Commercial REITs have been hit hard during the COVID-19 pandemic, but some are performing better than others. Businesswise, that is, as most commercial REITs still have their share prices close to all-time lows, including Eurocommercial Properties (OTC:EUCMF), the Dutch REIT with assets in Italy, Sweden, France and Belgium. I haven’t always been positive about Eurocommercial as I don’t agree with the estimated fair value of the properties (which I think is a bit optimistic) and the REIT’s lack to propose an attractive stock dividend. Despite these two elements, Eurocommercial got way too cheap in the lower-20s and has gotten only cheaper since as the REIT has been able to deal with the fallout of the COVID-19 pandemic.
Source: Yahoo Finance
Eurocommercial’s US listing is quite illiquid and I would recommend all investors to trade in the REIT’s shares through the facilities of Euronext Amsterdam where it’s trading with ECMPA as the ticker symbol. The average daily volume in Amsterdam is approximately 160,000 shares per day which currently represents a monetary value of approximately 1.6M EUR. The current market cap is just around 500M EUR, a steep decrease from the almost 1.5B EUR nearly a year ago.
Eurocommercial’s website contains mostly “direct download” links but you can find all relevant information here.
Some rent deferrals, but all in all a very robust year for Eurocommercial
All eyes were on the second quarter of the current calendar year as Eurocommercial’s first nine months of the year (July 1 2019-March 31 2020) were totally fine as the majority of the rental income was generated in the pre COVID-19 era. A lot of commercial REITs have been suffering lately, but I’m positively surprised by Eurocommercial’s ability to secure its rent as the rent collection was 78% for Q2. France remains the weakest country with a Q2 rent collection of just 68%.
Source: H1 press release
Interestingly, Eurocommercial has agreed to rent holidays on the sole condition that rents will resume after the rent holidays (which were limited in time during for instance mandatory closures) with agreed upon payment schedules. This seems to have been an excellent strategy as the July rent collection number increased to 93%, so the tenants are keeping up to their part of the bargain. Visitor numbers are on the rise again with 83% of the 2019 footfall having returned to the Eurocommercial malls as of the end of June. We still aren’t back to pre COVID-19 levels (and that will probably still take a while), but the situation is improving fast.
Eurocommercial recorded just about 100M EUR in rental income in the first semester of the current calendar year, a 3% decrease compared to H2 CY 2019, and that’s in line with the expectations as most of the rent was deferred and not forgiven. The 19.7M EUR in deferred rent was booked as a rental income but added to the balance sheet as a receivable. Eurocommercial has been quite flexible with its tenants as it plans to amortize these rents over the next several years to make the burden bearable for the tenants.
Source: H1 report
This does mean Eurocommercial is still at risk in case the tenants file for bankruptcy before they can repay the full amount, but the amortization schedule seems very manageable. The amortization of 5.9M EUR in FY 2021 for instance represents less than 3% of the annual rental income.
By recording the deferred rental income in the top line, Eurocommercial kept the “damage” very limited. In fact, its direct income was excellent as it ended the first 12 months of its extended financial year (this will be a one-time 18 month financial year to bring the financial year in line with the calendar year) with a direct income of 118.9M EUR or 2.41 EUR per share, in line with the 120.2M EUR or 2.42 EUR per share in the 12 months ending June 2019.
Source: H1 report
This bodes well, very well. But only if the situation normalizes soon. I also was curious what would happen to the direct result if I would assume the effective rent collection would remain at 85%. That’s higher than the 78% in Q2 but lower than the 93% collected in July, so I would consider it my worst-case scenario.
Taking that into consideration, on an annual basis, the rental income would decrease by about 30M EUR per year. And let’s assume there would be no impact on the operating expenses, then the direct result will fall to 90M EUR per year, or around 1.80 EUR per share. Again, that’s based on a 15% rent collection decrease across the board and completely ignores the recent rental agreements signed by ECMPA which include high single-digit rent hikes.
Or going backward, I wondered what the minimum direct result would have to be if I wanted to see a dividend of 1.40 EUR (for a 14% yield) based on a 90% payout ratio? Then I’d need to see a 1.56 EUR per year direct income, which represents 77.2M EUR. Given the direct operating expenses of 33M EUR, the 4M EUR in service charge expenses, 2M EUR in investment expenses and 42M EUR in interest payments, the total required rental revenue would be 160M EUR, or approximately 77.3% of the normalized rent to be collected. So in order to receive a 1.40 EUR annual dividend, Eurocommercial’s rent collection rates can even be a tad lower than its average Q2 collection rate.
What does this mean for the dividend?
Of course, most REIT investors are in it for the dividend. In a recent article, author Nikolaos Sismanis explained the 20%+ dividend yield remains covered. And he’s obviously right. Given the direct result of 2.41 EUR per share, the 2.18 EUR per share dividend remains covered as this represents a payout ratio of roughly 90.5% of the direct result.
However, it’s not because a dividend is technically fully covered it has to be paid out. If anything, the COVID-19 pandemic caused a massive scare among the commercial REITs and this is the one opportunity for Eurocommercial to get away paying a small dividend while retaining most of the cash it generated this year. I think the market already has priced in a dividend cut and would be very forgiving if Eurocommercial for instance paid out a 1 EUR dividend for the current financial year, while retaining the 2.5 EUR in direct result it doesn’t pay out. That would allow ECMPA to retain roughly 125M EUR in cash on the balance sheet which would have an immediate and substantial impact on the official LTV ratio which would drop by approximately 4%. If Eurocommercial announces a 1 EUR dividend with the promise to re-establish the 2021 dividend at 1.75 EUR per share or higher, no one would really care and Eurocommercial’s share price would probably increase on the news as a dividend cut has been priced in.
It also means ECMPA will have to let its almost 25-year streak of continuously increasing dividends go.
Source: company website
A least preferred option would be Eurocommercial announcing a 2.19 EUR dividend just for the sake of having another year of dividend growth. This would still leave over 60M EUR on the balance sheet as announcing a 2.19 EUR dividend would be a cheat solution considering FY 2020 will consist of 18 months rather than 12. But it’s one way for Eurocommercial to deal with its ever-increasing dividends. And if the company wants to retain more cash while keeping the dividend announcement at 2.19 EUR per share, it could make the stock dividend attractive, for a change.
My own NAV calculation
These are special times and perhaps this emphasizes the point I have been making in previous articles: We shouldn’t rely too much on the third party valuations of the real estate assets as those valuations always appear to be based on an optimistic interpretation. Even after reducing the fair value of the assets by about 3% in H1 2020, the net initial yield remains pretty low.
Source: company presentation
In my scenario, I will be conservative. I will use the annualized normal rental income of around 208M EUR, but I will only take 90% of this into account as I would like to run a very conservative scenario. I will use a required rental yield 7%.
Source: author table, based on publicly available information
Even in this conservative scenario, the NAV/share is twice as high as where Eurocommercial is trading at today. Sure, the LTV ratio would increase sharply as well to an undesired percentage but keep in mind this is a very conservative scenario.
It looks like Eurocommercial Properties will generate a direct result north of 3.50 EUR per share in this extended financial year, but I hope the company will be smart and only pay a symbolic dividend this year to shore up the balance sheet before resuming higher dividends from next year on. I understand no one cares about commercial REITs at this point, but this also creates opportunities. Even using a conservative scenario with an eternal 10% rent collection drop indicates the fair value is twice as high compared to what Eurocommercial is currently trading for.
The only risk is the management getting ahead of itself and getting too optimistic while keeping the streak of dividend increases intact. Sure, Eurocommercial will be able to report a 2.19 EUR dividend per share (thanks to the extended financial year), but the management should be smart enough to build in a margin of safety by offering an attractive stock dividend (although I understand that’s a mental challenge when the share price is trading at such a deep discount).
I have a full long position in Eurocommercial Properties and I’m considering going overweight.
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Disclosure: I am/we are long EUCMF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.