Heimstaden Bostad - Next move - Rating Agency
All,
Please find our updated model here.
The numbers reported by Heimstaden Bostad for Q3 are, in themselves, non-consequential. We go into more details below, but the underlying tone of the call was that discussions continue with their institutional investors. The timing on any equity injection has definitely been pushed back. We expect early FY24. We are increasingly convinced that the Company is likely to wait for the S&P downgrade to BBB- and for any guidance from S&P on what triggers/ICR ratios will need to be avoided to result in a further downgrade to non-investment grade. In the meantime, the Company are pursuing their privatisation program.
Investment Rationale:
- We maintain our small 1% long position in the 2026 Hybrid bonds. We accept that any coupon deferral would cause the bonds to fall substantially, which is reflected in our small position. However, we maintain that the equity holders will provide some additional support to the Company, which is likely to have a disproportionate impact on these Hybrid bonds.
- We will re-evaluate our position when, as we expect, S&P downgrade the Company to BBB- in the coming days.
Takeaway from Results:
- Underlying operational data has improved, in line with the Company guidance. This is better than our model, which we had suspected was conservative in nature. We have made some adjustments to our underlying model, but on reflection, changes to the underlying operational data do not change the near-term capital requirement.
- Rental Income increased by 2.7% across the portfolio, with 4.8% in Sweden and 3.6% in Germany. Denmark, Heimstaden’s third market, increased by only 0.5%. Heimstaden has seen an improvement in net operating income margin across the board, specifically in Sweden and Denmark. In Germany, margins have reduced from Q2 2023, but YTD remains marginally higher than the prior year.
- Overall valuations have declined by 1.4%, to SEK 338bn, as yield requirements have widened to 3.5%. This has resulted in the LTV increasing to 58% from 57.2%. Interest Coverage Ratio (S&P method) was 1.8x in the quarter, falling from 2.1x.
Outstanding Issues:
- We have emailed the Company (not yet had a response) to clarify the cash inflow from “Investments in Associated Companies and Joint Ventures” which was SEK184m in Q3 and SEK674m YTD. We are not able to ascertain which of the associated Companies/Investments is generating positive cash flow. This inflow does not impact the ICR ratio at the primary level, so we are a little less worried about it but still await clarity.
- The second issue is the inclusion of Realised gains/losses from the divestment of properties above the line in the P&L and therefore included in the ICR calculation. This has little impact on current ratios, but with the Company embarking on its privatisation program, the gains from selling assets above NAV are likely to increase, resulting in a material impact on Operating Profit and ICR ratios if Heimstaden are allowed to include these gains. We suspect S&P will make adjustments to exclude the gains from their ICR calculations but it is worth noting that the Company are likely to seek to include these in future calculations.
- However, it does reduce the possibility of an asset sale at below NAV levels to an existing equity holder more unlikely, as the NAV discount would impact the Operating Profit and in turn ICR.
Shareholder Discussions:
- We were surprised that the Company has not discussed other options to inject equity into the entity (for example our proposal of one of the equity holders acquiring assets at a small discount to NAV which has the impact of deleveraging). It would appear discussions are centred on a straightforward equity injection.
- The Company acknowledged that shareholder approval is required to do a rights issue at a discount to NAV and current discussions are centred on that topic.
We don’t think the Q3 results change our view of the credit. We expect an imminent downgrade to BBB- by S&P and we will reevaluate our small position on the back of this announcement.
Happy to discuss.
Tomás
E: tmannion@sarria.co.uk
T: +44 20 3744 7009
www.sarria.co.uk