2023-06-08 23:57:24 ET
Summary
- DIC Asset is a German real estate company that owns a sizable commercial portfolio of logistics and office properties.
- On top of that, it also manages about EUR 10 Billion of real estate for institutional clients and earns a management fee for doing so.
- Although the company has a significant debt load, it's reasonably priced relative to conservatively calculated fair value and pays a juicy dividend.
Dear readers/followers,
Following a number of articles I've written on US office REITs, an article on a European office landlord is long overdue. Just like I argued in my article on Klepierre ( KLPEF ) that the European shopping mall culture is quite different from the one in the US, the same goes for offices. This is because work from home is not nearly as big a threat in Europe, as for the most part, companies require people to come to the office way more than in the US. Home office is not a norm, but a privilege and most people in most average corporate jobs are happy to get one to two days a week. This is especially true in Germany, where going to the office remains a norm. That is why today I want to cover a major German real estate player focused on office space - DIC Asset ( DDCCF ).
DIC is a mix of a traditional REIT which owns and leases properties and an asset management firm that invests third-party institutional money to earn a fee. To best understand it, we'll look at each part of its business separately and then put everything together at the end, focusing on the true fair value of the company and comparing it to what we are paying in the market today.
Portfolio of properties
DIC's portfolio has changed quite substantially over the past year, growing from EUR 2.2 Billion to EUR 4.1 Billion. This significant growth was a consequence of management's strategic decision to move away from office and include logistics. In April 2022, DIC acquired a majority 60% stake in VIB at a significant premium at the time. Though I'm quite happy with their logistics exposure, I think they could have timed the transaction better and achieved better pricing if they waited a bit longer. This major portfolio change was then followed by a major disposal of 31 retail properties in Q1 2023 which left the company with nearly half a billion in cash.
As of now, the company owns a commercial portfolio which consists of 174 properties with an annual rental income of EUR 184 Million. About 40% of properties are logistics/industrial (think warehouses), followed by 37% in offices and smaller 8% allocations towards retail and mix-use (rezi+retail) projects. For now, ignore the market value shown in the table below, as we will calculate our own fair value later.
The operational performance of the portfolio has been quite good. Vacancy for logistics remains extremely low at only 1.4%, while office sits comfortably above 90% occupancy. Leasing was up 88% on the year, largely because of the inclusion of the VIB logistics portfolio which wasn't included in Q1 2022 numbers. Excluding those leases, leasing on a same-store comparable basis was still up 20% YoY at 78,000 sqm in Q1 2023. Moreover, the company saw its rent increase by 4.7% YoY, mainly due to inflation driven indexation.
Asset management
Beyond a simple real estate portfolio, the company runs a fast growing asset management business with EUR 10 Billion in assets under management. While that's a lot, it's nowhere near the size of major asset management firms such as Blackstone ( BX ) so it leaves a long growth runway that the company can capitalize on. AUM grew by about 6% YoY and a similar level of growth is expected for this year. In terms of asset allocation, the vast majority (74%) is allocated towards office properties, followed by logistics (11%) and retail (6%). DIC invests almost exclusively institutional money.
As any asset manager, the company earns a management fee. In case of DIC, the base fee of around 0.4% generates about EUR 8-10 Million per quarter. On top of this, the company earns transaction and performance fees, but since the real estate market has been largely frozen over the past year, there were no "extra" fees earned during Q1 2023, which understandably hurt the business. I expect this to be short-lived and as transactions start happening again, DIC should be able to earn more in fees.
Financials
When looking at Q1 results, the YoY comparison is not very meaningful as their portfolio and debt profile has completely changed after the acquisition of VIB. Still, it's good to see that their commercial portfolio saw a meaningful 58% YoY increase in FFO, despite the net interest expense being 3x higher than last year, mainly due to newly added financing for the VIB acquisition. The asset management division, which failed to generate any additional incentive fees, broke-even after OPEX.
In terms of guidance for the year, management expects gross rental income of EUR 190 Million, asset management fees of EUR 75 Million at mid-point and total FFO of EUR 90-97 Million. With this guidance and using conservative assumptions we can calculate fair value of the two parts of their business.
In particular, for the commercial portfolio I assume:
- 10% of gross rent will relate to service charge leakage and other property-related expenses (this was 12% in Q1)
- OPEX annualized in line with Q1 numbers
- cap rates of 4.5%, 8% and 5.5% for logistics, office and retail/mix-use respectively. These are based on major publicly traded peers, namely Prologis ( PLD ) for logistics and Boston Properties ( BXP ) for office.
For the asset management business I assume:
- OPEX annualized in line with Q1 numbers
- FRE multiple of 20x which is slightly below more established peers such as Blackstone or Brookfield ( BAM ) which average 22-25x.
Together, these realistic assumptions yield a total fair value of the portfolio of roughly EUR 3.4 Billion.
The only thing is that DIC has taken on a lot of debt. The company has about EUR 3.2 Billion in debt. What's even worse is that a significant part of this will come due next year. Thankfully, after the disposal of a significant part of their retail portfolio, they have almost EUR 0.5 Billion in cash and assuming that they will be able to refinance the VIB bridge loan (likely) they should be able to handle the maturities as they come due, but it's more likely than not that their weighted average interest expense will increase from the 2.8% they pay currently. A key advantage of DIC is that if they want to sell some of their properties to generate more liquidity, they don't need to sell to an outside buyer, but can easily move the property to their asset management business.
With a fair value of their portfolio at EUR 3.4 Billion, net debt of EUR 2.7 Billion and a market cap of EUR 450 Million, the stock is trading at a slight discount to its fair value (about a EUR 250 Million discount or 8%).
DIC also pays an annual dividend of EUR 0.75 per share, which accounts for about 60% of their expected 2023 FFO (hence quite well covered) and yields 13.5%. With debt maturities more or less covered by cash and solid operational performance of the commercial portfolio, I can actually see the company sustaining the dividend. Moreover, with their significant leverage a mere 8% discount to fair value means up to 50% in stock price if the gap to fair value is to be closed (EUR 250 Million increase in market cap to EUR 700 Million). And if the economic situation improves and valuations go higher, the upside could be much higher as well.
Frankly, their high leverage does pose risk, but the stock is a Spec BUY for me here at EUR 5.40 per share with a PT of EUR 8.40 per share (market cap of EUR 700 Million as above). Know that high leverage will inevitably translate into high volatility of the stock price, but volatility goes both ways. The potential reward is worth it for me.
For further details see:
DIC Asset: Speculative, But Potentially Rewarding