BALDF - Fastighets AB Balder: Refinancing Needs Are A Major Concern

2023-05-04 06:03:43 ET

Summary

• Balder is a Swedish real estate company, focused on the residential and commercial segments.
• It has reported a resilient operating performance in 2022, despite the challenging market environment.
• Its refinancing needs and balance sheet leverage are two major issues to address over the coming quarters.

Fastighets AB Balder ( OTCPK:BALDF ) has reported a good operating performance related to 2022, but its balance sheet and debt management remain key concerns.

As I’ve covered in a previous article , Balder has an interesting business profile within the Nordic real estate market, but its refinancing needs in the short term are a major concern. In this article, I analyze its most recent earnings, and update Balder’s investment case to see if its shares are now more appealing to long-term investors or not.

Earnings Analysis

Balder has released its 2022 earnings some weeks ago, reporting resilient results taking into account the more challenging backdrop in the European real estate market over the past few quarters. Indeed, due to the rising interest rate environment, the property market has been negatively affected by lower valuations and a declining transaction markets, plus rising financing costs and inflation are also headwinds for new developments.

Despite this, Balder reported a property portfolio valued at around $21 billion, maintaining its growth trajectory of the past few years. It had more than 1,800 properties at the end of 2022, including residential and commercial properties, plus new construction projects across the Scandinavian countries, Germany and the U.K.

Due to its relatively large property portfolio, Balder is one the largest real estate companies in Sweden, being a long-term owner aiming to generate value through a high level of activity and efficient management, with the goal of generating stable cash flows over the economic cycle.

The majority of its assets are in the residential segment (about 57%), which are relatively low risk and provide recurring and predictable long-term cash flows. Other segments include office (16% of the portfolio), followed by retail (9%), logistics (7%), and others. Geographically, its two most important regions are Helsinki in Finland (22% of the portfolio) and Gothenburg in Sweden (19%).

In 2022, Balder’s rental income amounted to $1.02 billion, an increase of 17.5% YoY, largely explained by acquisitions and new construction. Its vacancy rate was only 4% at the end of the year, stable compared to 2021, showing that its properties have good value. Due to gains from divestments, its net profit for the year was close to $1 billion, while its profit from property management was $595 million (up by 10.8% YoY) and its return on equity ((ROE)) ratio was 12.1%.

Contrary to many companies in the real estate sector, Balder does not have a dividend policy of distributing a large part of its profits to shareholders, instead it prefers to reinvest profits in the business through a combination of acquisitions, new construction, or renovation of its existing properties. This means that a dividend is not expected to be declared in the near future, which makes its stock not particularly attractive to income investors, being therefore more suitable for growth investors.

While historically the company has grown through acquisitions and new developments, taking into account the more challenging macroeconomic backdrop and tighter funding conditions in the real estate sector, Balder expects to decrease its investment during 2023 and is not likely to pursue major acquisitions. Its capital expenditures were already reduced in 2022 (capex of $1.5 billion vs. $2.9 billion in 2021) to preserve its cash flows, and a big reduction to only $400 million is expected in 2023.

This reduced level of investments is also explained by rising costs, even though Balder’s current developments are mainly at fixed construction costs, new developments will reflect higher costs due to inflation and the war in Ukraine that led to rising material costs. This means that new construction is much less profitable for developers, which naturally will lead to much lower activity in the near future compared to the past few years.

This shows that Balder is adapting its business model for the current operating landscape in real estate sector, which seems to be a sensible move by its management. Regarding its operating performance, its guidance is to achieve a profit from property management of about $600 million in 2023, which is a small increase compared to 2022. While this is not impressive, considering the difficult operating landscape it can be considered an acceptable performance, even though there is considerable uncertainty in this forecast.

Regarding its balance sheet and liquidity position, Balder has a somewhat leveraged financial position, like many other companies in the European real estate sector. While during many years real estate players benefited from a low interest rate environment and plenty of liquidity in the bond market, this has changed markedly during the past year, with investors being now much more worried about debt levels and refinancing needs over the short to medium term.

Due to this different mindset, Balder is now focused on balance sheet management and has introduced a new financial target, aiming to have a net debt-to-EBITDA ratio of less than 11x, to be achieved by reducing debt levels, higher income from current properties and new construction being completed and starting to generate income.

At the end of 2022, Balder’s net debt-to-EBITDA ratio was above 13x, showing that is financial leverage position is higher than desired. Considering that its EBITDA is not expected to grow much organically in the short term, Balder needs to reduce leverage by selling properties and by improving its organic cash generation, explaining it big reduction in capex expected for this year.

Regarding other main financial targets, Balder also wants to have a net debt-to-assets ratio below 50%, an equity-to-assets ratio above 40%, an interest coverage ratio of at least 2x, and an investment grade credit rating. At the end of 2022, Balder was within its targets, even though it didn’t have much surplus as shown in the next table, which means its financial position could be stronger.

Moreover, its debt maturity profile is also concerning given that it has significant debt maturities over the next two years (2023-24), given that about 27% of its total liabilities mature during this period. At the end of 2022, Balder’s liquidity position and confirmed loan commitments amounted to nearly $2.4 billion, which is enough to cover its upcoming debt maturities in the next eighteen months. This means that a liquidity crunch is not expected in the short term, but Balder needs to refinance its debt during the next few months and deleveraging its balance sheet at the same time, which puts the company in a delicate situation.

Credit conditions in the bond market remain quite difficult for real estate companies, with only the largest ones being able to do some transactions with private creditors, such as Vonovia ( OTCPK:VONOY ) has recently done with Apollo Global Management ( APO ). Given that Balder is also a relatively large player in the European real estate sector, it may enter into some type of deal to monetize its assets, which would be positive for its credit profile and to reduce its debt levels.

Nevertheless, I don’t expect Balder to return to the debt market in the short term, which means most likely the company will need to use secured funding to roll over upcoming debt and loan maturities. This will have higher financing costs than current debt, being another headwind for earnings growth over the coming years,

Conclusion

Balder is a solid company within the European real estate market, but its balance sheet position could be better and is a major concern for investors right now. This means that its discounted valuation of about 0.56x NAV is justified by debt concerns, and investors should remain on the sidelines until the company is able to strengthen its financial position and refinance a good part of its upcoming debt maturities.

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