TAGOF - TAG Immobilien: Liquidity Concerns Makes Me Wary

2023-05-18 20:22:02 ET

Summary

• TAG Immobilien holds residential units both in Germany and Poland.
• Its recent operating performance has been resilient considering the difficult market environment.
• The company’s relatively high financial leverage and weak liquidity are major issues to fix.

TAG Immobilien ( TAGOF ) has reported a positive operating performance recently, but its liquidity needs in the coming months is a major reason to avoid its shares.

As I’ve covered in a previous article , TAG Immobilien stock trades at a discount to its closest German peers, but this seems to be justified by the company’s fundamental issues and my recommendation was to avoid its shares. In this article, I analyze TAG’s most recent earnings and update its investment case, to see if its shares are now attractive for long-term investors or remain a trap within the German residential sector.

Recent Developments

The operating landscape in the German real estate market has been quite challenging in recent quarters, as rising interest rates led to higher funding costs and negative investor sentiment. This has impacted negatively property valuations and the transaction market is much less active, making companies in this industry changing their business strategies from growth to balance sheet management.

TAG has been no exception and its smaller size than some of its peers also puts more pressure on its refinancing needs, as the company’s capability of raising funds in the bond market is more difficult than of larger competitors.

Despite this more difficult background, TAG was able to report a resilient operating performance during 2022 , as the market deteriorated more markedly only in the last few months of the year. Therefore, TAG was able to increase its rental growth in Germany by 2.7% YoY in the year, and reduce the vacancy rate to 4.4% (vs. 5.4% at the end of 2021). Despite its vacancy being on a positive downward trajectory, it’s still higher than Vonovia ( VONOY ) for instance which reported a vacancy rate of about 2.4% in the same period.

Nevertheless, its property portfolio valuation decreased during the year, as the upward valuation of 4% in the first half was not enough to offset a decline of 5.5% in the second half, justified mainly by yield compression.

In Poland, the company has completed more than 1,000 units during 2022 and this country has already contributed with more than €27 million in rental income during the year, a contribution that is expected to increase over the next couple of years as units under construction become completed and start to generate income.

In Germany, the company was able to sell about 900 units in Q4 2022, raising about €86 million in 1,600 units disposed during 2022 (as part of its €250 million asset disposal program), being important to improve its liquidity and maintain leverage ratios at acceptable levels. Investors should also note that TAG performed a right issue in July 2022 (raising €202 million in gross proceeds) and decided to suspend its dividend related to 2022 earnings, saving about €143 million in cash outflows.

This clearly shows that TAG’s strategy has shifted from growth to cash management, like it has happened for all of its peers in recent months, as funding conditions have become much tighter for European real estate companies since the European Central Bank monetary policy changed to an interest rate hiking pace in mid-2022.

During the first three months of 2023 , TAG maintained a positive trend in rental growth, reporting like-for-like increase of 1.6% YoY and 2.8% YoY including vacancy rate reduction, which was the strongest performance in the first quarter compared to the previous three years.

However, the company’s overall vacancy rate increased to 4.7% at the end of March, up by 30 basis points compared to the end of 2022, showing that the economic slowdown is taking effect on the housing market. In Poland, there were more than 2,100 units already completed at the end of Q1, being positive for rental growth across the company,

Regarding its property portfolio valuation, the company only performs revaluations on a half-year basis, thus its portfolio is not reflected at market values, as other competitors such as Vonovia reported declining property valuations in Q1. Nevertheless, TAG was able to agree a net disposal of about 1,000 units in Germany during Q1, generating gross proceeds of €84 million and a book value loss of only 4.3 million, expecting this deal to close during the next two quarters.

In Poland, the company maintained its growth strategy, even though it has suspended new projects, but it will complete current building under construction. It also announced a new joint-venture with an institutional investor, to target land for acquisition and develop new buildings for sale, with an initial investment value of about €100 million. This is a positive development in my opinion, given that it will enable TAG to maintain its growth strategy in the country and allocate less resources for new constructions, which is positive for its balance sheet.

From an operating perspective, TAG reported a resilient performance in Q1, given that net rental income amounted to €70.8 million, a small increase compared to the previous quarter, and its consolidated net profit was €33.1 million.

Regarding its financial profile, TAG’s loan-to-value ratio was 46.4% at the end of last March, a higher level than desired by the company (about 45%), and also slightly higher than compared to its closest peers. Moreover, as TAG has not revalued its property portfolio this quarter, this ratio is likely to increase in Q2, as property values are expected to maintain a downward trajectory in the coming months.

Given that increased debt levels are a major concern for investors right now, TAG’s financial position is not particularly strong and further asset sales seem to be needed to maintain its LTV ratio within its target level. Regarding its debt maturity schedule, TAG has some €243 million maturing in 2023, €509 million in 2024, and €482 million in 2025, while its liquidity position was about €200 million at the end of last quarter considering both cash and other current assets.

This means that TAG does not have enough cash to cover upcoming maturities and needs to refinance debt to not enter into financial distress, which is not the best position to be considering the though funding market for real estate companies right now.

While TAG expects to generate cash, given that its FFO guidance is about €172 million in 2023, this is not enough to cover its debt maturities this year, thus its cash position will reduce in the coming months unless it is able to sell more units in the coming months and its liquidity position remains somewhat constrained.

Conclusion

TAG Immobilien has reported a resilient operating performance in recent quarters considering the more challenging market backdrop, but its balance sheet and liquidity positions are major concerns and key factors that justify its current low valuation.

The company needs to sell assets to improve liquidity given that credit markets remain shut for the company, and its peers, which may not be easy to achieve in the current market environment. Therefore, I think TAG remains a company to avoid within the German residential sector for the time being, until the company can improve its liquidity position in a meaningful way.

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