Deutsche Grundstücksauktionen — As good as it gets

For over more than 30 years, DGA has firmly established itself as clear market leader in the auctioning of all types of real estate in Germany. Founded in Berlin in 1984 and known originally as Berlin Grundstücksauktionen, the company expanded actively after its 1999 listing with a network of four regional auction houses – Sächsische (Dresden), Norddeutsche (Rostock), Plettner & Brecht (Berlin) and Westdeutsche (Köln) – as well as an online business. Consequently, it has a nationwide presence although the new federal states following reunification still account for the bulk of turnover from auction sales (c80% in 2016). Live auctions are held quarterly, while online auctions (c12% of 2016 group pre-tax profit) are more frequent (generally, twice a month). Property vendors are notably varied, including private and commercial, the federal government and its institutions, banks and insolvency administrators. Items on offer vary from widely contrasting size and quality of residential and commercial properties to the smallest pieces of land or outbuildings, hence the seemingly modest overall average sales price of €53,000 in 2016. A seller’s and buyer’s commission is payable as a percentage of the sales revenue. There is also a small brokerage operation within Plettner & Brecht.

The financial performance since listing has been broadly resilient. We highlight below (Exhibit 1) the impact of expansion which the listing spurred, followed by that of the financial crisis and subsequent recovery and stabilisation. Importantly, it shows the company’s unbroken ability to pay a dividend and its recent trading buoyancy as its favoured KPI, annual turnover from auction sales, exceeded €100m for the third year in a row for the first time, if still well below the pre-crisis peak.

Analysis of individual auction house contributions (Exhibit 2 shows 2016) can be misleading as performance varies year-on-year, so overall group assessment is suggested. However, it is worth noting that Berlin-based parent company, Deutsche, has consistently generated the highest turnover from auction sales, while the four regional houses contribute similar levels of turnover. Although relatively small in turnover terms (3%), the internet business tends to be substantially more profitable than offline.

The following applies to all properties submitted for auction:

DGA is not reliant on any particular market for its supply, as shown in the chart below and geographically in Exhibit 2.

Moreover, within the public sector supplier base strenuous efforts have been made to establish long-term relationships and therefore significant, recurrent sales volume. Prime among these is a four-year exclusive framework contract until 2020 with the Bundesanstalt für Immobilienaufgaben (Institute for Federal Real Estate). With assets of c €21bn, this agency sells real estate, no longer required by the Federal government, through a number of channels, including auctions. DGA’s contract win in an EU-wide, open tender reflects its extensive experience since 2003 in working with the Federal government and its companies. Auction turnover for this contract in 2016 was c €7m, similar to the previous year when the agreement was shorter term and not exclusive. There are also framework contracts until 2018 with Deutsche Bahn and BVVG, which is responsible for privatising formerly state-owned agricultural and forest areas of the old GDR. Each extends longstanding relationships and has contributed c €2m auction turnover pa. Total Federal government-related auction turnover was therefore 12% of group auction turnover and management is confident of matching that in 2017.

Online business has become increasingly important to DGA, both as a favoured channel of public sector work (80% of turnover) and contributor to overall profit (c 12% in 2016). Auctions are held every two weeks and unlike live operations, are not constrained by time (in the case of competing bids, individual lots may take hours to settle). Compared with live auctions (Exhibit 4), online is clearly higher margin in terms of commission as the average lot price is but a fraction (c €6,000 against c €77,000). This and the relative lack of fixed costs allow predictably an even greater margin disparity at the pre-tax profit level. For 2017, management looks to beat last year’s record turnover.

DGA is the pre-eminent property auctioneer in Germany. With 87% market share, it points only to its nearest competitor with auction turnover of €12m and a regional business in Saxony with turnover of just €3m. This has been the situation for a long time and the company does not foresee it changing in the short term. Indeed, we note the failure of the last major move into the market. The leading US online property auction company, Auction.com, entered with a great fanfare in 2012 only to withdraw within two years after disappointing results. Management is confident that its expertise and reputation, backed by long client relationships and unmatchable public sector contracts, provide protection and, of course, the fact that to date auctions have only a small share of total property transactions.

There have been no corporate announcements since the recent (early May) publication of the 2016 Annual Report, which is otherwise reflected in this appraisal. It confirmed the success of the Q117 auctions, as reported in March, and confidence about the full year outturn.

News of Q2 auctions is due at the end of the quarter, with H1 financial results due on 4 September. Thereafter, the company is set to announce Q3 and Q4 auction results and outline guidance for the full year early in 2018.

Positive economic fundamentals have lately underpinned the German property market, so there is reassurance in very recent continued endorsement by the Bundesbank in its latest monthly report (May 2017). The outlook for employment, disposable income and public finances remains good and thus conducive to investment in property. This is reflected in a bumper start to 2017 in terms of transaction volumes in both the commercial and residential sectors, eg +60% and +75% in Q1 respectively, according to JLL.

Nevertheless, favourable demographics, namely a sharply rising population, spurred by inward migration, and increasing homeownership rates, have also been a key stimulant. As evident in Exhibit 5, inward migration was historically insignificant only to peak at 1.14m in 2015. Figures for last year have yet to be reported but are expected still to be substantial, if considerably lower. With the number of completed homes well under 0.3m pa, the gap between supply and demand may only widen with consequent upward pressure on prices.

Germany has a much higher population density than the EU average, at 229 residents per km2, and a rising level of urbanisation. In addition, renting is more popular in Germany than in most of Europe and there has been notable migration to the cities, especially by the younger generation. This demand has coincided with a lack of supply, following a steady fall in building permits after the reunification boom ended in the mid-1990s.

As an example, the Berlin market has seen steady population growth, with migration adding 40,000-50,000 residents a year. The density has reached 4,000 residents per km2 as a result, compared with 1,500/km2 in London. It has also attracted start-up capital and employment opportunities, which give it a broader appeal for residents. This has pushed up median rents from as low as €5.50 per m2 per month in 2008 to approximately €9.50 by the end of last year. Purchase prices have also more than doubled over the same period. Similarly, North Rhine Westphalia, which is the most heavily populated federal state, has a population density that is double the rest of the country after recent migration. As a result, median rents and purchase prices in cities like Cologne and Düsseldorf have seen significant increases in the past five years.

CBRE research has shown that, despite an improvement in building permits and housing completions in multi-storey residential, supply remained insufficient to meet demand in 2016. The result was a further 35% increase in purchase prices to an average of €93,000 per unit and €1,490 per m2. CBRE expects this supply deficit to continue in 2017, with the effect that the competition for the best property locations will intensify and prices will increase again. CBRE expects this to be exacerbated by international investors, who are attracted by the stable economic and political environment in Germany. As a result, CBRE forecasts transaction volumes in portfolios of over 50 units to be at a similar level to last year’s €13.7bn.

Another important trend is the low returns in the bond markets, relative to property in its core markets. This has generated significant investment appetite from both European and North American investors and saw investment volumes exceed the previous 2008 peak in 2016. As a result, of the $66bn raised for closed-end real estate funds in the first nine months of 2016, 29% was raised for Europe. In a recent survey of investor intentions, Europe was expected to exceed North America as a regional investment target over the next 12 months.

Supervisory board and management board

German companies are required to have a clear separation of management and supervisory functions. The management board is responsible for managing the company and representing it in dealings with third parties. It is overseen by the supervisory board, which also appoints its members. Members of the supervisory board may generally not be involved in the day-to-day management of the company, but their prior consent must be obtained on decisions or actions having a fundamental impact on the assets, financial or profit situation of the company. DGA’s supervisory board has been chaired by Michael Siegmund, a lawyer, since 2012. Other members of the supervisory board are Christian Ansorge (from 2012; partner in a long-established Berlin estate agency) and Manfred Krüger (appointed 2010). Their families were co-founders of the auction house.

Management team

Michael Plettner (CEO) and Gerd Fleischmann are both senior property auctioneers and have worked for the company since 1990.

Shareholders and free float

There are four longstanding major shareholders (founders and family), accounting for c 40%.The free float is c 60%.

The financial statements are in accordance with HGB. DGA, the parent company, is influenced to a considerable extent by the results of its fully owned subsidiaries but is not obliged to present consolidated accounts and management reports. As a result of profit transfer agreements with its five subsidiaries, the total result of the group is therefore shown in the statements of the parent company.

Consequently, for the sake of clarity we show (shaded below) both gross turnover (auction sale proceeds) and net commission at the group level, as these drive the transferred profits. They are also regarded by management as key indicators. However, they are, of course, only proxies for the subsidiaries’ revenue, which is not disclosed, so accurate top-line analysis is not possible.

With 2012 not including Westdeutsche and subject to an exceptional item, as highlighted above, we believe that it is more helpful to use 2013 as a starting-point for analysis of the P&L. At once we see a doubling of EBITDA by 2016, driven by a 19% rise in turnover from auction sales at stable margin. While impressive, it is also important to appreciate that with gross turnover showing more measured growth or even decline, as of late, the nature of the company’s commission fee-based model can allow profit resilience. For example, the mix of lots on offer and negotiating skills of the auction staff can mitigate apparent pressure at the gross level. 2016 saw turnover from auction sales down by 4%, yet commission (effectively, revenue in terms of company accounts) was up 2%. Of course this works in reverse as the previous year’s 2% gross turnover increase converted to marginally lower commission. It is nonetheless arguable that turnover might have been expected not to have flattened, given the aforementioned positive factors and the scale of shortfall on pre-crisis levels.

Exhibit 8 confirms the volatility of individual auction houses but also how they tend to compensate for each other, as reflected in the subsidiaries’ composite performance, which is encouragingly resilient. Westdeutsche, for example, was boosted in 2014 and 2016 by the sale of certain high-value items, while 2015 saw Norddeutsche benefit from additional auctions, greater market awareness and particularly effective cost control. The apparently low profitability of the parent business is attributed to its effective status as a holding company with associated central costs.

As for the outlook, in the absence of consensus forecasts, we rely on reported management guidance. This has been consistently upbeat following Q1 auctions, where gross turnover rose by 36% to €26.4m and commission by 15% to €2.46m. Westdeutsche stole the show (auction turnover more than trebled) as its transaction of premium properties in Q416, including the former Indonesian embassy in Bonn, led to improved market awareness and more attractive deliveries. Westdeutsche apart, group gross turnover was up 8%.

While still early in the year, management’s goal of reaching the average gross turnover of the last three years, ie just 2% ahead of 2016 (€102.8m) appears undemanding, given the strong start, confirmation of unbroken high demand and the growth potential of key clients.

Finances have remained sound throughout the period of our review, as detailed above. Surplus cash (the company has no debt) allows profit to be distributed almost entirely by way of dividend (see Exhibit 1). Similarly, DGA was able to return to shareholders the proceeds of the 2012 PBV disposal.

Management expresses pride in its dividend record as proof of the company’s flexibility and success. It is also well aware of investor demand for sustained and attractive dividend yield at a time of low interest rates.

With no direct peer listed on the Frankfurt Stock Exchange, we look at the iShares MSCI Germany Small-Cap ETF, which seeks to track the investment results of an index composed of small-cap German equities. This shows historical P/E ratio of 18x (DGA 21x) and 12-month trailing yield of 1.6% (DGA 4.4%). As noted above, the history of a sustained and attractive dividend should lend support to the shares.

Given that we are not producing our own forecasts or model, using a DCF has too much subjectivity to be of much value.