activist investors, commercial property, Deutsche Wohnen, German property, Net LTV, Price/Book, residential property, Sirius Real Estate, value investing
OK folks, I was pondering an introductory blog post as I wrestled with the WordPress setup, and finally thought why not just jump in and get on with it! Maybe I’ll dispense with some of the formalities later, meanwhile here are some thoughts on:
Price: EUR 0.22
Market Capitalization: EUR 66.5 mio
Net Loan-To-Value (LTV)%: 57.6%
Price/Book (P/B): 0.31
Fair Value: EUR 0.71
Upside Potential: 223%
Sirius has a portfolio of 38 large mixed-use commercial sites in Germany, which have been upgraded into modern, flexible workspaces. I’m a huge fan of German property as it’s significantly undervalued in a global context, it never really participated in the asset/property inflation of the 2000s, I believe there’s a secular trend to increase property ownership in Germany and current Bund yield trends are immensely supportive of German property company financials and valuations. Additionally, I think German property (and perhaps even German equities?) represents the perfect hedge for the Euro debt crisis – if we sail through the crisis, the fundamental case I outlined remains, while if everything goes horribly wrong (increasing budget deficits, debt restructurings, defaults, Euro ejections/withdrawals etc.) that will be even more reason for investors to flee to German assets, the hard core of the Euro and Europe.
I’ve just increased my SRE stake from 3.6% to 4.1% of my portfolio. I’d have a higher allocation only for my current 4.2% allocation to Deutsche Wohnen (DWNI:GR), so I already have a pretty aggressive bet on German property at this point. My intention was to be biased towards residential (DWNI) versus commercial property (SRE), but the much greater under-valuation of SRE has progressively led me to an equal allocation for both. First thing to focus on with a property company is, of course, leverage. My main focus is generally Net LTV %, which I’d define as:
(Financial Liabilities + Derivative Liabilities – Cash/[Marketable Securities] – Derivative Assets) / (Investment Property/Assets for Sale/Inventories + [Joint Ventures/Associates * 50%])
Including derivatives in the calculation is conservative and not something most companies (and analysts?) will do, but you can be assured that banks include them in their analysis, and the damage wrought in the past few years by gigantic interest rate swap liabilities (Develica Deutschland was a notorious example – and no longer listed) (or foreign exchange liabilities for certain investment companies, e.g. Alternative Asset Opportunities (TLI:LN)) on many property company balance sheets, liquidity and valuations testifies to this. Be careful with Marketable Securities – it’s often not very clear how liquid/realizable they are, so if in doubt just exclude (particularly if they’re listed in Non-Current Assets) or only include 50% of the Balance Sheet (B/S) value. In a similar fashion, I’ll occasionally include 50% of the value of Joint Ventures/Associates, but prefer to exclude as it’s usually not clear what kind of control, liquidity or leverage potential a company has with this type of asset. I also scan the rest of the B/S for anything unusual, and adjust accordingly – e.g. if Payables far exceed Receivables, you may want to adjust for Net Payables to be conservative/reflect potential upcoming Debt issuance/Cash use. With SRE, I calculate:
(EUR 302.215 mio + 9.444 – 23.583 – 0.165 + 10.583 Estimated Capex – 2.500 Disposals) / (505.500 + 10.583 Capex Additions – 2.500 Disposals) = 57.6% Net LTV
As you can see, I’ve also adjusted for the October Trading Statement. This Net LTV is quite acceptable – after losing the run of myself some years back, as did most people, I now limit my interest to property cos with a maximum Net LTV of 60-65%. Even if I find a compelling/’cheap’ (but highly leveraged) stock and drift from virtue (like Mae West!), my safety net (hopefully) is a fairly systematic P/B valuation scale that progressively downgrades fair valuation as Net LTV increases. I’ve found that this approach generally means that highly leveraged companies, no matter how ‘cheap’, don’t present enough upside potential when I look at market price versus my fair value assessment.
Next, let’s look at the property itself – the latest valuation is EUR 438 per square metre, comparing very favourably with an average of EUR 923 persqm for other German property cos, but likely reflecting the geographically dispersed, edge/out of town, (converted) light industrial/warehouse nature of much of the property. Of course, German property in general is absurdly cheap globally when you consider property prices in New York, London, Paris, Moscow etc. where valuations of 1,000 (pick your currency) per square FOOT are quite normal! Average rent is EUR 4.13 per mth, which equates to an attractive 11.3% rental yield vs. an average 7.6% yield in the rest of the sector. Just as interesting is the occupancy level at 77% – poor, you say?! Well, I’m always bemused by management and investors who are immensely pleased with 95%+ occupancy levels…why? Seems to me the only way is down from that kind of level, and a much lower occupancy level (IF it can be financially supported in the interim) is far more attractive in terms of the upside it presents. And even if current management is the reason for a poor occupancy level, one can hope to benefit ultimately from a low original entry price, new activist shareholders appearing or even a takeover bid from a better managed (or financed) company. Speaking of, the shareholder base is intriguing, and likely to be a real catalyst for share price appreciation in the future: Weiss (13%, and 2 board directors), Karoo (25%, 1 director), Laxey (10%, 1 director), Principle (10%), with smaller stakes belonging to the Oppenheims (management), Taube and Alpine Woods. You may recognize all of these as influential, well-respected and/or activist investors.
In summary, we have a compelling investment thesis (German property), great underlying property fundamentals and valuations, a good margin of safety with a Net LTV of 58%, and a potential catalyst in the form of activist shareholders on the share register and, most importantly, the board. Finally, we need to look at our Fair Value assessment: Based on my leverage comments above, and a 58% Net LTV, I’d normally put Fair Value at a discount to a 1.0 P/B ratio (despite many leveraged property cos trading at significant premiums to Book some years back, and then trolling absurd depths in 2007-09…hopefully I’ve arrived at a happy and safe medium?!). Then again (and despite my leverage comments above!), I think in this case a Fair Value P/B ratio of 1.0 is warranted due to the cheapness and lack of prior price appreciation for the underlying property. I’m generally happy to assess Book as an average of IFRS Net Asset Value (NAV) and EPRA NAV – EPRA is inevitably higher, but acceptable as it excludes items (Derivative Valuations and Deferred Tax) which may never crystallize, or that may be offset but not reflected elsewhere on the Balance Sheet (companies revalue interest rate swaps but generally don’t revalue the underlying hedged debt), and it recognizes that many companies (no surprise!) and investors (rightly or wrongly) have become increasingly focused on EPRA NAV. Therefore, I calculate SRE’s Book Value at:
(EUR 0.6914 NAV + 0.7285 EPRA NAV) / 2 = EUR 0.71 = Fair Value (@ 1.0 P/B)
This is vs. a current Market Price of EUR 0.22, giving us an Upside Potential of 223%. Best of luck!
Btw As I review the above posting, I wonder if it’s a little long?! But I’d prefer, at this point, to err on the side of verbosity to ensure I present you with all my underlying investment reasoning, analysis, philosophy – plus any examples, side comments etc. that occur to me. So please bear with me, and of course all comments (and questions) are extremely welcome – I suspect/hope that over time, and as we get to know each other better, my posts will incorporate some analysis/assumption shortcuts and become that much briefer and more efficient!