VIBBF - DIC Asset: A Fighting Chance - And A Call Option On The ECB Stopping Its Rate Hikes

2023-09-19 10:30:00 ET

Summary

• DIC Asset needs to deleverage and improve its balance sheet.
• The REIT's first semester results were weak, with increased interest expenses and a minimal contribution from the asset management division.
• DIC Asset expects to generate a higher FFO in the second half of the year and has increased its cash position, but additional asset sales are needed for a stronger financial position.

Introduction

I can be pretty short about DIC Asset ( OTCPK:DDCCF ) , the real estate company that acquired a majority stake in VIB Vermoegen ( OTC:VIBBF ) which I covered last year . The REIT absolutely still needs to deleverage. That’s it. And that’s also why I wasn’t too keen on the REIT paying a cash dividend over FY 2022 (not even proposing an attractive stock dividend to shore up its balance sheet). There have been some good articles on DIC Asset here on Seeking Alpha and I’d recommend you to have a closer look to get a better understanding of the business model.

DIC Asset has two main divisions: the commercial portfolio includes the owned assets while the institutional business division basically represents the asset management division. Both divisions are focused on Germany.

DIC Asset has its primary listing in Germany where it's trading with DIC as its ticker symbol . The current market capitalization is approximately 350M EUR. As the average daily trading volume excess 130,000 shares per day, I’d strongly recommend to use this pretty liquid German listing to trade in the company’s shares.

Looking back at the first semester

As you can see below, the FFO I (the FFO before taking the profit or losses on dispositions into account) was weak, very weak. With just 22.4M EUR in FFO (excluding the profits on disposals, the REIT performed substantially worse than the 53M EUR generated in the first half of last year).

There are two culprits here: First of all, the total interest expenses increased by 21M EUR. That explains why the FFO in the commercial portfolio was so weak as this had a negative impact of 22M EUR. That also means the FFO adjusted for interest expenses increased from less than 46M EUR to almost 55M EUR. This means that on an underlying basis, DIC isn’t doing too bad at all but the higher interest rates are hurting the bottom line pretty bad.

Secondly, the contribution from the asset management division ("institutional business") was almost zero. The 0.4M EUR was next to nothing compared to the 17.1M EUR in H1 2022.

Why? Because the transaction volume fell back to almost nothing . DIC expects transaction volumes to pick up again in the second half of the year, but I’m not holding my breath just yet. I would like to see a noticeable pick-up in Q3 before believing the more upbeat expectations in terms of transactions in the second half of this year.

The REIT expects to generate an FFO I of 50-55M EUR this year. That’s pretty upbeat considering the H1 result was only 22M EUR. This indeed implies the H2 FFO will come in around 33M EUR and thus 50% higher than in the first semester. Using the lower end of the guidance (50M EUR) results in an FFO of 60 cents per share. And DIC better not use a substantial portion of that amount to pay a dividend.

One thing DIC did well is increasing its cash position. As of the end of June, DIC hoarded almost 500M EUR in cash after some asset sales and used 200M EUR to repay a portion of the bridge loan and extend the remaining amount by one year to the end of July 2024. Based on the full-year guidance, the minimum target of dispositions has already been met but I am expecting additional sales as DIC realizes it needs to have a comfortable cash position to start renegotiating refinancings.

There's a 150M EUR bond due later this year, and the existing cash position will take care of that. So that’s not an issue, and DIC will still have about 100M EUR in cash left. Additionally, it will generate about 50-75M EUR in FFO between now and the summer of 2024 which will help to tackle the 2024 refinancings. In 2024, an additional 580M EUR has to be refinanced (including the 200M EUR bridge loan extension). In an ideal world, DIC should indeed be able to sell a few hundred million in additional assets between now and the end of Q2 2024 to reduce the refinancing pressure. If it can sell 250M EUR of assets, it will only need to refinance about 200M EUR of the debt coming due in 2024. And sure, that will be expensive, but there will be some savings on the other side of the equation as some of the debt will be fully repaid.

This also means we may be close to "peak interest expenses" (not to be confused with "peak interest rates"), especially if the ECB stops increasing their benchmark interest rate and DIC indeed repays the 2023 bond and the bridge loan in 2024. Based on the most recent details, repaying the 200M EUR bridge loan and the bond this year will save about 6M EUR per year in interest expenses. That’s in excess of 10% of this year’s anticipated FFO.

The main saving grace may actually be the ECB right now. After hiking the benchmark interest rate to 4% earlier this week, the European Central Bank made it sound like that could very well have been the final rate hike. If that's the case, this could signal a big buy signal across the REIT industry in Europe as it basically provides stabilization. And it was the lack of stabilization and increasing uncertainty that reduced the appetite to invest in real estate. But if we're now fixing the benchmark interest rate at 4%, then investing in real assets at 5.5-6-6.5% DOES become attractive again.

And stabilizing benchmark interest rates also should result in more stable capitalization rates used to determine the value of the portfolio. The "official" net rental yield on the portfolio is 3.9% as per the H1 report but when I run the numbers I end up closer to 5% using the net rental income versus the book value. I’ll keep an eye on that.

The adjusted LTV is 54.3% (based on a sub-5% net rental yield and an assumed value of 522M EUR for the asset management division – the latter is only justified if business indeed picks up sharply again in 2024) and while that is below the 60% level mentioned in the bond covenants, it's still pretty close to the limits for my liking. I do like this asset management division though as there are multiple ways for DIC Asset to generate an income.

Investment thesis

An investment in DIC is not for the nervous investor. And in a way, it now is a call option on the ECB indeed not hiking its interest rates any further. This should stabilize the REIT’s funding costs (and not just DIC, but across the board of course) and provide more clarity on how to move forward). And that stabilization also will draw more investors to the sector in general. Not necessarily to investing in REITs but investing in real estate. And the cash flows from the asset management division are likely the lottery ticket for DIC to rapidly increase its FFO again and repay debt.

I have a long position in DIC Asset but I'm pretty deeply under water. Additional asset sales would put the company on a much stronger financial footing.

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