Heimstaden - Walking The Tightrope - Positioning
All,
Please find our updated model here.
A mismatch of assets and liabilities can have horrendous consequences for equity holders. And this is the case for many of European REITS including Heimstaden Bostad. However, with fortuitous movement in underlying rates, and a commencement of a privatisation program, a narrow path can be forged to avoid catastrophe. The Company has to walk the tightrope of balancing LTV concerns, especially secured LTV and ICR ratios, to maintain its investment grade rating and sustain its balance sheet.
There always remains the possibility of issuing fresh equity and/or do a larger asset sale, but the basis of our current analysis is this is not the main priority of management in the short term.
Investment Rationale:
- We took a 1% long position in the 2026 Hybrids at 48% in late September 2023, Subsequently, following announcement of a corruption investigation by Swedish FSA at its shareholders, the bonds fell to high 30’s. They have subsequently recovered into year-end as more details emerge, but mainly on underlying rates movement.
- We are now increasing the position to 4% long position in the same Hybrids. We remain confident the Company will deal positively with the 2025 Hybrids but given there elevated trading levels, there is a larger downside to these bonds.
- There is nothing concrete to point to Heimstaden Bostad management being proactive and dealing with the Hybrids, so we start our analysis on where is the downside protection. We calculate the downside based on 350-400bps back of the long-dated unsecured. With the long-end trading tighter than 7% (mid), we see downside on the Hybrids at 55-60% level if the Hybrids are not called.
- Upside is more difficult to estimate, but we can envisage the Company coming with a “Unibail” transaction, offering existing Hybrids 10-20pts of cash plus a new Hybrid with similar coupon. (Obviously, Heimstaden Bostad can offer higher coupon and lower cash, but there is a balance between ICR and LTV concerns). Assuming a new 5yr Hybrid with € + 3.5% coupon is offered, this should trade c. 60-70 level, similar levels to current levels. However, current investors would benefit from 15-20pts of pay down. (Blended price, assuming the new Hybrid would trade at 65% with 15pts of cash, is 70%, 10pts higher than here).
- Therefore, we estimate that on the downside (apart from a substantial widening in rates), is a couple of points, which is negated by the Hybrid coupon. As the Company stated, they intend to maintain cash coupon on the hybrids in all but distressed scenarios. Upside is a return of 20% return on investment over the year assuming the 2025 Hybrids are called.
- We are not totally dismissing the possibility of an equity raise (or larger asset sale) but our base case investment is centred on self-help transactions by Heimstaden Bostad.
Balance Sheet Dilemma:
- There are a couple of constraints Heimstaden Bostad have to navigate to maintain Investment Grade rating and to sustain its capital structure, namely:
- A LTV of 60% through the Unsecured debt (65% is the covenant level)
- A LTV of 40% through the Secured Debt (45% is the covenant level)
- An ICR ratio > 1.6x.
- With no meaningful Secured Debt maturing this year (FY24), Heimstaden Bostad has capacity to issue more secured debt, and stay within its 40% LTV limit. (Assuming no asset sales, and no divestment, there is c. SEK 23bn of capacity).
- This capacity is needed to meet the SEK 19bn of unsecured debt due in FY24. Note, any privatisation sales will reduce the capacity, but the proceeds will be used to repay unsecured debt. Assuming Heimstaden Bostad sells its SEK 7.5bn of assets, but at no premium, and the balance of unsecured is financed at secured level, the secured level LTV would increase by 4pts to 37%.
- Although the LTV secured covenant will tighten, we are confident it will remain below 40% (45% is the covenant level, but 40% is the unwritten rule for secured lending).
- The bigger issue is the ICR. Interest Coverage Ratio will breach the 1.6x level in early FY25 if the upcoming Hybrids are not called and S&P treat them 100% as debt. This treatment will only impact individual Hybrids and even if Heimstaden Bostad do not call the first Hybrid, subsequent hybrids will still qualify for 50:50 treatment.
- In order to maintain its ICR ratio above 1.8x, Heimstaden Bostad needs to maintain some hybrids as part of its capital structure. The bearish view is that Heimstaden Bostad do not call the first Hybrids, in order not to spoil a deal with subsequent Hybrids (as they would undoubtedly appreciate). However, given various comments from management, our base case scenario is the Company attempts a “Unibail” type transaction, by converting the existing hybrid into a new Hybrid with a higher coupon and a partial paydown.
Q4/FY23 Results:
- The Q4/FY23 results confirms our view that operational data is not a concern for Heimstaden Bostad. Rental Growth continues to increase, up 5.6% in the quarter, and occupancy staying above 98%. Net Operating Margin at 67.4% for FY23 remains ahead of FY22 levels, driven by strong Q4 data.
- Initial results from the privatisation program are promising, with a 32% premium to book value achieved in Q4. This program is in its infancy, but all indications point to proceeds likely to exceed book value.
- Company announced the suspension of dividends, including the Preference A’s (to Heimstaden AB) for FY23.
Maturity Profile:
- Heimstaden Bostad have made progress over the last year improving its maturity profile. Various secured bank deals have enabled the Company to extend and procure new facilities in order to extend maturities and repay unsecured bonds during the year, while the unsecured market remains closed for Heimstaden Bostad.
- The Company are in a position to maintain liquidity and upcoming maturities for FY24 from secured sources if, as we suspect the unsecured market remains closed. However, as rates continue to tighten, and the long end of the unsecured bonds tighten to c. 7% we expect the Company will access the unsecured market during the year.
- Heimstaden Bostad have SEK 19bn of unsecured bonds falling due in FY24, with unutilised secured facilities of broadly the same amount. The Company have no (material) bank debt falling due in FY24.
- In FY25, there are SEK 15bn of maturities, SEK 5bn in Secured and SEK 10bn in unsecured.
- These are vastly better figures than as of December 2022 which was SEK 26bn in FY24 and SEK 23bn in FY25 (and SEK 11bn in FY23).
Valuations:
- Ignoring FX impact, Portfolio value declined by c. 1.6% primarily due to property prices in Sweden (28% of total portfolio) and Germany (25%). In other jurisdictions, the Company reported a stabilisation of asset valuations.
- We still maintain that book value of assets remain overstated versus fair value, and highlight that if property yields returned to FY21 levels (on a spread basis over the relevant 10yr government bond), prices would fall to c. 67% of current valuations. This value, c. SEK 215bn, would equate to c. 140bps of widening from current levels, and leave LTV through the bonds at 83% and 95% through the Hybrids.
- We must reiterate, we view this valuation of SEK 215bn very much a downside scenario, and acknowledge even at this level there is some (small) equity value to the institutional investors.
- More importantly, to maintain a 40% LTV at the secured level, the Company can withstand c. 15-20bps of widening across the total portfolio. We suspect any further widening will be country-specific and unlikely to be across the board.
Heimstaden AB:
- We are not comfortable in taking a position at Heimstaden AB. Although we believe in the equity value at Heimstaden Bostad and can envisage a scenario where no new equity is required (and therefore no further dilution to Heimstaden AB’s stake), we see the only path to upward movement in the bonds at AB is from external money arriving into the Heimstaden AB structure. As it currently stands, AB are likely to repay 2024 bonds with cash on balance sheet (proceeds from the Icelandic asset sales), and postpone any decisions on the 2025 SEK bonds and the two Euro bonds.
- Heimstaden AB may attempt further tenders for the SEK 2025 bonds, creating equity value vis subpar tenders. With the suspension of dividends, management may believe now is the right time to attempt further subpar tenders, but previous attempts have been underwhelming.
Happy to discuss.
Tomás
E: tmannion@sarria.co.uk
T: +44 20 3744 7009
www.sarria.co.uk