Bancherul - BANCI / ENGLISH / Erste: CEE Real Estate stocks with upside potential of 15%, profitability lags behind

* Erste analysts forecast 4% ROE for real estate companies in 2012; 15% upside potential for CEE real estate shares possible until year end
* Below average profitability levels are biggest obstacle to reach P/BV levels of closer to 1.0x
* Upward trend in CEE driven by low vacancy, strong occupier demand and low pipeline
* Top picks: Buy recommendations for GTC, Immofinanz and S Immo due to best financial stability, highest retail exposure and strongest profitability

The recent fall in highly-rated government bond yields makes investment in real estate look more attractive in terms of relative pricing between asset classes, said Erste in a press release.

“We are currently witnessing the highest yield gap since spring 2009. However, current ROE levels are still disappointingly low. Whereas rents have recovered from the crisis, savings in operating costs still have to be unlocked, especially as the development volumes and profits will not reach pre-crises levels anytime soon. Speaking in favour of real estate shares is the 50% discount to book value”, said Günther Artner, Co-Head CEE Equity Research. In an international peer group comparison, CEE real estate stocks show clear discounts based on book values, but are traded in line with peers on cash flow-based multiples, highlighting the below-average profitability level.

The market turbulences since August this year pushed back the valuation of real estate stocks to 2009 levels, when trough valuations were just left behind. Given these low stock price valuation levels compared to book values, it is increasingly interesting to buy back shares or other outstanding financial instruments instead of direct property investments. This is already being used by conwert and Immofinanz, others may follow.

Investment volume declined q/q by 12%

Investment volumes in Europe are following the economic development more than ever before. In 2Q11, transaction volumes in the European investment market declined by 12% q/q to EUR 25bn. Also, in a yearly comparison, the investment turnover is down by 3% from EUR 25.7bn in 2Q10. The annual prime yield compression continued in 2Q11, with the cities of Moscow, St. Petersburg, Bucharest and Kiev showing the strongest decline in CEE. Investment volumes in the CEE property investment market reached EUR 6.9bn by mid-August 2011, which is 20% higher than the full-year figure of 2010, accounted for by roughly 120 transactions. The majority of investment turnover continued to be concentrated on the markets Poland and Russia, which account for more than 70% of total CEE investment. The Czech Republic is the third largest market in terms of property investments in the region and already reported volume growth of 50% until mid-August compared to the FY10 figure. In the office segment, investment turnover amounted to EUR 2.2bn in 1H11, mainly driven by transactions in Russia and Poland, which accounted for 75% of total volume. Even though there is still more than 50% of the turnover coming from local investors, cross-border activity is on the rise.

Outlook

Most real estate companies cannot take advantage of the persistently low interest rate environment, as they are hedged at higher levels. Both factors are still stumbling blocks to an improvement in ROE. “Reaching the pre-crisis levels of 10% ROE and P/BV parity seems unlikely to us, as these numbers were based on a strongly positive leverage effect and included high revaluation gains as well. We expect a bit higher revaluation gains at companies with fresh assets in good locations. Based on our new reduced estimates, a regression analysis of ROE vs. P/BV shows 15% upside potential until year-end and 25% until the end of 2012 (in addition to the dividend distributions)”, stated Martina Valenta, Real Estate Analyst at Erste Group. In Erste Group’s regression analysis of ROE vs. P/BV, real estate companies would have to reach ROE of 11% to reach P/BV parity. The average forecast ROE is 3.7% for the Austrian real estate companies and 1.9% for CEE developers for 2012. The 25% upside until year-end 2012 would translate into an average P/BV 2013e multiple of 0.6x at this point of time.