Heimstaden Bostad/AB - Change On The Horizon
All,
Please find our updated analysis on Heimstaden Bostad and Heimstaden AB here.
Distressed debt was seeking good companies and adequate asset coverage, with bad balance sheets. Both Heimstaden Bostad and Heimstaden AB display this. Even allowing for a widening in yields to historic spreads over the 10yr government rate, the underlying residential portfolio provides sufficient asset coverage. However the mismatch of long-term assets and relatively short-term liabilities means it is a story of Interest Coverage Ratio and maintaining Investment Grade ratings, and with this in mind, yields across the Heimstaden structure do not compensate for the downside risk.
Investment Rationale at Heimstaden Bostad:
- We exited our long position in Heimstaden Bostad's perpetual bonds too early in May, (although maintained perpetual exposure in other European Real estate names), we are not minded to reestablish a long position at the current levels. The perpetuals have rallied into the high 80s/low 90s and are now pricing in near perfection. Although we do expect an exchange for the upcoming perpetual maturities coupled with an asset sale in the coming months, there are significant risks to the downside given Heimstaden's overall leverage. The bonds have rallied substantially, with the unsecured now trading at c.5% (except for two illiquid 20235 bonds) offering very little upside.
-Due to Heimstaden's leverage, the ICR is precariously close to breaching the 1.5x level to maintain Investment Grade ratings. Our base case is the Company will maintain the ratio over 1.5x for the next 3 quarters, to June 2024, as the Company continue its privatisation programme. However, without a major asset sale, they will breach the Investment Grade threshold.
- We expect the perpetual bonds will be exchanged, and retain 50% equity rating, this is not sufficient to maintain the Investment Grade rating in the medium term.
- There are no operational reasons for the exit - in fact, the first slide of Heimstaden Bostad's presentation leads with the phrase - Q1 2024: A Turning Point? Our further analysis highlights that even when dealing with the Hybrids similar to AroundTown or Unibail, Heimstaden Bostad will still fail the ICR coverage ratio >1.6x during FY25.
Investment Rationale at Heimstaden AB:
- We are not taking a position in Heimstaden AB at the current time. Despite the rally in the high-yield bonds (and perpetuals) we still are not investing in Heimstaden AB. Even with an 80bps widening from current yields, there is sufficient asset coverage for both the High Yield and perpetual bonds. It is close to where the equity is currently quoted for Heimstaden AB. 80bps is equivalent to the average spread over the 10-year curve in 2021.
- However, despite the asset coverage, we don't foresee dividends recommencing from Heimstaden Bostad before 2026, and the maturity of the first High Yield bond.
- Management's focus will be on maintaining Investment Grade status at Heimstaden Bostad and even with a large asset sale at Bostad, money is unlikely to flow between the two entities.
Options available to the Company:
1) Asset Sale:
- Fueled by comments by management, the market expects and is pricing in, an asset sale to be announced before year-end. We calculate that Heimstaden Bostad would require an asset sale of c. SEK20bn to maintain its Investment Grade rating. We have assumed a 5% discount to NAV for modelling purposes, but a 10% discount on a SEK20bn asset sale would only maintain Investment Grade ratings to the end of FY25. Heimstaden Bostad would require a larger asset sale to give further headroom and recommence dividends. Heimstaden AB would not be able to deal with its upcoming maturities without demonstrating a path for dividends to recommence.
2) Equity Raise:
- An equity raise at Heimstaden Bostad would have a similar impact as asset sales. We had favoured this approach earlier in the year as a way to bolster Heimstaden Bostad’s finances and more importantly their ICR numbers but the Company appear to have discounted this approach. It was always going to be difficult to balance the needs of Heimstaden Bostad versus the dilutive nature of non-participating shareholders, including Heimstaden AB. However, we did think a deal would have been possible, particularly if AB tried to monetise its preference shares.
3) Perpetual Bonds:
- Heimstaden Bostad’s main priority is to maintain its Investment Grade rating. Therefore, Heimstaden Bostad need to maintain the equity ratings for the perpetuals and is likely to exchange those perps with upcoming calls, similar to other European real estate issuers. We don’t see any other options available to the Company in respect of its perpetuals. With the perpetuals trading c.90%, there is potentially 10pts of upside, via a par refinance. However, we view this as unlikely, and expect a perpetual exchange. We would not expect any exchange to be done at par, and therefore, the upside is likely to be limited.
Operational and Recent Results:
- In line with their peers, Heimstaden Bostad reported solid Q2 results with both rental income and NOI margin growing. The Privatisation Program is 40% ahead of our forecast and coupled with achieving a 29% premium over book value, attracting most of the headlines. But to put it into context, Heimstaden sold only 363 units in the quarter (The company own 163k!), with the privatisation programme still in ramp-up phase.
- Property values have marginally increased due to NOI growth compensating for the slightly higher yields in the market. LTV remains in line with covenants, but the ICR has dropped to 1.6x from 2.1x at year-end and is expected to remain in the 1.5-1.6x range. Heimstaden management guided to lfl growth continuing at >5%, with LTV stabilising at 57-58%.
Happy to discuss.
Tomás
E: tmannion@sarria.co.uk
T: +44 20 3744 7009
www.sarria.co.uk