BALDF - Fastighets AB Balder: Now Is A Good Time To Buy This Undervalued European Real Estate Company

2023-11-03 14:53:37 ET

Summary

• Fastighets AB Balder has reported positive operating performance and an acceptable liquidity position, making it an undervalued play in the European real estate sector.
• The company's property portfolio has declined due to higher interest rates, but its vacancy rate remains low and stable.
• Balder continues to report strong rental income growth and has shifted its financing from capital markets to bank loans.

Fastighets AB Balder (BALDF) has reported a positive operating performance lately and has an acceptable liquidity position, being now a good undervalued player within the European real estate sector.

As I’ve covered in previous articles , Balder has some attractive business fundamentals within the Nordic real estate markets, but like many of its peers, its refinancing needs are a key issue in the short term.

In this article, I update its most recent financial performance and investment case, to see if Balder’s shares are now more attractive to long-term investors or if they should remain on the sidelines.

Financial Overview

As I’ve analyzed recently on TAG Immobilien (TAGOF), the European real estate market has been on a cyclical downturn due to higher interest rates over the past eighteen months, leading to lower property valuations and tough refinancing conditions for players across the industry.

Despite that, the operating momentum of these companies can be considered somewhat positive, as they have adapted their business to the current operating environment and have successfully managed their liquidity and debt profiles.

Balder has been no exception and its recent financial performance can be considered resilient considering the industry and economic backdrop, which has been much more challenging than over the past few years.

At the end of September 2023, its property portfolio was valued at about $19.7 billion, down by 6.2% since the end of 2022, a decline that is justified by higher interest rates and is more or less in line with its peers. Investors should note that Balder’s property portfolio is 57% residential and 43% commercial real estate, including office, retail, logistics, and others, thus this portfolio devaluation is acceptable given that companies that are only focused on residential properties reported similar declines and have theoretically a lower risk profile.

Nevertheless, this means that after several years of reporting a growing portfolio value, Balder was naturally affected by the tougher industry environment, and its property portfolio is expected to report an annual decline, for the first time since 2012.

Despite that, showing that its portfolio has very good quality, its vacancy rate was only 4% at the end of Q3 2023, a relatively stable ratio compared to the end of 2022. Given that a significant part of its property portfolio is in commercial real estate, this low vacancy rate and stable trend is a great achievement for the company, being lower than for instance compared to TAG Immobilien which is only exposed to the housing segment in Germany and Poland.

This also shows that despite the fact that commercial real estate is expected to be weaker in the current economic downtrend, particularly in the office segment, this trend can have different outcomes depending on geography and location, which is a key factor in property quality in the real estate industry.

Given that a large part of Balder’s portfolio is exposed to capitals and larger cities in Scandinavian countries, this provides it with a relatively defensive profile, justifying to a large extent why its portfolio decline was somewhat moderate and its vacancy rate has been stable over the past few quarters.

Another sign that its portfolio has good quality is that Balder continues to report strong rental income growth, as demand for quality properties remains supportive across Scandinavian countries.

Indeed, during the first nine months of 2023 , Balder’s rental income amounted to $796 million, an increase of 15% YoY, due to organic rental growth and the completion of new developments. Its profit from property management was $421 million (+2% YoY), a lower increase than rental growth due to higher costs and interest rates. For the full year, the company’s guidance is to report a profit from property management of about $557 million, a slight increase compared to the previous year.

Regarding its balance sheet management, Balder has shifted its financing from the capital markets to bank loans, a situation that is expected to be maintained for some time to come. At the end of September, Balder had available liquidity of about $1.7 billion, which more than covers its upcoming maturities in the next twelve months.

Nevertheless, its net debt-to-EBITDA ratio was above 12.7x at the end of last quarter, which is a higher leverage ratio than desired. While the company has been able to reduce its leverage a little bit in recent quarters, through a reduction of debt and the completion of projects under construction that start to generate income, further deleveraging is required and therefore it’s not likely that Balder will change its capital returns policy in the near future.

Indeed, investors should be aware that Balder has a different strategy than most companies in the real estate sector, which usually distribute a good part of its earnings through dividends to shareholders, while Balder has historically decided to reinvest its earnings in business growth, through acquisitions, new projects, and renovations of its existing properties.

However, due to the current industry landscape of high-interest rates and tight funding conditions, Balder is not expected to increase its development portfolio much and, most likely, will allocate a good part of its earnings to debt reduction. This means that Balder is currently prioritizing its balance sheet overgrowth in the coming years, thus while the company has a good growth history over the past decade, this is not likely to repeat over the next few years.

This is visible in Balder’s capital expenditures, which were reduced to $1.5 billion in 2022, compared to $2.9 billion in 2021, and to less than $500 million in the first nine months of 2023. The company’s focus is now on cash flow generation to maintain a strong balance sheet and don’t face any liquidity issues in the coming quarters, at the expense of lower growth ahead.

Conclusion

The European real estate sector is facing a cyclical downturn due to rising interest rates that have put pressure on property valuations and have shifted investor sentiment to be more averse to companies with high debt levels.

While Balder has good fundamentals and has reported a resilient operating performance, it’s naturally not immune to industry headwinds, justifying its current discounted valuation. Based on its main listing in Sweden, its shares are currently trading at some 0.60x its Net Asset Value ((NAV)) per share, which is much lower than its historical average over the past five years of around 1.4x.

Even considering that Balder’s growth prospects are weaker than in the past, this discount seems to be undemanding and Balder is clearly undervalued. Given that interest rates seem to have reached a peak in Europe, this seems to be a good time to buy undervalued real estate companies and Balder is an interesting value play right now.

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