Ernst Russ — Market outlook supports further repositioning

ERAG reported an operating profit (excluding non-operating items as classified by the company) of €3.3m in H118 compared to €2.1m in H117. Pre-tax profit came in at €2.9m, which is about 14% below last year. The company’s bottom line in both H118 and H117 was influenced by a number of positive and negative one-time effects, which are summarised in Exhibit 1. These include reversal of provisions and negative goodwill, insurance indemnification, write-down of receivables and realisation of receivables previously written off. H117 results also include income from restructuring of liabilities to banks, income from deconsolidation of two former subsidiaries, as well as impairment losses. When adjusted for these items, ERAG’s H118 pre-tax loss reached €0.6m compared with a loss of €0.8m in H117. The H118 results also include a loss from investments in associates of €0.6m (vs close to null in H117).

Group revenues increased 34.5% y-o-y to €27.9m, driven predominantly by the real estate business, where sales went up to €10.8m vs €1.7m in H117. The result in this segment was primarily boosted by revenue from the disposal of a property in Essen (which yielded a disposal gain of €2.4m), as well as transaction fees from the disposal of three fund properties in Amsterdam, The Hague and Hanover. After the report date, ERAG also finalised the sale of the RWI4 property in Düsseldorf, which translated into fees in excess of €2.0m (to be recognised in Q318) and generated a total capital return of c 750%. Revenues in the shipping business rose slightly by 2.1% y-o-y. Through its JV with Pareto Securities, ERAG has disposed of two tankers in February (placed by Pareto in the Norwegian market), which generated transaction fees of €1.0m (of which half is attributable to ERAG). In line with management expectations, the scope of the Investor Management, Alternative Investments and other services (which include a fair amount of legacy business) is gradually being reduced. In particular, the number of funds under fiduciary management continued to decline. The reported (non-adjusted) net profit stood at €2.1m, down 34% from €3.1m in H117.

On the operating expense side, the considerable increase in ERAG’s material expenses (€14.0m vs €3.1m in H117) is the consequence of the Essen property disposal (€5.5m), the increase in expenses from crewing subcontractors as ERAG seized to employ own maritime personnel (€3.5m, with a corresponding €3.6m decline in personnel expenses) and the operating expenses associated with the two ships acquired last year (€2.0m). This was somewhat offset by the decline in expenses for third-party services related to sub-management of ships (€1.3m compared with €2.0m in H117). Importantly, the company completed the merger of its sites into a new headquarters in Hamburg. This will translate into savings in rental expenses and more streamlined business processes.

The risks related to claims against ERAG in conjunction with its legacy business seem to be gradually diminishing and currently all claims associated with ERAG’s liabilities for the prospectus or status as founding partners of the funds categorised by ERAG as unlikely or highly unlikely. The corresponding provisions declined to €0.3m from €1.3m at end-2017. Moreover, the value of repayable liquidity distributions from ERAG’s funds as at end-June 2018 amounted to €15.1m, down from €16.4m at end-2017.

ERAG’s AUM as at end-June 2018 stood at €6.1bn (vs €6.0bn at end-2017), of which €0.4bn represents assets where the company is investor or co-investor. This was divided into shipping (€2.8bn with a fleet of c 110 ships under management), real estate (€1.6bn) and alternative investments (€1.7bn). AUM increased only slightly versus end-2017, as new asset acquisitions and M&A activity was able to offset the decline from disposals. Importantly, ERAG estimates that the share of its legacy business declined to 40% at end-June 2018 compared with 80% in 2016.

The company continues to expand its fleet through the recently established JV Elbfeeder, with the acquisition of two further ships in April 2018. Moreover, ERAG acquired a 3,091 TEU vessel entirely on its own book in July 2018. Clarksons’ data suggests prices of 10-year-old second-hand container ships bottomed out in late 2016/early 2017 and grew further in 2017 and early 2018, remaining stable in recent months. Prices for 2,500 TEU ships are currently close to 2013–2015 levels. Thus, it seems that ERAG was able to start ramping up its shipping portfolio in late 2017/early 2018 at a relatively fortunate (even if not optimal) entry point. The company plans to finalise the acquisition of two additional ships through Elbfeeder in September, which will bring the total owned fleet (including JV) to 10 ships. Importantly, the company holds a 49.99% stake in Elbfeeder, but it is in discussions to acquire a majority stake. On the divestment front, apart from the earlier mentioned real estate and shipping transactions, ERAG sold its 29.98% stake in Marenave Schiffahrts in March 2018. In addition, as part of the capital group restructuring, ERAG has also sold its 18% stake in eFonds (an online platform focused on the distribution of closed-end real assets investment funds) and will recognise a disposal gain of c €1.5m in Q318.

Management reiterated its FY18 guidance of at least 10% y-o-y revenue growth and positive operating profit at last year’s level (€3.9m). ERAG intends to stabilise the AUM around €6.1bn through the addition of new assets and portfolios, as well as new asset management mandates. This should be supported by the favourable conditions in the shipping markets, which benefit from continuing growth in global trade (IMF forecasts are 4.8% for 2018 and 4.5% for 2019), backed by the solid macro environment (IMF expects global GDP growth at 3.9% in both 2018 and 2019). Mutual trade tariffs recently introduced by the US, China and Europe have not significantly influenced trade volumes so far, although they pose a risk for the shipping industry. According to Clarksons’ data, the outlook remains positive in the container market segment (particularly in the segment of 1,000 to 5,000 TEU), where demand growth (5.1%) should outstrip supply growth (4.8% after scrapping). The historically low level of order book (ie the global pipeline of new container ships being built), which stands at 13.3% of current supply (as per Ernst Russ), suggests a potential slowdown in container ship supply growth. Time charter rates are generally rising across all container sectors this year and only 1.6% of available container capacity (as per Alphaliner) is unemployed. Although rates have eased recently, this is in line with the normal seasonal pattern. A downside risk over the rest of the year is the recent increase in idle tonnage, resulting not only from the low-season effect, but also new-built tonnage and low scrapping activity. Moreover, it seems the usual pass-through mechanism of fuel cost hikes has not yet been restored after the crisis.

In the bulker market, supply and demand looks relatively balanced at the moment. As scrap activity is relatively subdued, Clarksons expects fleet growth at 2.5% in 2018. This compares with their demand growth expectations at 2.7% in 2018, assisted by the expected increase in iron ore and coal imported by the sea, which should be driven by higher consumption in China. The charter rates were quite volatile recently, with the Baltic Dry Index’s 52-week low and high at c 948 and 1774 points, respectively and the current level of 1,434 (as at 24 September).

The tanker segment, which was the weakest part of the shipping markets in recent years, is gradually improving. Supply growth remains modest with expectations (according to ERAG) for 2018 at 0.8% and 1.5% for crude oil and product tankers, respectively. However, there seems to be a certain degree of oversupply in the product tanker fleet based on ERAG’s comments. Demand should be stronger, with 2.4% and 2.6% y-o-y growth in 2018, respectively. Tanker charter rates lag the other segments and are still at relatively low levels in H118, despite being slightly higher y-o-y.

We believe a relevant peer group for Ernst Russ should contain local asset managers active in the shipping and/or real estate domain. We have selected six peers, with MPC Capital and Lloyd Fonds the closest competitors. Due to the lack of consensus estimates for ERAG, we have based our analysis on LTM numbers and management guidance of FY18 operating profit in line with FY17 levels (€3.9m). Please note that these figures contain a certain amount of distorting one-off items which are hard to eliminate completely. ERAG is trading at a 62% and 34% discount to peer group on LTM P/E and EV/EBIT numbers, respectively. Moreover, the company’s EV/EBIT ratio based on management guidance for FY18 is around 29% below peer group. Also, ERAG’s shares trade below last reported book value per share (P/BV) at 0.7x. The valuation looks relatively undemanding given the potential future benefits of ERAG’s ongoing transformation and the good prospects for shipping markets. Given that ERAG’s earnings are largely dependent on the size of its AUM, it may also be instructive to examine the market cap/AUM ratios for the company and its peers based on last reported asset figures. ERAG’s market cap represents 0.5% of its AUM, which is below the figures for MPC Capital (3.0%), Corestate Capital (4.0%) and Patrizia (4.0%).

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