Globalworth Real Estate — Strong growth continuing

Since it listed in 2013, GWI has grown rapidly to become one of the leading real estate companies in the CEE region. It is focused on Romania and Poland, where commercial property markets are supported by strong economic growth, above the EU average, and an increasing number of multinational companies operating in the region. 2018 was a year of dynamic growth for Globalworth and this has continued into 2019. During FY18, GWI consolidated the late 2017 acquisition of a controlling stake in Polish GPRE, closed acquisitions with a total value of more than €500m, mostly in Poland, and made further progress with its development pipeline in Romania. Already in 2019 it has completed the issue of 55m new shares with a value of c €500m, has closed or agreed acquisitions with an aggregate value of c €280m, and has greatly simplified the group structure by acquiring the minority interest in its Polish subsidiary. We commented briefly on the FY18 results in our update note published on 13 March 2019. In this note we update our multi-year financial forecasts for the period to end-FY22. Our forecasts assume a modest re-gearing of the balance sheet, including a notional €125m of acquisitions to take the LTV closer to the 40% medium term target. In practice, we would expect the group to do more than this, given its dynamic track record of growth and strategic goal of further portfolio expansion over time, locking in attractive returns, and building scale to become the landlord of choice, funded through a balance of new equity and debt resources. The recently completed issue of 55m new shares at slightly above EPRA NAV and recent upgrades to investment grade of the group’s issuer credit rating by both Moody’s and S&P (Fitch already rated GWI investment grade) underline the group’s access to capital markets on favourable terms. While we recognise this potential upside, we do not include it in our forecasts given the uncertainties surrounding the scale, terms and timing of such action.

Consistent with its growth strategy, GWI recently completed the issue of 55m new shares. These were directed at part-funding continuing portfolio investment and the acquisition of minority interests in Globalworth Poland. Of the 55m new shares issued at €9.10 per share, slightly ahead of the end-FY18 EPRA NAV per share of €9.04, c 38.2m shares were placed (“the placing”) with investors to raise gross proceeds of €347.6m. Growthpoint, South Africa’s largest REIT and since 2016 GWI’s largest shareholder, subscribed to c 1.6m of the placing shares and it also received c 16.8m new shares in exchange for its 21.6% direct investment in Globalworth Poland (formerly GPRE). Growthpoint acquired the stake in June 2018 when it subscribed to an equity raise by GWI’s Polish subsidiary.

As a result of the transactions, Growthpoint’s shareholding in the enlarged GWI share capital has increased slightly, to 29.8%, and including some other, smaller recent minority acquisitions, GWI’s ownership of Globalworth Poland has now increased to 99.6%. GWI has begun the procedure for delisting the Globalworth Poland subsidiary, which it expects to complete later in the year. This will represent a welcome rationalisation of the group structure, presenting a simpler equity story to investors, and has the potential to reduce administration costs and deliver operational synergies.

With an 18.1% stake, Aroundtown SA, one of the largest listed commercial and residential real estate companies in Europe, with a market capitalisation of more than €8bn, becomes GWI’s second large listed investor.

The net proceeds of the placing will be used to fund investment opportunities in both Romania and Poland, as well as for general corporate purposes, while providing support for GWI’s long-term gearing strategy, which targets an LTV of less than 40%. Since announcing the capital increase, the acquisitions of four office properties in Poland (the near-term pipeline of opportunities under exclusive negotiation, announced in March), for an aggregate €283m before debt, have been agreed. Two have already completed, for an aggregate consideration of c €170m, and two are expected to complete in July, for an aggregate c €113m, subject to conditions being met. GWI’s strategy is to seek further acquisitions of office assets in Poland, providing potential for economies of scale and asset management driven value creation. In Romania, GWI has a strong pipeline of office/light industrial and logistics developments, and management estimates future capital investment of c €250m including current and planned projects.

Reflecting the further strengthening of the group’s financial position, both Moody’s Investors Service and S&P, the international credit rating agencies, have recently upgraded their issuer credit ratings on GWI; Moody’s from to Baa3 from Ba1, and S&P from BBB- to BB+. GWI is now rated investment grade with each of Moody’s, S&P and Fitch. The impact on GWI’s unsecured bonds, listed on the Irish and the Bucharest stock exchanges, has been noticeably favourable, which is a positive indicator for future funding costs as the group looks to further grow its portfolio. The yield on the company’s 2.875% unsecured Eurobonds due in 2022 is now 1.23% (17 May 2019), having been at around 2% for most of 2018 before rising closer to 3% in the late-year worldwide market sell-off. The yield on the 3.0% unsecured loan notes due in 2025 is now at 2.3%, having been c 3% throughout 2018 and closer to 4% at end-2018.

In line with its plans to further expand in Poland through acquisition, in March the company announced a pipeline of near-term opportunities consisting of four Class A office assets under exclusive negotiation, with an aggregate value of c €280m, and a blended stabilised yield of above 7.5%. The acquisitions of Rondo Business Park in Krakow and the Warsaw Trade Tower have been completed, and the acquisitions of Retro Office House in Wroclaw and Silesia Star in Katowice have been conditionally agreed and are expected to complete in July. Assuming full completion, the four assets represent an aggregate investment of €283.1m, and will add an immediate €20.7m to annual contracted rental income. We estimate reversionary potential to €22.1m of annual contracted rent, or a stabilised yield of c 7.8%.

Rondo Business Park is strategically located directly adjacent to the already owned Quattro Business Park. Warsaw Trade Tower benefits from AXA as the largest tenant, alongside other international companies including American Express and Mattel, with reversionary potential from letting vacant space. Retro Office House is a 100% let newly completed office development in central Wroclaw, benefiting from good transport links to other parts of the city. Silesia Star, fully let to multiple occupiers, is a complex of two interconnecting buildings in the centre of Katowice, developed in 2014 and 2016.

A strong FY18 performance included good underlying progress from the existing portfolio and a full-year earnings contribution from Globalworth Poland, fully reflected in the FY17 balance sheet but contributing to the FY17 income statement for less than one month. Underlying progress reflected strong leasing activity and an increasing contribution from recently completed developments, rental growth, ongoing acquisitions and operational efficiency. FY18 net operating income increased from €51.1m to €133.4m and EPRA earnings grew from €16.8m (17.9 cents per share) to €60.9m (46.0 cents per share). Including increased DPS and growth in EPRA NAV per share to €9.04, the NAV total return for the year was 7.8%.

Having reviewed the results in detail, and taken account of recent further acquisitions, the Globalworth Poland minority buy-out and the capital increase, we have updated our multi-year financial forecasts for the period to end-FY22 (Exhibit 3). Our forecasts for growth in rental income and capital values include an increased contribution from recently completed acquisitions and developments, assumed further acquisitions of €125m to partly re-gear the balance sheet following the recent equity raise, rental growth and a significant potential contribution from the active development programme. Not specifically included in our forecasts is the potential for additional capital growth that would result from a convergence of Bucharest office yields towards the lower levels seen in markets elsewhere around the CEE region.

Compared with our previous forecasts, income, earnings and net assets are all much higher, although in per share terms forecast EPRA earnings and NAV are lower. There are a number of factors contributing to the per share reductions including:

We are now assuming a flat DPS in the current year and have slightly trimmed our rate of DPS growth so as to build EPRA earnings cover and then maintain it at c 1.1x.

Specifically, we have updated the detailed forecast set out in our outlook note to include:

Current market conditions suggest good potential for prime office yields to tighten in Bucharest in particular, where prime office yields remain well above the levels in other regional markets and valuations remain well below historical highs. Although prime office yields in Bucharest have declined over the past three years, the tightening has not kept pace with that seen in Warsaw, Budapest and Prague (1.0–1.5pp), and they remain noticeably higher. Bucharest prime yields of c 7.25% compare with c 5.0% in Warsaw, 6.0% in Budapest and c 4.75% in Prague, and remain well above the c 6.0% seen at the 2007 pre-financial crisis market peak. GWI management continues to anticipate that the gap with other CEE centres will narrow, which would have a positive impact on our EPRA NAV and total return forecasts.

The full occupancy yield on the Romanian commercial portfolio was c 7.4% at end-FY18 or 6.9% based on contracted rental income, a small discount to the Bucharest prime office yield of 7.25% and reflecting the quality and location of the assets.

In Exhibit 5 we show an updated sensitivity of our EPRA NAV forecasts to alternative full occupancy yield assumptions. We estimate that a 50bp tightening in yields across the portfolio would increase FY22 EPRA NAV per share by c €2, or c 17%. If confined to Romanian assets, this would equate to a c 100bp tightening in Romanian yields.

The FY18 aggregate dividend per share increased to €0.54 from €0.44, set with a view to the expected growth in income earnings, as recent acquisitions make a full contribution and current and planned developments complete. We expect dividends to represent a significant element of shareholder returns and our revised forecasts continue to indicate strong growth in DPS, to €0.66 (declared basis) in FY22, 1.07x covered by EPRA earnings.

Capital growth has been strong since the IPO and we forecast this to continue, enhancing income returns further. As noted above, our base forecasts assume no market-driven shifts in the portfolio valuation yield, with revaluation movements driven by expected inflation indexation of rents and our forecast for development gains. The latter are based on management’s expectations for the costs, timing and rent potential of the developments and our assumption that the post-completion yields will be similar to current portfolio levels.

Combining our DPS and capital return expectations, we estimate an aggregate 51% EPRA NAV total return between end-FY18 and end-FY22, or a compound annual average return of 10.9%. Dividends represent just under half of the forecast return and capital growth represents the balance. Although lower than the aggregate return of 60.7% and compound annual average return of 12.6% implied by our previous forecasts, we consider this to be an attractive prospect in the current low rate environment.

As noted above, yield convergence, especially in relation to the Romanian portfolio, has the potential to materially increase returns above the levels that we estimate.

Although there are no direct comparators to GWI, in Exhibit 7 we show a summary valuation and share price performance comparison of GWI with a small number of other quoted companies that are also significant investors in the CEE regional commercial property market within more broadly spread portfolios. The table uses historical (rather than forecast) financial data. On this basis, GWI offers a higher yield than the peer group average, while trading at a slightly higher P/NAV. The GWI share price has performed strongly over the past three months and we would expect future shareholder returns to be driven by growth in EPRA NAV per share and supported by the attractive yield and growing DPS.