Wereldhave: An 11.5% Unlevered Return Opportunity For 2023-2026 (OTCMKTS:WRDEF)

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Investment Thesis

I think Wereldhave (OTCPK:WRDEF) still offers a good medium term investment opportunity once the residential gains (1.6-1.85 EUR/share) are booked in 2023 and beyond. However after the recent appreciation the stock is trading at a slight premium (market-implied net initial yield of circa 7%) to its listed Belgian subsidiary Wereldhave Belgium (market implied net initial yield of about 7.4%) which boasts a very conservative loan-to-value (LTV) of 28.2% versus Wereldhave’s 41%. While the difference can largely be explained by the residential gains to be booked by Wereldhave, some residential projects concern Wereldhave Belgium as well. All in all, over the short term the shares of Wereldhave Belgium seem to offer a better entry point. Nevertheless, the 7% market-implied yield is very healthy compared to Klepierre (OTCPK:KLPEF) at about 5.9% or Unibail-Rodamco-Westfield (OTCPK:UNBLF) at about 5.5%, both of which offer somewhat more limited redevelopment opportunities away from retail.

Operational Overview

Wereldhave managed to deliver a direct result of 0.41 EUR/share in Q4 2021, which would put the current run-rate at the top of the 1.5 – 1.6 EUR/share management forecast for 2022:

2021 Overview

2021 Overview (Wereldhave Q4 2021 Presentation)

Interestingly, management narrowed the LTV target from 30-40% to 35-40%, which in my view expresses confidence that valuations have bottomed and portrays a lesser urgency for the disposal of the last 2 remaining French assets.

Market-implied Net Initial Yield Valuation

To calculate the market-implied net initial yield I will take the EPRA Net Disposal Value (NDV) which stood at 20.89 EUR/share in Q4 2021:

Market-implied net initial yield = Valuation net initial yield / Division factor where:

Division factor = Price/Book Ratio * ( 1 – Loan-to-value ratio) + Loan-to-value ratio

with the Q4 2021 parameters, namely:

1. EPRA NDV = 20.89 EUR

2. Loan-to-value = 41%

3. Valuation net initial yield = 6%

4. Closing price at the time of writing = 15.79 EUR

You get a P/B Ratio of 15.79 /20.89 = 0.76, a division factor of 0.86 (0.76 * (1-0.41) + 0.41 ) and a market implied net initial yield of roughly 7.01%.

For comparison, Klepierre stood around 5.9%, Unibail-Rodamco-Westfield delivers circa 5.5%, and Wereldhave Belgium was around 7.4%.

Valuation based on current cash flow forecasts

As you might imagine, the more debt-heavy capital structure your company has, the better it looks in terms of cash flow multiple. Case in point, Wereldhave is trading at around 10 times its 1.5-1.6 EUR/share management forecast. Wereldhave Belgium, with a LTV of just 28.2%, is trading north of 11 times its 4.7-4.8EUR/share management forecast. Unibail-Rodamco-Westfield with a net debt of 22.6B EUR and a market capitalization of 9.6B EUR looks the least expensive, trading at 8.3 times its 8.2-8.4 EUR/share management forecast range.

The residential opportunity

I think that the main differentiating factor for Wereldhave will be the residential gains to be booked in 2023 and beyond:

Residential Opportunity

Residential Opportunity (Wereldhave Q4 2021 Presentation)

Taking the midpoint of the 1.6-1.85 EUR/share range, the 1.72 EUR/share would represent a 11% one-time benefit against the current share price of 15.8 EUR/share. Of course these gains will take several years to be realized in full.

A period of abnormal returns

The above residential opportunity paragraph brings me to my point that starting in 2023, Wereldhave should experience a brief period of abnormally large returns. Firstly, while there is limited visibility what COVID-19 restrictions will be in place next year, it may well be the first year in which there are no significant restrictions for businesses. Case in point, 2022 still had days in January in which shops and restaurants operated in a very limited capacity, which will weigh on 2022 results. Furthermore, management forecasts a direct result per share (DRPS) growth in 2023-2026 above inflation:

DRPS growth breakdown

DRPS growth breakdown (Wereldhave Q4 2021 Presentation)

Combining all components mentioned so far, namely a net initial yield of circa 7%, a 2.75% contribution (11% divided by 4) for 2023-2026 from residential gains, and a 3.7% management forecast for unlevered growth, we end up with a very healthy expected return of about 13.45% per annum for 2023-2026. If we assume overhead eats up about 0.5% of the return and 20% of the net initial yield is allocated to non-yielding CAPEX(circa 1.4%), we end up around 11.55% for the next 4 years, to be followed by about 7.1% thereafter (5.6% net initial yield after non-yielding CAPEX and 1.5% inflation indexation):

Return Components in the period 2023-2026 Percentage Contribution
Market-Implied Net Initial Yield At Current Price 15.8 EUR/share 7%
Residential Gains At Current Price 15.8 EUR/share 2.75%
Unlevered Growth 3.7%
Management Overhead -0.5%
Non-yielding CAPEX -1.4%
Total Unlevered Return In 2023-2026 11.55%

It is important to note that the current capital structure of Wereldhave, with 634M EUR in equity and 788M EUR in net debt is still debt heavy and the above unlevered calculations need to be taken with a grain of salt. Looking beyond, whether or not Wereldhave manages to navigate online retail headwinds remains to be seen. In any case the transformation to alternative uses will be less painful at Wereldhave as compared to larger peers given lower property valuations in absolute terms.

The Risk of Rising Rates

Just as the impact of COVID-19 on valuations seems to be fading interest rates have started to rise. Although 88% of Wereldhave’s debt is with a fixed percentage, the 3.8 years average maturity will force the company to refinance in the years ahead. If the ECB was to normalize policy in the period 2023-2026 and the rate on the deposit facility reaches a more normal 1.5%, the 2% rise from current levels of -0.5% should boost annual interest expense by about 15.8M EUR, or 0.39EUR/share, severely impacting direct result earnings.

Likewise, a rise in the net initial yield used for valuations from 6% to 8% would cut the value of Wereldhave’s properties by about 485M EUR and push the LTV up to 54%. In that scenario the IFRS NAV would drop from 21.6 EUR/share to about 9.55 EUR/share.

Investor Takeaway

Wereldhave still offers a good medium term return opportunity but looks vulnerable over the short term given lagging valuation at Wereldhave Belgium and strong recent performance in the share price. Nevertheless, I think a correction will prove to be a buying opportunity as long as interest rates do not rise excessively. Thus I think combining the position with long exposure in bank shares looks appropriate. Personally, I will sit on my hands until the March options expiration and assess the situation at that point.

Thank you for reading.

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