Cube Report (7 June 2021) – Property stocks send mixed messages
Good morning, it’s Roland here with Monday’s Cube Report.
The last year has seen some big moves in the stock market. Some stocks have performed extremely well, while others have lagged the wider market recovery. One consequence that I’ve seen in my own portfolio is that my position sizing has changed. This has altered the level of concentration in my portfolio and the balance between positions.
This is a topic Graham is also wrestling with at the moment. In a new premium piece for subscribers, he’s provided an update on his share portfolio and discussed some possible changes to achieve his desired level of concentration. You can find the piece here — it’s well worth a read, in my view.
Moving swiftly on, the companies I’d like to look at today are:
- Serviced office provider IWG (which owns the Regus brand)
- German commercial property firm Sirius Real Estate
- Time permitting, I also want to highlight interesting updates from Reckitt Benckiser and S4 Capital
- Stock data should display here.
|Writer disclosure||No position|
Unfortunately, it seems that demand for IWG’s services is not recovering as quickly as expected. Today’s trading update is a profit warning. The company says:
the overall improvement in occupancy across the whole Group has been lower than previously anticipated as a result of the prolonged impact of COVID-19
Although the US market is said to be seeing “positive occupancy momentum”, a wider recovery across the group is now expected to take longer than expected. As a result, profits will be below expectations:
given the operational gearing of the Group, is expected to have a significant impact on the Group’s results for 2021, with underlying Group EBITDA for 2021 now expected to be well below the level in 2020.
How bad is this? To put today’s warning in context, here are the numbers I can see:
- 2020 adjusted EBITDA: £1,234m
- 2021 consensus forecast EBITDA (before today’s warning): £1,066m
Broker forecasts already seemed to be pricing in a 14% fall in EBITDA this year. I assume that today’s warning means the decline will be significantly greater — I’d guess in excess of 20%.
Today’s update takes a far more cautious tone than IWG’s April update, which said the company had seen “a clear inflection point” in Q1 2021 and expected “this momentum to continue throughout Q2”. It looks like this optimistic stance may have been premature.
From what I’ve heard, many organisations plan to adopt a hybrid approach to office working following the pandemic. Workers will be able to use offices to work and collaborate, but they’ll also have greater freedom to work at home.
It remains to be seen how this will affect demand for IWG’s workspaces. The bullish case seems to be that the firm’s workspaces could be popular, as they offer a flexible, capex-light solution way to for companies to access modern office space. A more bearish scenario might be that IWG’s spaces may simply contribute to a glut of empty office space.
Time will tell. But is IWG equity attractive to me today?
IWG’s scale, geographic diversity and established brands have some appeal, in my view. But two other factors deter me.
Balance sheet: You might expect a company like this to own the properties it lets to its tenants. But IWG doesn’t. The group’s latest balance sheet shows that the bulk of its property assets are leased:
Essentially, IWG appears to be an arbitrage play on property — the company takes cheaper, long-term leases on property and then hopes to let it out at higher rates on short-term lets. This model can be profitable when times are good, but provides little downside protection when things are bad. Unlike — say — British Land or Landsec, IWG can’t sell its property assets — it doesn’t own [many of] them.
Today’s update refers to “the operational gearing” of the group. I’d guess fixed lease costs are the major factor in this — they stay constant regardless of occupancy. A small change in occupancy may drive a big percentage change in profitability.
I don’t see this as a very attractive model. I prefer to invest in property companies which own the properties they operate, as I believe this provides much greater downside protection.
IWG’s 2020 balance sheet shows equity of just £514m, for a property company with a £3.1bn market cap. This highlights the extent to which this business is valued on earnings, rather than net asset value. This leads me to my second concern.
Valuation: I suspect that today’s news may also have an unfavourable impact on IWG’s gearing, which was reported as 2.7x EBITDA at the end of last year.
I’d need to do further work to model this, due to the complexities of IFRS 16 accounting. But even without considering leverage, IWG’s valuation gives me pause for thought.
Ahead of today’s update, IWG was expected to report an after-tax loss in 2021, with a return to profitability in 2022. Broker forecasts were pricing the stock at 37 times 2022 earnings, falling to 24 times earnings in 2023.
Although I think IWG probably will see good days again, the stock’s valuation seemed to price in a remarkably rosy scenario.
Management guidance is that the outlook for 2022 remains “broadly unchanged”. I’d read that as slightly lower. However, even if 2022 earnings are in line with current forecasts, the stock is still trading on 31 times 2022 forecast earnings after today’s slump.
IWG looked fully valued to me before today’s profit warning and continues to do so. Although I’m encouraged by the fact that CEO Mark Dixon owns 28.5% of this business, I’m not inclined to buy after today’s news. In my view, the downside risks outweigh any likely opportunity.
- Stock data should display here.
|Writer disclosure||No position|
German commercial property group Sirius Real Estate provides a welcome contrast to IWG. I’ve owned and followed Sirius for a number of years, although sadly I have sold my stock and no longer have a position. I
probably should have held.
SRE operates mixed-use business parks across Germany, typically including both light industrial and office space. The company has an active management policy, buying assets were it can add value and periodically selling those where it thinks opportunities are limited. The tenant base is diverse and includes multinationals, public sector organisations and smaller German companies.
It’s a nice mix that has proved remarkably resilient over the last year. These figures cover the 12 months to 31 March 2021:
- Pre-tax profit up 47.7% to €163.7m due to €103.9m of property revaluation gains
- Total shareholder accounting return of 19.5% (FY20: 13.1%), thanks to a 15% increase in adjusted NAV and dividends paid
- Annualised rent roll up 7.6% to €97.2m due to organic growth and acquisitions/disposals
- Rent roll up 5.2% on a like-for-like basis
- Net asset value per share up 14.2% to 88.3 eurocents/EPRA NAV up 14.7% to 92.3 eurocents per share
- Funds from operations (FFO) up 9.3% to €60.9m
- Full-year dividend up 6.4% to 3.8 eurocents, in line with policy of 65% of FFO.
- Net loan-to-value (LTV) ratio of 31.4% (FY20 32.8%)
- Occupancy 87% (FY20 85.3%)
- Cash collection rate of 98.2% for the 12-month period
I don’t know all that much about the German property market, or the level of government support afforded to tenants last year. But Sirius has been able to maintain high levels of rent collection and has also continued to attract new tenants. The company has also remained active in the property market, buying and selling a number of sites on what appear to be attractive terms.
Very few UK-listed commercial property companies managed to report increases in shareholder NAV and dividend growth last year, while maintaining an attractively low level of gearing (in my opinion). The only exceptions that comes to mind are UK warehouse/logistics property specialists.
At current levels, Sirius Real Estate shares are trading on around 1.4 times NAV, with a forecast yield of 3.3%. That doesn’t seem outrageous to me, but I would note that the shares are at a post-2008 high.
On balance, my view is that the share price is up with events in bullish (cyclical) market conditions. Indeed, CFO Alistair Marks notes in today’s numbers that it’s getting harder to find properties that meet the company’s return expectations.
However, if I still owned Sirius shares I’d certainly be happy to keep holding after today’s results. I think this is one of the better property businesses listed on the London market.
I just have time for a couple of other quick notes on news from mid/large cap stocks.
Reckitt (RKT): The FTSE 100 group formerly known as Reckitt Benckiser is selling its infant formula business in China for $2.2bn. This includes the exclusive right to use the Mead Johnson and Enfa brands in China.
It looks like Reckitt’s newish boss Laxman Narasimhan is starting to unwind the group’s $17.9bn acquisition of Mead Johnson in 2017.
The company notes that selling the China business will result in a £2.5bn net loss, “principally relating to the re-measurement of goodwill and intangible assets for IFCN China”. In other words, Reckitt is selling these assets for £2.5bn less than it paid in 2017. An unfortunate result for shareholders.
Indeed, I think the performance of Reckitt’s infant formula business since 2017 has been disappointing. China has been particularly difficult, so I think it makes sense to exit this market.
Personally, I would prefer to invest in Reckitt’s mix of branded health and hygiene products without baby formula. Although Reckitt shares are moving towards a valuation where I might consider buying, at this point I still prefer Unilever (I hold).
S4 Capital (SFOR): This digital marketing group has grown rapidly since former WPP boss Sir Martin Sorrell took charge. S4 has issued an AGM statement today. I make no comment on it, but I would say that for anyone interested in this business, today’s statement provides a useful description of the development of this business.
That’s all for today, thanks for reading.
I’d welcome any feedback on the shorter-style notes at the end. Are these of any use, or would you prefer I concentrate my efforts on fewer, in-depth topics?
All feedback welcome, as always, via the thumbs up below or the comment box.