Tuesday, 20 January 2015

Immofinanz and the tale of Russian exposure

Now for something a bit closer to home. I’ve been looking for ways to slowly start taking advantage of the current mess that’s happening in Russia and think the best approach is having a basket of securities. Immofinanz could make an interesting addition to this basket.

The company was started back in 1990 and is now one of the largest European real estate companies, listed in Vienna and Warsaw. The company has an integrated operating model of developing properties, servicing and managing, and trading as and when interesting opportunities arise (they call it the “real estate machine”…the machine).  The current portfolio consists of 470 properties with rentable area of 3.5m sqm. Their core markets are CEE/SEE (c. 70%) while the rest in Austria/Germany. Around 85% of the portfolio is in office/retail with the rest in logistics (under consideration for an eventual exit) and other non-core assets. The portfolio is very well developed, with 86% in rent generating properties and 7% each for properties under construction and pipeline. All of the above is carried at €6.8bn (€5.9bn in revenue generating assets). The average LTV on the various properties is 42%, while it’s 52% at the consolidated level with financing cost of 4%. Mgmt said they are comfortable with this level going forward (indicated 45-55% on a recent call). The below illustrates what Immofinanz owns as of October last year.

Source: Immofinanz

In addition, the company owns a 49% stake in BUWOG – collection of residential real estate assets in Germany and Austria. It was originally acquired from the Austrian government in 2004 and last April it spun-off this business to focus on core assets both geographically (mostly CEE/SEE) and segment wise (commercial). Immofinanz retains a 49% stake in the business and doesn’t consolidate it. This stake is worth around €820m currently and given the nature of the business, offers a solid dividend yield of 4-5%. Actually, part of the reason of the spin-off was to increase the yield on the overall portfolio. Prior to the spin gross running yield was 6.8% that increased to around 7.8% on Immofinanz. The company expects to be out of BUWOG in the mid-term.

Source: Immofinanz

The single largest exposure is Russia, which makes up 25% of portfolio and over 35% of the rental income, which seems to have spooked a lot of people in 2014 (Immofinanz share price down from €3 to €2 currently). The company has 6 assets in Russia, of which 5 are retail in Moscow, generating a 10% gross yield (for now). Unfortunately, the looming recession in the country is dampening consumer spending, which makes it harder for retailers to cover rent. The rent is either in USD or EUR, against which the RUB substantially devalued so as you can see retailers are hit twice. To help them out Immofinanz is offering temporary fixing of the FX on the rents for the next three months. They’ve done the same in the 08/09 crisis. A positive element for retailers (not so much for developers) is the fact that the Russian shopping centre market has one of the largest pipelines of new projects in the region, which could push down rental prices. Granted a chunk of it will be delayed/cancelled, but certainly not helping in this environment. Nevertheless, given the situation vacancy rates will likely be increasing, while rental values have already fallen thus write-offs on the Russian assets are likely forthcoming (assets currently carried at €1.7bn). It is going to be a tough 12-18 months for sure. Excluding Russia the situation is better, with attractive yields in (an artificially) low interest rate environment with more money coming into the region (e.g. Romania and Hungary) leading to increased transaction volumes.

The company has spent considerable efforts to streamline the portfolio, selling €2.7bn worth of properties over a 4 year period (mostly non-core, residential, hotels etc) with average margin of 14% over carried value, and looks to do more going forward, which should help cash flow. Immofinanz also plans €1-1.5bn of property development over the mid-term on the retail side. Currently, there is around €390m costs outstanding on development projects, mostly in Germany and Poland, in addition to €480m already spent (vs €980m fair value).

In the last financial year the company didn’t pay a dividend (in-lieu it spun off BUWOG, which pays a solid dividend). At the beginning of the year the company planned on €0.15-0.2/share dividend and buyback (8.6% yield at midpoint), however the dividend might be cancelled (for various accounting/tax reasons under Austrian law – it basically needs distributable profits), however a buyback programme will likely be maintained. The company plans to repay a financing tied to its treasury shares, cancel these (c. 9% outstanding) and launch another buyback. Personally, at this valuation I'd prefer a buyback vs dividend.

Just a word on mgmt. Back in 2008 the former CEO was ousted (later convicted for breach of trust – urge you to read around the story a bit). The current CEO – Eduard Zehetner – was brought in and did a tremendous job turning the company around, which at one point was near bankruptcy, however he will be stepping down this year.

Now for the juicy stuff (I’m including the treasury shares for the calculations, though these are in the process of being retired). The NAV of the portfolio is €4.5bn of which €3.1bn is in Eastern European/Russian assets (€0.6bn in Austria and €0.8bn for the BUWOG assets), while the market cap is €2.3bn, for a c. 50% discount. Assuming for a second that you fix the holding discount on the W. European assets at 0, BUWOG at market, the implied discount on the Eastern European assets is over 70%! I know things are bad but this is excessive.

So what about upside/downside cases. To be super bearish, if you wanted to completely write-off the E. European/Russian assets (inc. Romania, Hungary etc) you’d get to around €1.3/share but this is a very unlikely situation. Based on my estimates, downside is around €2/share (though if dividend is not paid this year and not replaced with buyback it could dip below). Upside depends on how much you believe the discount on the E. European/Russian assets would shrink. A discount of 40-50% on these implies €2.6-2.8/share, even after taking into account some write-off on the Russian assets. The key catalyst is obviously improvement in geopolitics for which you have to look through the next 12-18 months for sure. In addition, follow-on buybacks supported by asset sales would also help.

If you don’t feel comfortable owning the equity directly you could structure the trade with convertibles e.g. the 2018 maturity, 4.25% interest, put option in 2016 with full dividend protection. You’ll get exposure to both Immofinanz and BUWOG and can pick up a c. 4% yield.