Barmer Wohnungsbau, catalyst, commercial property, convergence, correlation, Deutsche Wohnen, EPRA NAV, German bunds, German property, Germany, Karl Ehlerding, KWG Kommunale Wohnen, large cap stocks, marathon, NAV, NAV discount, NAV premium, Net LTV, North Rhine-Westphalia, Price/Book, REIT/MLP sector, rental yield, residential property, Sirius Real Estate, small cap stocks, Stavros Efremidis, Taliesin, value investing
Continued from here. A 5-part series might seem like overkill – hmm, I’ve done worse 😉 – hopefully, you found something useful in each post. And, of course, I wanted to illustrate the research (& contemplation) required for any real investment edge in your stock-picking & portfolio. Peer/sector analysis may perhaps be the most rewarding component – though it drives me to distraction occasionally…
Picture it: You come across a random gem – you suspect it’s best of breed & should be pounced upon asap! Instead you take a breath, step back & force yourself to research it (and its peers) from all conceivable angles. Meanwhile, your gem’s share price begins to ascend rapidly, and you’re totally missing out… I’m suffering that with one idea I want to exploit – the apparent gem of the sector’s jumped 20%+, gahhh!
But investing isn’t a sprint, it’s an (often painful) marathon. We all remember a satisfying quick-fire buy that worked out, but we’re really just trying to forget the pain of misguided duds… Disasters we might perhaps have avoided if we’d researched them a little more, or picked the better horse. Research & patience are ultimately far more profitable than grabbing the first nice stock you see. Also, peer/sector analysis is essential to my preferred approach to investment:
OK, confession time: There were 2 key omissions from the series. First, this post should probably have been titled ‘A Buy (& A Sell)!’ I’ve just sold off a Deutsche Wohnen (DWNI:GR) holding at EUR 14.41, a 226% gain on my net entry price. My previous post, & DWNI‘s 1.31 P/B ratio, offers obvious explanation for my sale. I never actually got to a DWNI blog write-up. [Though eagle-eyed readers may have noticed this slip in my v first post!] I was comfortable making the bet myself, but I didn’t feel comfortable writing up a stock (at a fairly small NAV discount) & hypothesizing it would trade at a significant premium in due course. Now, at current levels, I was feeling distinctly uncomfortable holding it…
Which might be plain dumb: a) Look at US property stocks/REITs – premiums can obviously trade far higher, and b) a significant premium offers a miraculous opportunity to raise funds at a price that’s accretive to NAV! [That’s the last secret weapon of over-inflated US REITs – go on, choke those idiot investors with more stock – you know you want to!] But I can’t help it… I don’t want to advocate a nympho approach here, but DWNI no longer offers a Great Price. But I still love the Great Story (German property’s undervaluation & prospects) – so, can I find another Great Company? Which leads to my second confession:
I omitted 1 stock from my last post. 😉 A post which perhaps highlighted the difficulty of choosing a clear winner… Value investors are often at most risk here – the (inevitable) cheapness of small and/or over-leveraged stocks can prove too tempting! [Don’t you just envy growth investors? Sure, they often pile in far too late, but they’re so damn happy doing it!] For me, too much leverage is a risk too far… And small stocks tend to stay small unless they enjoy a catalyst, or can grow out of it – a tall order in most cases.
With a German property stock, I want a Net LTV of 65%, or less. Elsewhere, I might demand much less. In terms of size, I hinted at something intriguing: A distinct correlation between P/B & Mkt Cap (or Net LTV). I could knock off some graphs/curves to illustrate, but a dozen data points hardly justifies it! Anyway, the pattern’s obvious: 100 mio+ market caps cluster ’round an avg. 1.02 P/B, a large premium to the avg. 0.59 P/B of sub-100 mio stocks. Not to over-emphasize it (the tail should never wag the dog), but this apparent sweet spot around 100 mio definitely guided my final stock selection. Let me introduce:
KWG Kommunale Wohnen Ag (BIW:GR): EUR 5.152
KWG’s Hamburg-based, and focuses on E & W German residential property. They don’t do new construction, or development, but all asset management is conducted in-house. They target above-average appreciation by focusing on the opportunistic acquisition of high vacancy portfolios, usually requiring modernization & renovation to enhance rents. They manage their portfolio on a Core & Investment basis. Stavros Efremidis has been MD since 2007, and Torsten Hoffmann‘s CFO since 2010 – both with 2 decades of real-estate experience.
KWG originated with a group of investors buying control of a listed shell (Carthago Biotech AG) in 2005. Its portfolio only began to acquire some scale at end-07. This proved fortunate – KWG didn’t suffer the over-leverage many German property companies experienced post-financial crisis. That put them in a great position to opportunistically double their portfolio to 5,000 apartments by end-08. This scaling-up (from a small base) has taken some years to digest, but in 2012 they’ve stepped back up to the plate big time.
In March, KWG announced a deal to take majority control of Barmer Wohnungsbau AG (BWAG), which owned about 1,400 apartments in North Rhine-Westphalia. Then in July, they announced their largest deal ever – to purchase 2,900 apartments in NRW & Berlin. Presuming the deal closes, their portfolio will amount to almost 10,000 apartments. With an exclusive & signed term sheet in place, and financing already committed, this looks a done deal. This evolution has, of course, been accompanied by regular fund-raising:
May-06: 3.0 mio shares
Dec-07: 6.1 mio
Dec-08: 8.6 mio
Dec-09: 9.8 mio
Dec-10/11: 10.8 mio
Nov-12: 15.881 mio shares (& 0.326 mio to be issued for prior acquisitions)
This puts KWG’s market cap at 82 mio – but you have to wonder what that issuance has done to NAV, in terms of potential dilution? Take a look:
Dec-07: EUR 6.47
Dec-08: EUR 6.53
Dec-09: EUR 6.59
Dec-10: EUR 7.23
Dec-11: EUR 8.41 (EPRA NAV from here on)
Jun-12: EUR 9.02
What a pleasant surprise! So, how was this achieved? A number of ways – all pointing to the potential of KWG’s 2012 acquisitions. Opportunistic purchases, renovation, vacancy reductions, and internalization of property management have all contributed to increasing rents, an improving P&L, and steady appreciation in the avg. property valuation per sqm. A focus on energy efficiency has helped, and now increasing economies of scale are being enjoyed.
Most importantly, there’s a constant focus on shareholder value: Management’s persuaded vendors (on occasion) to accept shares at a premium, issued shares opportunistically in the market, and they’ve enjoyed continuous support from a 65% core investor base. I’m fascinated to see Karl Ehlerding & family as a key shareholder – he has a spectacular & volatile history, but appears to be making a (more under-stated) comeback in the past few years! Overall, KWG’s operational & NAV history are v encouraging, and the following mantra is hugely reassuring:
‘…we must make sure that our equity is used in ways that avoid diluting the net asset value (NAV) to the greatest extent as possible.’
Most management pay lip-service to such a principle…and then wilfully ignore it (to them, fund-raising always appears more palatable than retrenchment)! But KWG’s repeatedly demonstrated their commitment to shareholder value. So what do current metrics look like for KWG? [All figures in this post are based on their H1-2012 report, subject to appropriate adjustments. Note KWG’s just issued a v positive press release for Q3-2012, but no report or accounts.]
It makes sense to include their latest acquisition – a EUR 93 mio purchase (at a 9.5 multiple on current cold rent) of 203 K sqm, with a 23% vacancy rate. This equates to an extraordinary EUR 458 per sqm & a 10.5% yield. Which nicely illustrates the rule of thumb for large portfolio purchases – vacant apartments are thrown in for free! Let’s incorporate this into KWG’s existing portfolio:
(402.5 * 8.3% + 203 * 23%) / 605.5 = 13.2% vacancy rate
(402.5 * 4.81 + 203 * (458 / 9.5 / 12)) / 605.5 = EUR 4.54 rent per sqm
(402.5 * 758 + 203 * 458) / 605.5 = EUR 658 valuation per sqm
4.54 * 12 / 658 = 8.3% rental yield
The overall vacancy rate is a mix: An underlying low single digit vacancy rate in KWG’s Core portfolio, and a 20-30%+ rate in its more recently acquired Investment portfolio. This represents a source of opportunity, rather than concern. Portfolio valuation & yield are highly attractive in comparison to the peer average. But how does KWG stack up financially?
(155.0 Loans + 93.0 New Acq. Loans + 1.6 Pension / 2 + 0.8 Derivatives – 13.4 Cash) / (305.2 Property + 93.0 New Acq.) = 59.3% Net LTV
Despite the financing required for the new acquisition, KWG’s Net LTV will still be a full 1% below the 60.3% sector average. Renovation expenditure will obviously be planned once the new acquisition closes, but financing has already been committed for this also. I suspect any Net LTV impact will be offset by a further increase in valuation. Debt maturities are fairly evenly distributed over the next 11 years, with a peak maturity of only EUR 23 mio in 2015. Current interest rates offer comfort (and P&L upside), as re-financing can be executed around 3.3% vs. a yr-end 2011 average of 4.9%. Finally, cash-flow looks reasonable, with operating free cash-flow (after interest, taxes & net intangibles/PPE) basically flat in 2011 & H1 2012. Now, let’s answer the obvious burning question:
(126.0 Equity (bef. N-CI) + 13.7 Equity (Spec. Items) / (14.381 + 1.5 + 0.326) Issued/To be Issued Shares + 1.00 New Acq. Accretion * 50% = EUR 9.12 NAV
(126.0 + 13.7 + 5.7 Net Deferred Tax + 0.8 Derivatives) / 16.207 + 1.00 * 50% = EUR 9.52 EPRA NAV
EUR 5.152 Share Price / EUR 9.32 Avg. NAV = 0.55 Price/Book
Note: Equity (Special Items) simply represents To be Issued Shares, and will be absorbed into regular Equity in due course. Management expects a EUR 1.00 NAV uplift from their most recently announced acquisition. Based on their NAV history, and their delivery on a similar promise (from the BWAG deal), I think it’s perfectly acceptable to now incorporate 50% of this uplift into my current NAV calcs.
Clearly, at a 0.55 P/B, KWG’s been tagged with the same small cap P/B ratio I’ve already highlighted. But this really makes no sense... Management has rapidly grown the company, is committed to shareholder value & has increased NAV significantly, has been financially prudent, and has assembled a portfolio that looks significantly undervalued vs. its peers. Surely that deserves a rating equal to the 0.84 P/B sector average? That would imply a EUR 7.85 share price target, which offers an upside potential of 52%.
But let’s not forget that sweet spot! At yr-end 2011, KWG’s mkt cap was only EUR 52 mio, equity was EUR 90 mio, and total assets were EUR 239 mio. By mid-year, total assets surpassed EUR 300 mio. Interestingly, this is the asset size Taliesin (TPF:LN) has targeted as an objective. It’s worth quoting their perspective:
‘It is our hope that, by making the Company bigger, this transaction will help to bring us a wider investor audience and improve somewhat the liquidity of our stock. Ultimately, we think that growing to a size of around €300mn of assets will enhance the likelihood of an institutional take-out at a price much closer to replacement cost.’
Now, by yr-end 2012, we can reasonably assume KWG’s equity will be around EUR 156 mio, with total assets well in excess of EUR 400 mio. This confirms KWG’s vaulted past the sweet spot already, on a fundamental basis – now we’re just waiting for investors to bloody well sit up & take notice. This looks inevitable… Some media publicity when the latest deal closes, increasing share trading volumes, the promised yr-end uplift in NAV uplift & larger balance sheet, etc. should all provide the last boost needed for KWG’s market cap to blow through 100 mio. That should really open the flood-gates…
Based on that, I’m confident the same 100 mio+ Fair Value 1.02 P/B ratio will be awarded to KWG, in due course – corresponding to a EUR 9.51 Fair Value per share, and an 85% Upside Potential.
But let’s look ahead to the medium/long term: I believe it’s entirely reasonable to assume KWG’s portfolio valuation will (eventually) converge with that of its peer group. Currently, its EUR 658 valuation per sqm is 31% below average, while its 8.3% yield is 14% higher than the sector median of 7.25%. I estimate such a convergence, on a yield basis, could result in a potential 41% uplift to equity.
That offers a potential Secondary Price Target of EUR 13.41 Fair Value per share, for an eventual 160% Upside Potential.
I’ve already got a 3.4% holding in Sirius Real Estate (SRE:LN), which I may increase, so that somewhat limits my additional exposure to German property. At this point, I’ve still accumulated a pretty meaningful 4.1% portfolio stake in KWG.
- KWG Kommunale Wohnen Ag (BIW:GR): EUR 5.152
- Market Cap: EUR 81.8 mio
- Net LTV: 59.3%
- Price/Book: 0.55
- Tgt P/B: 1.02
- Tgt Mkt Cap: EUR 154.1 mio
- Fair Value: EUR 9.51
- Upside Potential: 85%
- Secondary FV: EUR 13.41
- Secondary UP: EUR 160%