Ernst Russ — Streamlining its operations

Ernst Russ reported AUM at 30 June 2019 amounting to €2.5bn following a decline from €2.9bn at end December 2018, driven by the disposal of all subsidiaries from the solar energy and investor management segments. Importantly, these figures reflect the new calculation method, which is based on current valuation instead of managed equity and external capital (the end-2018 number was restated from €5.2bn). Based on our conversation with the company, we understand that AUM in the shipping segment was subject to the largest downward adjustment. However, we also acknowledge that the revision was predominantly applied to less profitable ships.

Group revenues declined 25.5% y-o-y to €20.8m in H119 (compared to management’s FY19 guidance for a considerable increase in sales), which had included businesses now sold as mentioned above (accounted for in the investor management and alternative investment segments). The shipping business remained the largest contributor to group sales (c 61%), recording a 17.2% y-o-y improvement against H118 to €12.8m. We assume that this revenue comes from both chartering ERAG’s own fleet as well as ship management, complemented by management fees. In the real estate segment, we note that H118 figures include one-off income of €7.9m from the disposal of a property in Essen (which yielded a €2.4m disposal gain). Adjusting for this, H119 segment sales were up c 23% y-o-y to €3.5m and reflected mostly management fees (some of which were one-time liquidation and rental fees) as well as some rental income. The comparative base adjustment would translate into a c 3.9% y-o-y group revenue increase in H119.

The aforementioned transaction has also affected the cost of materials and services adding €5.5m to the H118 total, with H119 costs being 36% lower y-o-y at €8.9m. This year, they included mostly recurring expenditures such as €3.8m of purchased services related to ship operations (vs €2.0m in H118), crewing subcontractors (€3.6m vs €4.2m) and sub-management of ships (€0.6m vs €1.3m). Personnel expenses fell from €7.7m in H118 to €6.4m in H119 following the changes in ERAG’s capital group. Average headcount on a full-time equivalent (FTE) basis was 130 in H119 compared with 165 a year before. Following the disposal of the investor management business, FTEs at end-June 2019 stood at 90, which suggests that a further decline in personnel expenses in H219 is possible. The consolidated net profit swung to a €0.6m loss in H119 from a €2.1m profit in H118, although the latter was boosted by the above-mentioned real estate deal. We also note that H119 profit included certain one-off items, such as deconsolidation income from the disposal of the solar segment (€1.2m at pre-tax level), which was however more than offset by the loss from deconsolidation of the investor management segment (€1.6m at pre-tax level). It also included net write-downs on receivables (€1.0m vs €0.6m in H118) and reversal of provisions (€1.0m vs €1.8m in H118), while both income from the reversal of negative goodwill (€0.1m vs €1.6m in H118) and insurance compensation (€0.2m vs €1.1m in H118) were visibly below last year.

Management still expects sequential performance improvement in H219, driven by affordable housing projects, as well as ongoing fleet expansion in anticipation of a recovery in the shipping markets. On the other hand, it expects a negative impact from the deconsolidation of the investor management business in May 2019, which had been expected to contribute €4.5m to revenues and €1.5m to operating earnings in the remaining seven months of FY19.

ERAG’s net debt increased to €29.8m in H119 from €5.8m at end-2018, which we understand was partially the function of the company’s move towards a more asset-heavy business, with three new direct ship investments completed recently (see below for additional details). This translates into a net debt to total assets ratio of 25% (vs c 6% at end-2018). On full consolidation of ElbFeeder (see below), this will increase by a further €29m (although it will include considerable minorities).

ERAG has continued to reposition itself as an investor and asset manager in the shipping and real estate segments through investments, and through disposals of non-core business units. In February 2019, it sold three subsidiaries along with a fund and asset management contract in the solar segment. In the same month, ERAG also sold its remaining 31.37% stake in HAMMONIA Reederei (a technical ship manager for bulkers, container and multipurpose vessels) to a Scandinavian family office. Going forward, the technical management of ERAG’s own fleet (held as direct and co-investments) will be carried out in-house or by strategic partners.

Another significant step in the process of optimising the business was the sale of 29 trust services and distribution companies from the investor management segment, including PECURA Anleger- und Treuhandservice (its main trust services company). As ERAG does not intend to launch any further closed-end funds, deconsolidating these entities (with effect from 1 June 2019) was in line with its strategic focus on simplifying its organisational structure and cost optimisation. In the wake of numerous disposals assisted by various internal mergers and liquidations, ERAG’s consolidation scope at end H119 covered 59 entities (focused on shipping and real estate) vs 102 at end-2018.

ERAG’s managed portfolio in the shipping segment at 30 June 2019 consisted of 77 ships (vs 90 at end 2018 as the legacy (closed end funds) business reduces), with 27 held as direct and co-investments (vs 33 at end 2018) and 50 fund ships (down from 57 at end 2018). The latter group includes ships from both its legacy retail business and private placements to institutional clients. We note that the reduction in direct and co-investments is largely attributable to the reclassification of five ships previously accounted for as co-investments in JVs (now reflected in fund ships). Following the purchase of ERAG’s 3,091 TEU vessel in July 2018, expansion continued in H119 with the acquisition of a majority shareholding in a portfolio consisting of a handymax bulker and a 3,100 TEU container ship. Moreover, ERAG bought a 4,200 TEU container ship in June 2019. Finally, one ship held as a co-investment was sold in the period. This brings the total number of own ships to six, which should extend to 13 on full consolidation of the ElbFeeder JV (with seven ships) after buying an additional 2% stake to reach a 51.995% share in the JV’s capital.

In the real estate segment, ERAG manages 40 properties on 28 sites at 30 June 2019 (vs 41 assets at end 2018) and is now focusing on the development of new properties rather than the expansion of the real estate portfolio under management. Importantly, the company aims at strategic expansion of advisory and investment services on subsidised housing. In February 2019, its subsidiary Assetando invested €2m to acquire three project sites in ILO Park (Pinneberg) together with a JV partner to build c 75 subsidised housing units with a total living area of c 4,600 sqm by the end of 2021. Furthermore, the construction of 136 housing units is expected to begin in 2020 on the property in Bad Oldesloe (acquired in August 2019), again with a joint venture partner.

In H119, the investment climate was impaired by the global economic slowdown and political uncertainties. In the shipping business, it resulted in a more significant trade volume decline during Q119 compared to market expectations and last year, according to ERAG. Along with the upcoming 0.5% sulphur cap on marine fuels imposed by the IMO 2020 regulations, it put pressure on market participants to further increase efficiency and utilise economies of scale. As a result, H119 was relatively muted for small and mid-size ships, while large vessels were in high demand. In May 2019, charter rates for 8,000–9,000 TEU vessels reached US$26k per day following a US$2k y-o-y increase, according to ERAG. Similarly, 6,500–7,000 TEU containers saw charter rates improve to US$19k per day. There are also some indications of improving momentum in the bulk carrier charter market. Finally, despite the current macro headwinds, the continued accommodative monetary policy of major central banks is encouraging further investments in real assets.

The German real estate market in general continued to perform well in H119, regardless of potential risk in global economies and the fact that Germany is potentially entering a recessional phase. There seem to be some indications of a slowdown in the investment market, as H119 transaction volumes amounted to €32.2bn against €36.8bn in H118, according to JLL. An even more pronounced drop was recorded in the volume of portfolio transactions, which decreased by c 28% y-o-y. Having said that, we note that the broader market decline is from a high comparative base, as last year was strong for the German property market. In residential properties, we estimate that H119 volumes were still 3% ahead of the five-year average. Moreover, lower transactional activity may be at least partly due to insufficient supply of properties for sale (with demand holding up well).

We believe the relevant peer group for ERAG should contain local asset managers active in the shipping and/or real estate domain. We have selected five peers, with MPC Capital being the closest competitor. Due to the lack of consensus estimates for ERAG, we have used LTM results as at end June 2019. ERAG is trading at a 49% discount to peers on LTM P/E and a 4% premium on LTM EV/EBITDA. Part of the difference may be explained by the increase in ERAG’s net debt. Given that ERAG’s earnings are largely dependent on the size of its AUM, it is instructive to examine the market cap/AUM ratios for the company and its peers based on last reported figures. ERAG’s market cap represents 1.1% of its AUM, which is below the figures for MPC Capital (1.4%), Corestate Capital (2.4%) and Patrizia Immobilien (3.7%).