CDMGF - Icade: More Attractive Than Before With A Massive Yield

2023-08-11 05:05:49 ET

Summary

• Icade, a French REIT, has significantly underperformed due to changing interest rates and property market trends.
• Despite these challenges, Icade is considered one of the safest REITs in Europe from a fundamental standpoint.
• The company has a low LTV, solid financial indicators, and a development pipeline, making it an appealing investment opportunity.

Dear readers/followers,

Icade (CDMGF) was a company I wrote about, and invested in last year. It was, thankfully, a small position that I bought and held and have held to this day. Thankfully because the company has significantly underperformed in a changing interest rate and property sector trend, losing double-digits in a relatively short time frame.

There is also the fact that the company, a French REIT, is in the midst of a disposition and reorganization, which is putting pressure on forward earnings numbers.

However, I will argue in this article, that Icade is, as a matter of fact, one of the safest REITs in Europe from a purely fundamental standpoint. It's this fundamental safety that I make the leading case for continuing to invest in Icade, and why I hold no fears about the company's survivability in a forward context.

Let's see what we have going for us here.

Icade - Updating on a French REIT

So, the combination of rising interest rates together with an overall, well-documented decline in the European property market with companies like Vonovia (VONOY), has left few parts of this market untouched.

I primarily cover two French REITs. One is Icade, one is Gecina (GECFF). I own both, but my positions are limited. Other companies come out of the post-WW2 French housing shortage, to somehow solve the living space discrepancy in the country.

Despite a very limited size of just above €2.7B in market capitalization, Icade sports a BBB+ S&P Global credit rating. It also sports a dividend yield of 12%+ and a comparative FFO yield of almost 14%.

The company traditionally had a mix of office, residential and mixed-use assets in its portfolio together with the related prop services. The company abandoned its residential properties back in 2010 after the GFC, and its services segment in 2016, leaving it to focus on the segments of real estate assets that it currently owns, which comes to Office Space and Healthcare Space. This gives you the relevant comps to which you should view Icade if you want to compare it to US REITs.

The latest results we have from Icade are the 1H23 results, which at this time are very "fresh."

Despite what you in terms of share price development might view as a very negative trend, Icade actually had a good half-year with substantial and fundamental improvements across the board. Icade has one of the lowest LTVs of any REIT I cover, it's below 30%, at 29% currently.

It's also in the process of completing its Santé disposal which will bring in close to €3B in cash-in over the course of stages 1-3 over the coming years, most of which will be paid out in the form of dividends.

The company's financial indicators are solid. The company has reinforced its balance sheet through the disposition of healthcare assets, which would previously make up (at least that was the plan) some io the company's core.

This marks a shift in company strategy and not a small one. This also goes some way to explain the instability in the business. Whenever a business, including a REIT, does this sort of turnaround, it's bound to make people nervous.

The next stages of disposal include the annual inflows of funds managed by the PRimonial REIM. That's €300M in special dividends alone to be distributed until 2027, with more room to maneuver, and this doesn't yet include additional cash flows from dividends received from its healthcare portfolio, until the end of the disposition period.

The total move brings around €710M of special dividends, a debt reduction for the company, and cash to invest in other business areas, which as you can see above is focusing on commercial and property development.

What does this mean for my position as well as for future shareholders? It means that the recurring earnings are going to decline as this part of the portfolio is sold off, while the company will have to reinvest and continue to pay out dividends. I would personally have viewed it as more advantageous to see a higher degree of new and reinvestment as opposed to payouts. The current forecast makes it clear what sort of earnings we can expect on a forward-going basis.

But there is a softness in the market currently that makes profitable reinvestment not easy. 1H23 update in the Paris region, which is Icade's main market, is down 22% YoY. The company's expectation for the leasing market for office space is a naturally shifting demand that moves outside the CBD areas but to prime office spaces.

Total investment volume in France has cratered - down 42% YoY, and French investors continue to represent a vast majority of that investment volume. The market is very cautious here, and prime yields are adapting to the new environment. New large deals in the Central Business District (That's what CBD stands for, not Cannabis) in Paris are done at prime yields of 3.5-4%, with the non-CBD regions at around 5.5-6%. Yield decompression is slowly restoring attractiveness, but it's very slow progress, with investors more selective and careful than before.

On the leasing front, there are no negatives that I can see.

100% of the company's leases are indexed, with a 5% estimated impact of indexation beyond 2023. With the company's healthcare disposal, as well as these disposals the company no longer need to dispose of anything else.

The picture that the company wants to present is that the portfolio will be in a far more streamlined, efficient, and positive state with this done, and we can expect Icade to deliver better profitability and more stable earnings going forward. This would be welcome.

The company also has a development pipeline. Over €650M is committed, with €319M in CapEx over 3 years. The fundamentals of these prospects look excellent, on the basis of full pre-letting with completions in part by the end of -23.

The company is moving back into resi development, and while this market isn't in shambles as such, it's not in any sort of good position here. With rising interest rates, first-time buyers have credit and solvency issues. This is countered with a low French unemployment rate of below 7.5%, and strong demographic trends, with 11% population growth in 20 years. The picture in France is similar to the one in Scandinavia and northern Europe overall - a structural need for living space and units, but a high cost for building and lower interest from institutional investors and financing partners.

So, Icade is moving slowly, and taking advantage of its large backlog.

Going into the valuation and high-level view, we now need to consider that Icade will offer us a new "rent base" post the healthcare disposal. The company expects to deconsolidate stage 1 on July 5th of this year, turning its remaining stake into financial participation and generating dividends. This turns the company, on a forward expected basis, into generating a NCCF or net cumulative cash flow of about 60% of the NCCF of June 2022.

On a proforma basis, this metric is actually up 0.4% on a YoY basis. If we look at the underlying numbers from the two remaining segments, the P&Ls here are positive. Gross rental income is up, even if the net is somewhat down. However, due to Icade's very low debt and near-fully hedged interest costs, the company remains relatively shielded from the worst of the interest rate impacts.

Since this is an EU REIT, we work with EPRA numbers. The post-disposal transaction brings about an EPRA NTA, or net tangible asset value of just north of €6B. This is more than twice the implied current value based on Icade's share price of €35.96/share. On account of the current float, the per-share EPRA NTA comes to almost €80/share. This is inclusive of a €15.1 representative remaining stake in healthcare, and €18.5 in cash.

The company has also further reined in any financial expense. It has over 95% hedged debt until 2026 on average, with almost 6.5 years left on the hedging instruments. The cost of debt is at 1.59% post-deconsolidation. And I really want you to find a REIT with a lower cost of debt.

The LTV pathway has brought it to an almost ridiculously low level, though on an EBITDA basis, it's now at an "alright" level.

So here is what I see for valuation.

Icade's valuation - so much to like, but a decent amount of uncertainty and risk.

So, the company's valuation does not represent even a close to fair value of what I consider Icade to be worth, or what EPRA standards would put the company at. Just like with NAV or other ways of viewing, this does not mean that the company is massively undervalued. We want to put a discount on the company's EPRA NTA to account for some of the risks here.

Icade is, by most that follow the business, considered severely undervalued. GuruFocus metrics put the company at almost a €70/share PT. S&P Global has 11 analysts following the company, giving it an average of €48/share. The company's current share price is about €35-€36, which is below any estimates that the company would be valued at.

While we do indeed see the company at a significant undervaluation at this time, this also comes with at least 3 years of consecutive likely FFO/earnings decline. FactSet estimates the company's FFO to decline by 16.7% this year, another 11% next year, and 1% in 2025 before stabilizing. The company already is cheap. With this yield, you could forecast it at a €30/share PT, lower than the current one, and you'd still make off with almost 5% per year despite this.

Any northward-bound development here is likely to result in outperformance. At a 10-12x P/FFO and estimating it at below €50/share, you're still making off with 22% per year inclusive of dividends. This company is now dirt cheap.

I'll discount Icade by 40% to its EPRA NTA. This puts the price at around €48/share. At 60% of EPRA NTA, I believe we're protected enough no matter what happens to that yield or to the company in the near term. Icade has a very qualitative portfolio of core-located office properties that are near 100% occupancy, mostly indexed to inflation in terms of rent, and its development arm will turn around as the overall climate improves. The company will provide, going forward, a dividend at the level of its minimal legal distribution obligation, but will also provide a special dividend of at least €2.54 in 2024.

This special dividend alone puts the company at almost 7% yield, and there's still the ordinary dividend to consider atop this.

Icade has been through a relatively quick reorganization, but I see the wheels turning behind the company's various considerations, making it substantially less leveraged, with a substantially de-risked portfolio that no longer includes healthcare, with very resilient fundamentals based in part on the Paris CBD.

To this, I give you the following thesis.

Thesis

• Contrary to popular belief, Europe does have a couple of REITs that are worth getting into, as well as straight real estate companies. I've looked at a few of them so far, and I intend to continue doing so.
• Icade is, post-disposal of healthcare an interesting mix of office, and residential development with a 39% stake from the French government. These things, together with the fundamentals, make the company an appealing prospect to me. Once we've established that a company is an appealing prospect, what's left to estimate is the valuation.
• Post disposal and considering relevant EPRA numbers, I would put the company at a discount of 40% to its EPRA NTA. This still puts the PT at €48/share, which is a considerable upside from the current share price.
• I consider the company safe, and a "BUY" here.

Remember, I'm all about:

1. Buying undervalued - even if that undervaluation is slight, and not mind-numbingly massive - companies at a discount, allowing them to normalize over time and harvesting capital gains and dividends in the meantime.

2. If the company goes well beyond normalization and goes into overvaluation, I harvest gains and rotate my position into other undervalued stocks, repeating #1.

3. If the company doesn't go into overvaluation, but hovers within a fair value, or goes back down to undervaluation, I buy more as time allows.

4. I reinvest proceeds from dividends, savings from work, or other cash inflows as specified in #1.

Here are my criteria and how the company fulfills them (italicized).

• This company is overall qualitative.
• This company is fundamentally safe/conservative & well-run.
• This company pays a well-covered dividend.
• This company is currently cheap.
• This company has a realistic upside based on earnings growth or multiple expansion/reversion.

While certainly speculative at this point in time, I believe Icade is still an absolutely solid investment, and I'm buying more shares and expanding my overall position.

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