Summary
- The real estate sector is facing significant headwinds, especially in some sectors like the office asset class.
- The company provided 2023 guidance that calls for a decline in core EPS and core EBITDA, but longer term, it sees earnings continuing to increase at a rapid rate.
- There has been an uptick in the valuation since our last article, but shares still look attractively priced, we are adjusting our rating to "Buy."
The real estate is suffering multiple headwinds, and that was reflected in CBRE Group, Inc.'s ( CBRE ) FY2022 results , and particularly in the results of its fourth quarter. In Q4, core EPS was $1.33 which represents a ~26% year-over-year decline. In fact, most of the key business indicators were down in the fourth quarter. Revenue was down ~4%, net revenue decreased ~11%, core EBITDA came in ~30% lower, GAAP EPS suffered a ~88% decline, and core EPS was ~26% lower.
Still, given the headwinds, things could have been much worse. These headwinds include a weakening economy, rising interest rates, market declines, and constrained credit availability. Despite these headwinds, the company was able to slightly exceed expectations thanks to strength in the Advisory and Global Workplace Solutions segments. Looking at the whole year, things are not as bad, with full year core EPS growing ~7% to $5.69, net revenue up ~10%, and Core EBITDA slightly higher. CBRE stock also managed to deliver a ~75% free cash flow conversion.
CBRE Investor Presentation
One of the key things mentioned during the company's earnings call was that the cyclically resilient business segment performed particularly well. These businesses are mostly focused on outsourcing services and include things like project management and facilities management. In terms of asset classes, logistics performed very well. CBRE estimates that roughly 45% of its core EBITDA comes from resilient business segments, which helped offset a larger-than-expected decline in transactional revenue.
Given the size and reach of CBRE in the real estate industry, it is very interesting to hear from them how the different property types are performing. The company shared that multi-family and industrial fundamentals remain strong, but with occupancy declining slightly from peak levels and rent growth moderating. On the other hand, office remains extremely challenged, and the CBRE believes occupancy will not come close to pre-pandemic levels anytime soon. This is another important headwind for CBRE, as a little over 50% of its leasing comes from the office sector, even if that is down from ~70% in the past. The company expects more of its income stream in the leasing business to increasingly come from industrial relative to office.
2025 Core EPS Target
The company had previously shared with investors a 2025 financial target of delivering core EPS between $8 and $9 by year-end 2025. The company provided an update on this target, saying that despite the headwinds it still believes it can reach that level of earnings, but that it is likely to take it an extra 12 to 18 months to deliver this level of earnings. That means the company expects core earnings to reach ~$8.5 by roughly FY26 or FY27.
It is a little bit disappointing to see the company move the target date to reach this earnings level, but it is understandable given the state of the real estate market. Our glass half-full take is that it is positive that at least the company is still aiming for double-digit compound core EPS growth.
Balance Sheet
One thing that CBRE has going in its favor is a very strong balance sheet that should allow it to seize attractive M&A opportunities if they present themselves. The company mentioned during the conference call that it is willing to go up to two times leverage for a transformational deal, maybe even slightly higher. Currently, CBRE is operating with very little leverage and has relatively small amounts of debt maturing soon. Its total debt is ~$1.7 billion, which is offset by ~$1.3 billion in cash and short-term investments, resulting in net debt of only ~$416 million. The resulting net leverage is ~0.14x.
Guidance
Unsurprisingly, given the state of the real estate market, the company's guidance for 2023 is that Core EBITDA is expected to decline by a high-single-digit percentage, while Core EPS is expected to decline by a low-to-mid double-digit percentage. While 2023 is expected to be a tough year for the company, we remain optimistic about its earnings growth potential once the real estate market recovers. While it is disappointing to see earnings decline, it is reassuring to see that CBRE Group, Inc. is proving resilient and is maintaining a good degree of profitability through the downturn.
Valuation
CBRE Group, Inc. shares have gone up ~15% since our previous article , where we argued it was a great time to buy the shares. This compares quite favorably to the ~4% the S&P 500 Index (SP500) has delivered since then. Despite the headwinds, we continue to believe shares are undervalued, even if they are slightly more expensive now. Given the uptick in the valuation, we are adjusting our rating to "Buy" from "Strong Buy" previously, but we still believe shares are at an attractive price.
As can be seen below, CBRE shares are still trading below the ten-year average EV/EBITDA multiple and a relatively low value for what we believe is a quality business. Another way to think about the valuation is that shares are trading at only ~10x its core EPS target of ~$8.50 that it expects to reach in the next few years.
Risks
The biggest risk we see for CBRE Group, Inc. investors is that the company's guidance assumes a mild recession arriving soon, but it could turn out to be a severe recession. The risk is mitigated by the company's diversification, resilient business segments, and strong balance sheet. That said, shares could still decline significantly if a recession arrives or if the real estate market deteriorates further, even if the decline proves temporary.
Conclusion
The biggest takeaway from CBRE Group, Inc.'s recent earnings was that the real estate sector is facing significant headwinds, but that the company is proving resilient. It is being particularly helped by outsourcing services, such as project management and facilities management, while transactional revenue is being significantly impacted. The company is also seeing some headwinds from the office asset class, which remains under significant pressure due to the low physical occupancy resulting from the work-from-home trend. Still, the company reaffirmed its commitment to reach a Core EPS of ~$8.5 in the next few years, and CBRE Group, Inc. shares continue to look attractively priced.
For further details see:
CBRE Group: Resilience To Real Estate Headwinds Makes It A Buy (Rating Downgrade)