrowings (750) (761)
Net current liabilities (68) (69)
Deferred tax/other liabilities (12) (14)
Total liabilities (830) (844)
Net assets 678 543


Figure 5 - Net assets at market value
  Reflected in the accounts Not reflected in the accounts Total
  £m £m £m
Net assets at 1 October 2003 149 394 543
Required change in accounting policy re owned shares (2) 2 -
Restated net assets at 1 October 2003 147 396 543
       
Retained profits 27 (7) 20
Revaluation surpluses      
Tenanted residential 4 115 119
Development and trading
Investments 1 1
Goodwill movements (5) (5)
       
Market value net assets at 30 September 2004 178 500 678
       
Market value net assets per share £7.17 £20.17 £27.34


Figure 6 - Analysis of net asset value
  Statutory balance sheet Market value adjustments Market value balance sheets Frs13 Contingent tax NNNAV balance sheet
  £m £m £m £m £m £m
Properties 1,024 141 1,438 1,438
Investments/other assets/cash 66 4 70 70
Negative goodwill (85) 85
  1,005 503 1,508 1,508
Borrowings (750) - (750) (5) (755)
Net current liabilities (68) - (68) (68)
Provisions/contingent tax (9) (1) (10) 5 (216) (221)
Minority interest (2) (2) (2)
  (827) (3) (830) (216) (1,046)
Market value net assets at 30 September 2004 178 500 678 (216) 462
Market value net assets per share £7.17 £20.17 £27.34 £(0.01) £(8.71) £18.62


Figure 7 - Summary of gross borrowings
  Principal
£m
Interest
rate %
Terminating
Fixed to termination 45 6.3 2005-32
Hedged by swap contracts 223 6.4 2005-09
Hedged by financial caps 233 6.0 2005-09
Variable/fixed under one year 256 5.6 2005-14
Total debt 757 6.0  
Less: cash (54)    
Net debt 703    

Other assets and liabilities

Other net liabilities, excluding current instalments due on borrowings and cash balances, have remained at a level consistent with last year.

Net assets

Net assets at market value have increased from £543m to £678m. Major movements are shown in figure 5, left.

Net assets have increased by £135m from £543m to £678m, the increase coming from retained earnings less negative goodwill of £20m, net revaluation surpluses of £120m and adjustments to goodwill of £5m.

Diluted NAV (or NNNAV) is computed by adjusting NAV for the market value of long-term debt and derivatives and for contingent tax.

These amount to 1p and £8.71 per share respectively as shown in figure 6 below (2003: 31p and £7.72 respectively).

The FRS13 adjustment has fallen as a result of the refinancing undertaken in the year, which eliminated all expensive fixed rate debt. Contingent tax, which will only crystallise on the realisation of the assets and is therefore payable some time in the future, has increased because of the increases in valuation surpluses in the year.

We also present Grainger NAV to reflect our estimate of the present value of the reversionary surplus in our regulated and life tenancy portfolios (i.e. the difference between vacant possession value and market value after tax). We have calculated the present value of those surpluses net of tax using a discount rate of 8.6% (our weighted average of cost of capital plus a risk premium of 3%) (2003: 8.9%). This adjustment increases NNNAV by £5.38 per share to give Grainger NAV of £24.00 (2003: £18.40). It should be stressed that our calculation is based upon current house prices; no future house price movement is assumed.

Cash and debt

Cash balances at the year end amounted to £54m, representing some 3.6% of our total market value gross assets. Of this, £30m (2003: £54m), represents deposits received or acts as security for cash backed loan notes.

Group borrowings have decreased slightly from £761m to £750m.

Gearing on a revalued balance sheet basis fell to 103% from last year's figure of 125%.

Refinancing

During the year the group rearranged its debt structure. All of the group's debt with the exception of a non-recourse loan of £45m and loan notes of £32m were repaid. This led to early repayment charges of £5.4m on the fixed rate elements.

The new financing comprises a £900m facility with a club of eight banks, split into three tranches; a five year revolving credit facility of £475m, a five year term loan of £225m and a ten year term loan of £200m. The new facility is arranged on a floating charge basis and has a far simpler and more relevant covenant structure; this means that it is both cheaper and easier to manage and provides the group with greater flexibility in its day-to-day operations. Funding levels are more certain as there are no annual repayments and the average cost of debt has been reduced by approximately 32 basis points.

At 30 September 2004 £680m of the facility had been drawn down leaving headroom of £220m.

The refinancing exercise has been short listed by 'The Treasurer' magazine as one of the loan deals of the year 2004.

Capital management

The group finances its operations through a combination of shareholders' funds and borrowings and seeks to optimise its weighted average cost of capital (WACC). At 30 September 2004 our estimate of WACC was 5.64% (2003: 5.89%).

The group does not take trading positions in financial instruments but holds them to minimise the risk of exposure to fluctuating interest rates. The majority of our debt is subject to protective swaps, caps or collars or is maintained at fixed rates of interest. At 30 September 2004, £501m (71%) of the group's net debt was either fixed to termination, or for over one year, or was protected by financial instruments (2003: 90%).

A combination of interest rate swaps and financial caps is used to provide a degree of certainty over future interest rate costs whilst enabling the group to take advantage of any favourable short term rates. At 30 September 2004 the group held £223m of swap contracts at an average rate of 5.4% maturing between 2004 and 2014 (2003: £298m at 5.4%). There were also financial caps in place of £233m at an average cap rate of 6.1%, expiring between 2005 and 2009 (2003: £235m at 6.1%). A summary of our gross borrowings is shown in figure 7.

The notional effect of the fair value adjustment of marking the group's fixed rate debt and derivatives to current market rates ('FRS 13 adjustments') would be to produce a notional 'liability' after tax of £0.4m or 1p per share (2003: 31p). This adjustment represents approximately 0.05% of group gross borrowings at 30 September 2004 and will not be recognised in the accounts until the position matures or is terminated.

The group also maintains a range of borrowings maturities to enable it to balance continuity of funding with flexibility. At 30 September 2004 the average duration of the group's debt was 6.4 years (2003: 6.0 years).

International Financial Reporting Standards (IFRS)

IFRS are mandatory for UK quoted companies for accounting periods ending on or after 31 December 2005. Grainger's accounts will therefore be prepared in accordance with these standards for the year ended 30 September 2006. We are continuing to prepare for this change, ensuring we have the relevant information and systems that will be required.

Andrew Cunningham's signature.
Andrew Cunningham
Deputy Chief Executive and Finance Director
21 December 2004

Good prospects:

Our business model is solid and our strategy strong and focused.

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