AANNF - Aroundtown: A Deep Value Play Within The European Real Estate Sector

2023-08-30 23:20:22 ET

Summary

• Aroundtown has reported resilient operating performance despite challenging market conditions.
• Shares are undervalued compared to peers.
• The company's financial performance remains strong, and it is taking steps to manage the current market downturn.

Aroundtown ( AANFF ) has reported a resilient operating performance despite challenging market conditions and its shares remain undervalued.

I have been covering Aroundtown for some time, and some months ago I have raised my recommendation to 'Buy' as the company's valuation become too much depressed and further downside was not much likely at the time. Since my last article on Aroundtown, its shares are up by 50%, a much better performance than the equity market during the same period as shown in the next graph.

Given that Aroundtown has very recently released its H1 2023 financial figures, I think it's now a good time to analyze its most recent operating trends and update its investment case, to see if Aroundtown still offers value for long-term investors after its recent rally or not.

Earnings Analysis

As I've discussed in previous articles covering the European real estate market, investor sentiment has been quite negative towards these companies since interest rates started to rise in Europe during 2022, which led to quite depressed valuations.

Investors have been worried about relatively high debt levels, impacting negatively the share price of companies which have higher loan-to-value (LTV) ratios, a key measure of leverage within the sector.

As I've analyzed in previous articles on Aroundtown, while its reported LTV ratio is in-line with its peers at around 40%, when including hybrid debt the company's LTV ratio climbs to some 55%, which is somewhat higher than compared to its peers. Moreover, Aroundtown is highly exposed to offices and hotels, which are cyclical segments and account for some 60% of its assets, even though it's also indirectly exposed to the residential segment through its ownership of Grand City Properties ( GRNNF ).

Despite this background, Aroundtown's operating performance can be considered resilient in recent quarters, showing that investor concerns toward its operations are to some extent overblown. Nevertheless, its property portfolio was valued at about €20 billion at the end of last June , a decline of 6% compared to the end of 2022, which is justified by higher discount rates, but it's a drop in-line with its closest peers.

Regarding its operating performance, it has been positive given that during the first six months of 2023 (H1 2023), Aroundtown's net rental income was €596 million, a decline of 3% YoY, due to lower assets as the company performed disposals in recent quarters. On a like-for-like basis, its rental income increased by 3.4% YoY, mainly due to inflation indexation and continued to report an upward trend despite the challenging market setback.

Indeed, due to a tough market situation, like many of its peers, Aroundtown's strategy has changed from growth to cash preservation mode in recent months and this profile is not expected to change anytime soon. Aroundtown is likely to seek further disposals to raise cash and maintain an acceptable leverage position, while raising secured financing (mortgage loans) because its ability to raise new debt on the capital markets remains quite low.

So far, Aroundtown has been able to manage relatively well its liquidity position, which is an important cushion against its sizable debt load. At the end of June, Aroundtown's cash amounted to €2.5 billion, representing about 18% of its total debt. However, its cash position declined by some €500 million during Q2, as the company performed some liability management exercises and reduce debt by buying back bonds at a discounted price.

While these exercises reduce its cash position, they are opportunistic because they enable the company to reduce debt at depressed prices, smooth the debt maturity profile over the next three years, and enable Aroundtown to book profits by buying bonds at lower prices than they were issued. Therefore, Aroundtown is likely to use the cash proceeds from asset sales and organic cash flow to buy back its bonds in the future, at least until its bonds continue to trade at somewhat depressed prices on the market.

To reduce its leverage position, Aroundtown has sold some properties valued at €720 million during H1 2023, plus it has signed further disposals amounting to €545 million since the beginning of the year. While previously the company said that disposals were done at around book values, now Aroundtown says that signed disposals have been made slightly below book value, which will put further pressure on its earnings.

This also shows that despite the company's downward revisions in its properties' valuation, to sell assets it needs to accept even lower prices, as buyers are well aware of Aroundtown's need to dispose assets and have more bargaining power. As I've recently discussed on LEG Immobilien ( LEGIF ), not being a forced seller in the current market environment is key to maintain value, a position that only companies that don't have meaningful debt maturities in the next few years or a conservative leverage profile are able to be in.

That's not Aroundtown case, as the company has signed disposals of €2.2 billion since the beginning of 2022, a period that was not particularly good for sellers. Due to higher interest rates and tighter funding conditions, the vast majority of large players in the industry changed their strategy to net asset sellers, while buyers almost left the market. This means that Aroundtown does not have much negotiating power and further losses on disposals are likely over the coming months.

On a more positive note, Aroundtown continues to have good access to bank lending, which is a strong support for its liquidity in the short term and reduces potential cash constraints in the next few years. The company was able to sign some €790 million of new bank lending since the beginning of 2023, reducing investors' fears about its ability to refinance upcoming loans and debts, which is critical for the sustainability of its business model.

Due to its efforts to strengthen its balance sheet and reduce upcoming bond maturities, its cash position is now enough to cover 2024 and 2025 maturities, which is positive for its liquidity management and not be a forced asset seller in the short term. Moreover, some €20 billion of its properties are unencumbered and Aroundtown has plenty of room to raise further mortgage loans, thus it's quite unlikely that it will have a liquidity crunch over the next couple of years.

Regarding its property portfolio, Aroundtown has not been immune to challenging market conditions, especially in the office segment. Its vacancy rate in offices increased to 11.9%, up by 40 basis points (bps) compared to the end of Q1, while in other segments the vacancy rate declined slightly (for instance, in the residential segment its vacancy rate dropped from 4% to 3.7% over the last three months. Overall, Aroundtown's vacancy rate was stable during the past three months at 8.2%, which is positive considering its disposals and the negative outlook in the office segment due to the hybrid work environment usually embraced following the pandemic.

In the hotels segment, the market continues to recover even though Germany is a laggard and continues to report lower metrics compared to 2019, as a good part of tourism is for business purposes while in Southern countries is more related to leisure, and these countries are reporting growth compared to 2019. In this segment, the vacancy rate remained stable at 3.9% during the past quarter, but the positive outlook for this segment is likely to lead to a lower vacancy rate in the near future.

Overall, Aroundtown's portfolio was valued at €26.3 billion at the end of June, a decline of 5.4% quarter-on-quarter, due to asset disposals and lower valuations due to higher discount rates. Despite that, its rental yield increased to 4.8% (vs. 4.6% in Q1) and its annualized net rent remained stable, boding well for its revenue and cash flows ahead.

During H1 2023, Aroundtown's total revenue amounted to €815 million, an increase of 3.2% YoY, while its net income was quite negative impacted by the loss of €1.7 billion on property valuations. However, this is a non-cash expense, and therefore funds from operations (FFO) provides a better measure of operating profitability. Its FFO amounted to €175 million, a decline of 6% YoY, due to higher expenses and lower profits on equity investments due to Grand City Properties decision to suspend its dividend. Its NTA per share was €8.40 at the end of June, a decline of 9.7% from the end of 2022.

Regarding its guidance, it increased slightly its expected FFO range to €310-340 million in 2023, from €300-340 million previously, as the company's rental income should continue to grow strongly and improves its rent collection rate in the hotel segment, but on the other hand FFO is expected to be negatively impacted by asset disposals and higher funding costs.

Conclusion

Aroundtown has reported an acceptable financial performance in the past few quarters considering the challenging market environment, showing that its fundamentals remain strong and the company is taking the necessary steps to manage the current market downturn.

Despite that, Aroundtown is currently trading at only 0.18x NTA, higher than 0.10x when I upgraded its shares to 'Buy', but still much lower than compared to its closest peers that are trading between 0.35-0.45x NTA. This means that Aroundtown remains a deep value play and significant upside potential exists over the next few years, as market conditions potentially improve and investor sentiment turns more positive towards the real estate sector.

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