BUY
(Initiating Coverage)TAG deserves a better price
▪
TAG made a good start to the year 2007. Pre-tax profit tripled to €15.8m for 9M07 compared with the 9M06 figure, which was at a low level. Management has released a pre-tax profit target of €31m for FY2007, which means TAG has to double its 9M07 figure. We believe TAG should meet its target in light of the real-estate business cycle. The fourth quarter has always been the most profitable in a year for both TAG and the sector in general, and TAG sold a development project at the end of December 2007.▪
TAG returned to profitability in 2006. Its growth strategy has been based on fresh shareholder funds of €180m from two capital increases in 2006.We expect positive earnings development from TAG in coming years. The new business strategy to actively unlock the value of its real estate portfolio and to make new acquisitions should deliver enough profit potential.
▪
TAG has developed well since 2005 but this has not been reflected in the share price performance since June 2007. The current share price represents a discount of 50% on its NAV. Reasons for the rather dis- appointing development are not company specific but instead clearly lie in the US subprime crisis and its consequences. Investors are quite con-cerned about the future development of capital markets and especially the international real estate markets, and are likely to remain so for the next few months. But the German real estate market has not deterio-rated and it does not look like doing so this year. TAG shares therefore seem rather cheap compared with other real estate companies. We do not expect a short-term turnaround in real estate shares but we do be-lieve it will come in the medium term. Our price target is €8.20 per TAG share. We place a BUY recommendation on the shares of TAG.11
February 2008
Internet:
www.tag-ag.com Sector: Real Estate
Shareholders: Free float:
Taube Hodson Stonex Partners Ltd.: European Asset Value Fund: Investorengruppe Dr. Ristow: Ratio Asset Management LLP: Tudor Group Verwaltungsgesellschaft:
61% 16% 6% 7% 5% 5%
Close Brothers Seydler Research AG Phone: +49 (0)69 - 977 84 56 0 E-Mail: [email protected] Management Board: Andreas Ibel (CEO)
Erhard Flint (CFO) Supervisory Board: Dr. Lutz R. Ristow
Prof. Dr. Ronald Frohne Rolf Hauschildt Dr. Wolfgang Schnell
MEDIUM
(-)EUR 8.20
(-) Share data: Share Price: Shares outstanding (m): Market capitalisation: Ø daily trading volume:Performance data: High 52 weeks: Low 52 weeks:
Absolute performance (12 months):
Relative performance (SDAX): 1 month 3 months 6 months 12 months EUR 6.13 32.6 EUR 200m 90,900 11.73 5.50 -43.8 9.2% 2.1% -3.7% -24.8 WKN: 830350 ISIN: DE 0008303504
Source: CBS Research AG, Deutsche Börse Share price vs. SDAX (1 year)
Key data
EUR m 2005 2006 2007E 2008E 2009E Total Revenues 167.5 125.2 150.5 149.0 158.5 EBITDA 6.7 17.7 54.9 61.3 69.0 EBIT -13.8 17.1 53.0 59.3 66.9 Net profit -35.5 2.8 14.8 17.2 19.3
Investment Summary
Strengths▪
Focus on German metropolitan regions, especially Berlin, Hamburg, Munich, Leipzig and the Rhine-Main region (Frankfurt)▪
Expanding service segment enables a significant profit contribution with only limited equity capital usage▪
New strategy to unlock value of its real estate portfolio▪
Improved reporting transparencyWeaknesses
▪
TAG was a restructuring case▪
The company only returned to profit in 2006 and has yet to prove that it can deliver a sustainable profit level over time▪
The commercial real estate segment is ready to go public as a German REIT but the current market discount on NAV is not attractive for the managementOpportunities
▪
The German real estate market still looks underdeveloped compared with other European markets▪
Over the medium term G-REITs will open the German real estate market to a new kind of investor, and TAG can participate in this development with its com-mercial real estate model▪
Medium-term recovery of the German economyThreats
▪
Rise in interest rates increase funding costs▪
Investors‘ interest in the German real estate market could weaken further▪
As a real estate company, it is exposed to market- and sector-specific risks▪
Capital increase to finance potential acquisitionsTAG is a real estate investor. In our view the best evaluation of its fair value is therefore its net asset value (NAV). The current share prices of TAG and other real estate companies are well below their NAVs. A peer group comparison, together with some other fairesearch valuation models, should give a good overview regard-ing the performance potential of TAG shares: multiple comparisons, an earnregard-ings discount model, NAV and book value.
The company focuses on residential and commercial real estate in Germany and the asset management of real estate with a local emphasis on big cities. The peer group compiled by fairesearch therefore consists of six real estate companies that also focus on residential or commercial real estate in Germany. However, the busi-ness mix within the peer group is of course not identical, so the peer group com-parison is somewhat limited in our view.
fairesearch has calculated a per-share NAV for the real estate portfolio of TAG. The calculated figure is a NNNAV (ie market value minus deferred taxes on capital gains). We estimate the market value of TAG‘s real estate portfolio to be around 10% above the book value. We deducted a tax rate of 30% for deferred tax liabili-ties on the forecast capital gains as well as some sales commissions and other costs. The service segment is included at its present value. The NAV valuation is a good tool for pure real estate portfolio management and a buy-and-hold strategy.
A historic data comparison shows that investors have assessed real estate compa-nies quite differently on a P/NAV valuation over time. European and German real estate companies were valued with a discount of up to 40% to NAV in 2001-2005. On the other hand, investors were ready to pay a premium of up to 40% to the
Hidden reserves
NAV comparison (2006-2009E)
NAV 2006 2007E 2008E 2009E P/NAV 2008E Colonia Real Estate 6.3 14.8 17.3 20.5 0.76 Deutsche Wohnen 34.8 35.1 36.6 38.4 0.64 GAGFAH 11.9 13.8 15.0 15.8 0.78 PATRIZIA Immobilien 4.0 4.2 5.0 6.0 0.88 Alstria Office n.a. 15.5 18.9 21.1 0.58 DIC Asset 21.3 28.2 33.2 36.3 0.57
average 18.6 21.0 23.0 0.70
TAG 10.8 12.1 12.8 13.3 0.48
based on average 8.96
on the low side. The book value per TAG share (shareholder funds per share) is around €8.20 for 2007, and we think that is at least a fair price level for TAG shares. We calculated an average book value of €8.60 per share for the 2007e-2009e period.
The peer group comparison shows that the companies‘ multiples differ considera-bly. This could be due to differences in their business mix, strategy, prospects, free float and market confidence in management‘s skills. We therefore compared TAG‘s figures with the peer group average.
The forecasts for TAG are fairesearch estimates, while the peer group forecasts are based on consensus and market figures. Our P/E-based multiples valuation suggests that TAG is not undervalued. The target share price ranges from €5.35 for 2008e to €5.19 for 2009e based on the peer group average. The average target price for the 2007e-2009e period would be €5.30 per share, which does not make much sense in our view, because the extremely low P/E ratios of two peers distort the average multiple.
The EV/EBITDA valuation indicates that TAG is overvalued. The potential target price ranges from €5.37 per share for 2007e to €3.55 for 2009e. The average tar-get price for the 2007e-2009e period would be €4.28 per share. TAG is currently in an investment phase and the figures of the peer group have a wide range. The EV/EBITDA comparison seems therefore currently not appropriate for TAG evaluation.
Multiples comparison of major competitors (2007E – 2009E)
Company Price in €
Market cap.
€m EPS`07 EPS`08 EPS`09 P/E`07 P/E`08 P/E`09
Colonia Real Estate 13.20 290 3.02 2.98 3.20 4.4 4.4 4.1 Deutsche Wohnen 23.50 620 1.81 2.29 2.80 13.0 10.3 8.4 GAGFAH 11.73 2,639 0.65 0.86 0.93 18.1 13.6 12.6 PATRIZIA Immobilien 4.44 232 0.71 0.95 1.02 6.3 4.7 4.4 Alstria Office 11.0 616 0.93 0.90 1.03 11.8 12.2 10.7 DIC Asset 19.05 597 1.19 1.26 1.48 16.0 15.1 12.9 average 11.6 10.1 8.8 TAG 6.13 200 0.46 0.53 0.59 13.5 11.6 10.3 based on average 5.34 5.35 5.19
EV/EBITDA comparison (2007E-2009E)
EV/EBITDA 2007E 2008E 2009E
Colonia Real Estate 6.1 4.9 4.1 Deutsche Wohnen 16.7 13.7 11.2 GAGFAH 14.8 13.1 11.7 PATRIZIA Immobilien 2.6 2.0 1.6 Alstria Office 12.3 11.2 10.9 DIC Asset 11.1 7.3 6.5 average 10.6 8.7 7.7 TAG 12.1 13.6 13.3 based on average 5.37 3.92 3.55
Source: CBS Research AG, fairesearch, HSH NORDBANK
fairesearch also valued TAG using our shareholder profit model, which is an earn-ings discount model. We decided to opt for this rather than a DCF model because the cash flow of a real estate company is often strongly influenced by inventory investments and disposals. Such cash flows are particularly hard to forecast. In fairesearch‘s view, the earnings discount model is a more reliable means of valuing that business. We calculate a fair value of €9.11 per TAG share.
TAG looks undervalued according to our NAV and book value analysis as well as on our shareholder profit model. The different valuation methods we used yielded fair values that ranged from €3.55 to €9.11 per share for 2007e to 2009e. The av-erage target prices is €7.26 per share, which is clearly above the current share price of TAG.
TAG shares do not look expensive compared with other real estate companies. However, the whole sector has underperformed in 2007 and 2008 to date after a strong performance in 2004-2006. The weakness of some real estate markets, such as the US, UK and Spain, seems to be taking its toll on institutional investors‘ interest in the real estate market as a whole. The global financial turmoil caused by
TAG price per share by different valuation methods
P/E valuation 5.3
EV/EBITDA 4.3
NAV (2008E) 9.0
Book value 8.6
Shareholder profit model 9.1
Average price per share €7.26
Company Profile
Source: CBS Research AG, fairesearch, TAG Group structure of TAG (September 2007)
Holding company function TAG
- Listed at the SDAX - Equity €296m - Market cap €269m - Total assets €800m
- Total assets €79m
-Listed at the Prime Standard -Total assets €344m -29% free float
- Listed at the SDAX
Residential real estate
Bau-Verein zu Hamburg AG
Commercial real estate
TAG Gewerbe AG
Real estate services
TAG Asset Management
-Pre-REIT status -Total assets €336m 71% 100% 10% 90% A long history in a different business
TAG is a listed company which can look back on a history of 125 years. It has therefore a much longer company history than most of its German real estate peers. But TAG switched its business focus to real estate less than 10 years ago. The company was originally a railway company, which was founded in 1882. TAG leased its railway business to a third party in 1999. The railway business included properties with a total area of around 50,000 sqm on the banks of Lake Tegern, which still belong to TAG. The company switched its business focus to a listed real estate group following the acquisition of subsidiaries and real estate companies. At the end of 2006 TAG joined the German SDAX, which is an index of 50 German small caps, and it belongs to the 10 biggest listed German real estate companies.
TAG acquired 44.4% of Bau-Verein zu Hamburg AG in 2001. Bau-Verein zu Ham-burg was set up in 1892 as a real estate cooperative in the city of HamHam-burg. TAG increased its stake on Bau-Verein zu Hamburg to 87.9% at the beginning of 2002 and reduced it to 71% in August 2006 to increase the free-float. Andreas Ibel and Erhard Flint were appointed as members of the board of Bau-Verein zu Hamburg in 2001, and in 2006 also joined the board of TAG. TAG acquired JUS AG at the beginning of 2001 and changed its name to TAG Asset Management at the end of 2006.
Market value of TAG portfolio by type of use (end-June 2007)
Source: CBS Research AG, fairesearch, TAG
23%
22%
41% 14%
Residential investment portfolio Residential current asset portfolio Commercial Undeveloped real estate
TAG is the holding company of the real estate group and focuses on German metropolitan regions, especially Berlin, Hamburg, Munich, Leipzig and the Rhine-Main region (Frankfurt). The core business of TAG is the management and development of its own portfolio, new construction, portfolio management for third parties, and real estate services. TAG runs both the residential and the com-mercial real estate businesses via its subsidiaries. The company keeps around 5,000 residential and commercial units in its own portfolio. Another 1,500 units are under construction or in the pipeline. In addition, it manages 7,200 units for third parties.
TAG increased its capital three times in 2005 by a total of €28m and twice in 2006 by a total of €180m. The group‘s shareholder funds were €296.4m at the end of September 2007. The number of shares outstanding is currently 32.6m. The free float was 61% at the end of 2007, according to TAG, and 93% according to the definition of Deutsche Börse AG. The shareholder structure is detailed in the chart on the next page.
Shareholder structure of TAG 61% 16% 6% 7% 5% 5%
Free float Taube Hodson Stonex Partners Ltd. European Asset Value Fund Investorengruppe Dr. Ristow
Ratio AM Tudor group
Source: CBS Research AG, fairesearch, TAG
The shareholder funds it collected in 2006 will enable the company to increase its total assets to €1.3bn in 2008. The budget for acquisitions of real estate is €800m for the years 2006 to 2008.
Corporate strategy: buy, build and hold
TAG‘s strategy aims to generate long-term value growth. The company wants to realise that target with a combination of real estate portfolio maintenance and the development of the portfolio together with a real estate service provider. It there-fore covers the value chain for that real estate business. TAG believes that its long-term view enables the company to use the cyclical moves of the real estate market and to acquire properties at the cyclical bottom. TAG aims to build up a long-term real estate investment portfolio with stable cash flows and high returns.
Buy Build Hold Service
Major German cities with long-term prospects
Modernisation and repairs Long-term portfolio Property and asset management
Good residential locations Creation of extra space by extensions and addi-tional storeys
Trapping potential for raising rentals
Due diligence
Attractive rental yields with high cash flows
Extensions and new con-structions
Optimising operating costs
Project and construc-tion management
Focus on small to mid-size real estate portfolios
Improvements to sur-roundings
Controlling
Detailed due diligence reviews by expert staff
Active value creation by means of portfolio en-hancement activities
Book keeping
Market value of residential portfolio by region (end-June 2007) 27% 44% 10% 10% 9%
Hamburg Berlin Munich Leipzig Other
Source: CBS Research AG, fairesearch, TAG;
Residential real estate
Bau-Verein zu Hamburg runs the residential real estate business for the TAG group. Its core business is to develop its residential real estate portfolio as well as to build new dwellings in established locations in German metropolitan regions. Its focus is on Hamburg, Berlin, Munich, Leipzig and the Rhine-Main region. TAG sees markets expanding there due to rising populations. Bau-Verein zu Hamburg sold 90% of its commercial real estate subsidiary to TAG at the end of 2006. This subsidiary was renamed TAG Gewerbeimmobilien AG and now runs the commer-cial real estate of the TAG group.
Bau-Verein zu Hamburg wants to strengthen its own residential real estate portfolio sustainably through acquisitions and to enhance the value of its portfolio through active portfolio management. The company keeps around 5,000 residential and commercial units in its own portfolio. Another 1,500 units are under construction or in the pipeline. In addition, it manages 7,200 units for third parties. Bau-Verein zu Hamburg has branches in Berlin, Hamburg, Munich and Leipzig to keep close con-tact with the regional markets and its own real estate portfolio.
Residential real estate investment portfolio (end-2006)
Hamburg Berlin Munich Leipzig Other Total
Units 1,062 93 60 433 494 2,142
Area in sqm 59,205 10,121 4,092 24,752 40,950 139,120
Average size in sqm 56 109 68 57 83 65
Vacancy for rent in sqm 1,066 438 211 770 1,707 4,192
Vacancy for rent 2% 4% 5% 3% 4% 3%
Net rent in TEUR 4,615 350 465 413 2,582 8,425
Net rent in €/sqm 6.71 5.05 9.99 4.13 6.73 5.05
Market rent after development in TEUR 5,755 946 465 1,810 3,327 12,302
Market rent after development in €/sqm 8.10 7.79 9.47 6.09 6.77 7.37
Planned investment in TEUR 2,443 2,753 0 13,277 5,943 24,416
Source: CBS Research AG, fairesearch, TAG
Source: CBS Research AG, fairesearch, TAG Source: CBS Research AG, fairesearch, TAG;
Bau-Verein zu Hamburg sold an entire development project in Hamburg in 4Q07. TAG‘s revenue contribution from that sale should be close to €40m and pre-tax profit share around €12m, booked in 4Q07. It was a joint venture with DESIGN Bau AG. Some 750 apartments as well as commercial units and retail outlets covering a floor area of around 14,000 sqm are being developed and con-structed in this project, which abuts directly onto the City Park and is located in the Hamburg suburb of Winterhude. Construction work is expected to commence in the first quarter of 2008. TAG will remain involved in the execution of the project. Current assets - residential real estate portfolio (end-2006)
Hamburg Berlin Munich Leipzig Other Total
Units 308 1,915 210 31 143 2607
Area in sqm 19,913 115,866 10,572 1,939 3,510 151,800
Average size in sqm 65 61 50 63 25 58
Vacancy for rent in sqm 146 2,598 351 191 53 3,338
Vacancy for rent 1% 2% 3% 10% 2% 2%
Vacancy for sale in sqm 5,943 14,245 461 1,486 0 22,135
Vacancy for sale 30% 12% 4% 77% 0% 15%
Net rent in TEUR 986 4,149 876 16 330 6357
Net rent in €/sqm 4.13 2.98 6.90 0.70 7.83 3.49
Planned investment in TEUR 2,443 2,753 0 13,277 5,943 24,416
Current assets - Undeveloped real estate portfolio (end-2006)
Hamburg Berlin Munich Leipzig Rhine-Main Total
Area of land in sqm 128,725 7,940 5,187 10,455 15,000 167,307
Units planned 566 14 0 0 53 633
Area planned 70,185 1,558 12,916 0 7,179 91,838
Prospects
TAG‘s strategy of buying residential properties that have space with further devel-opment potential and levels of rent that are not fully developed makes a lot of sense in our view. It can therefore increase the value of its portfolio as well as its profitability after the necessary investments. The average rent per sqm of its in-vestment portfolio was still 46% below the average market rent at the end of 2006 (see the first table on the previous page).
The second pillar of TAG‘s strategy is a right one as well: to focus the real estate portfolio on German metropolitan regions. There has for some years been a clear trend in Germany to move back into major city centres; in addition, the average residential space per capita is forecast to rise by around 20% by 2030. We there-fore expect demand for housing to increase in areas where the TAG portfolio is located. The value of the investment portfolio and the market rent level should benefit from these trends. The value enhancement growth of TAG‘s investment portfolio was at least 5% p.a. over the last years.
TAG‘s last published deal in the project development business shows that there are some profitable business opportunities in its underdeveloped real estate portfo-lio. The construction of new dwellings in established locations in German metro-politan regions should benefit, as the investment portfolio will, from the demand development in this area, described above. The low vacancy rates of the residen-tial real estate portfolios of TAG support this view.
We therefore expect a sustainable increase in revenues and EBIT for the real es-tate business until 2009, driven mainly by the positive trends in the metropolitan regions. The figures for 2007 may be distorted by the sale of the development pro-ject at Hamburg in 4Q07. We do not believe that the current financial market tur-moil should have a big negative effect on the residential real estate market in Ger-man metropolitan regions in the next two years.
Residential real estate (2006-2009E)
€m 2006 2007E 2008E 2009E
Sales revenues 67.2 91 80 85
EBIT 20.1 31 28 31
Market value of commercial portfolio by region (end-June 2006) 12% 15% 37% 26% 10%
Hamburg Berlin Munich Rhine-Main Other
Source: CBS Research AG, fairesearch, TAG
Commercial real estate
TAG set up TAG Gewerbeimmobilien AG to run the group‘s commercial real estate at the end of 2006. The background was the positive legislative development relat-ing to the introduction of Real Estate Investment Trust (REITs) in Germany. TAG therefore converted its commercial real estate subsidiary from the legal status of a German GmbH to a listed company (AG) at the end of 2006. It was registered as a pre-REIT. The conditions for the establishment of TAG Gewerbeimmobilien AG as a German REIT (G-REIT) have been created and the target is to go public with this segment as a REIT.
TAG has said it is investing only in locations in cities including Munich, Hamburg and the Rhine-Main region and in the commercial real estate segment. The focus is there on investments in the best locations of second-best cities or second-best locations in premium cities. It aims to reach a good commercial real estate portfolio mix between investment properties with stable cash flows and undervalued proper-ties with value-added development potential. The ―buy, build and hold‖ strategy enables rental growth and realise space reserves of its properties.
TAG has a strong growing commercial real estate portfolio. The value of the portfo-lio was €105m at the end of 2006. The target is total assets of €400m for the com-mercial real estate portfolio at the end of 2007.
Current assets - commercial real estate portfolio (end-2006)
Hamburg Munich Rhine-Main Other Total
Units 26 56 101 28 211
Area in sqm 19,811 42,990 26,567 25,565 114,933
Vacancy for investment in sqm 457 2,692 2,327 1,618 7094
Vacancy for investment 2% 6% 9% 6% 6%
Vacancy for rent in sqm 0 0 3048 777 3825
Vacancy for rent 0% 0% 11% 3% 3%
Net rent in TEUR 849 3,499 2,315 1,052 7715
Net rent in €/sqm 3.57 6.78 7.26 3.43 5.59
Planned investment in TEUR 1,441 7,399 655 505 10,000
Source: CBS Research AG, fairesearch, TAG
Prospects
TAG made some relatively large acquisitions in its commercial real estate business last year. It has participated that German big companies prefer to sell its self used properties to potential G-REITs as setting up their own G-REITs. The so-called ―Exit Tax‖ on German REITs enables commercial real estate sellers to realise part of their capital gains on their sold properties with a 50% reduction in income, corporate income and local payments tax until the end of 2009. The companies sell and lease back their properties and can realise part of their disposal gains on the properties with reduced tax.
TAG should therefore hit its investment target for its commercial real estate portfo-lio in the current year. The second target currently seems harder to reach: to go public with this segment as a G-REIT. The valuation of real estate companies and commercial real estate portfolios has changed dramatically since spring 2007. The market was ready to pay a premium on the current net asset value of a real estate company one year ago. Now investors only buy with a considerable discount on the NAV.
We do not believe that the market‘s assessment of real estate companies is going to change in the short term. But the management of TAG still intends to sell its commercial real estate portfolio via an IPO as a G-REIT, close or above the NAV. We therefore predict that TAG will not be able to realise its G-REIT plans this year. The plan to reinvest the money from a G-REIT IPO into a new commercial real estate portfolio should be postponed as well. Our estimates for the commercial real estate business do not include any IPO contribution.
We predict no G-REIT this year
Services
TAG has pooled its real estate service activities in a subsidiary, TAG Asset Man-agement. The company carries out all activities related to real estate: acquisition, due diligence, project development and management, construction site supervi-sion, controlling and asset management. TAG Asset Management handles these functions for the group as well as for third parties. It supports national and interna-tional investors‘ construction projects. The most frequently used services relate to acquisitions, public relations, data processing and controlling.
The group has widened its source of non-capital-tied income with a reliable plan-ning horizon by expanding its range of services related to real estate. TAG is able to offer the entire value chain in the real estate sector together with its residential and commercial real estate activities. As a result it has been possible to extend the service business substantially.
New co-operation with HSH Nordbank
HSH Real Estate and TAG launched a joint asset management company at the beginning of 2008. An agreement establishing the joint venture, with each partner holding a 50% stake, was signed at the end of 2007. The headquarters will be in Hamburg. HSH Real Estate is a subsidiary of HSH Nordbank, one of the big public banks in Germany and the biggest local bank in the Hamburg/Schleswig-Holstein region.
The new company will manage a portfolio of commercial real estate in Germany with an initial volume of €1.2bn. The portfolio consists of some of TAG and HSH Real Estate‘s own commercial properties and real estate managed on behalf of third parties.
Prospects
We consider that TAG‘s strategy — to extend its source of non-capital-tied income with a reliable planning horizon by expanding its range of services related to real estate — is a good one. The company is concentrating its resources, improving know-how and improving profitability, without the need for additional capital. The co-operation with the subsidiary of HSH Nordbank should increase its busi-ness opportunities. We therefore forecast a strong increase in the segment‘s reve-nues and EBIT contribution in the next few years.
Services (2006-2009E)
€m 2006 2007E 2008E 2009E
Sales revenues 6.1 15.0 20 28
EBIT 1.1 3.8 5.6 8.5
The German residential real estate market has developed differently from those of other European countries. Prices for residential real estate have risen strongly in most European countries since 1998 but not in Germany, where they have re-mained more or less unchanged over that time. Meanwhile, we have seen the property bubble bursting in some markets, such as in Spain, Great Britain, Hungary or Ireland. The strong expansion in housing output was driven by considerable price increase and has led to overcapacity, resulting in a downturn in the high prop-erty prices in former boom markets. In Germany was no real estate pricing bubble and therefore no burst.
There are some reasons for this development in Germany. Firstly, the country‘s poor economic development has led to weak demand in the past years. Secondly, the German government has for decades subsidised the building of new residential properties via tax benefits. Demand for housing was huge in Germany after wide-spread destruction in World War II. After the war, the trend was supported by growth in the population and GDP.
European housing market price development (1998 = 100)
Country 1998 1999 2000 2001 2002 2003 2004 Average change per year (%) Hungary 100.0 106.1 112.3 206.9 242.5 256.5 194.8 27.8 Spain 100.0 112.4 129.2 148.7 174.4 204.8 241.5 20.2 France 100.0 109.0 120.0 127.3 142.4 162.8 188.0 12.6 UK 100.0 110.9 124.6 130.7 147.8 162.5 172.9 10.4 Norway 100.0 114.3 131.0 141.3 150.8 153.2 172.2 10.3 Ireland 100.0 100.0 113.9 123.1 133.4 151.2 166.3 9.5 Sweden 100.0 106.7 114.6 130.0 136.0 149.4 165.2 9.3 Netherlands 100.0 100.8 115.0 123.3 140.2 142.9 148.3 6.9 Italy 100.0 101.1 107.4 114.7 127.4 134.7 141.1 5.9 Poland 100.0 115.0 119.2 129.5 120.7 126.0 137.3 5.3 Denmark 100.0 107.1 113.1 120.2 123.8 128.1 134.6 4.9 Finland 100.0 110.6 110.1 111.0 115.4 123.2 129.3 4.2 Switzerland 100.0 100.1 101.0 103.0 107.0 109.5 111.7 1.7 Germany 100.0 99.6 101.3 103.0 104.2 103.1 102.1 0.3 Source: Euroconstruct
General trends in the German residential real estate market However, we see signs of a turnaround in the German residential real estate mar-ket. On the one hand, new builds more than halved from over 500,000 in 1995 to 211,000 for 2005. The building licences for new dwellings in Germany fell by 31% yoy to 136,000 for the first nine months of 2007. On the other hand, the German Federal Office for the Building Trade and Regional Planning expects that the number of households will continue to increase in Germany as a result of the general reduction in household size. Experts estimate an annual new housing de-mand of 340,000 units in Germany. The supply of new buildings has not met the high demand in Germany for several years. This deficit should lead to increasing or at least stable housing prices in Germany — with strong local differences, of course.
Germany had 39.2 million households in 2005, with approximately 82.7 million household members. This marked an 11% rise in households and 3% growth in the number of household members from 1991 levels. The average household size decreased from 2.27 people in 1991 to only 2.11 in 2005. The German Federal Statistical Office forecasts that this trend will continue for more than a decade and will peak at around 41 million households in 2018. This should have a positive ef-fect on demand for dwellings even if the population stagnates or decreases.
The building of new homes more than
halved…
…but the number of
households will con-tinue to increase in Germany
Projection of number of households development in Germany
Year in mln Change 2000 38.12 0.33 2001 38.45 0.33 2002 38.72 0.27 2003 38.94 0.22 2004 39.12 0.18 2005 39.20 0.08 2006E 39.43 0.23 2007E 39.70 0.27 2008E 39.94 0.24 2009E 40.15 0.21 2010E 40.41 0.26 2015E 41.02 0.61 2018E 41.09 0.07 2020E 41.01 -0.08
Source: CBS Research AG, fairesearch , The German Federal Statistical Office
In addition, we have seen the recovery of German economy. GDP increased by 2.8% in 2006 compared with a growth rate of only 0.9% for 2005, according to the German Federal Statistical Office. GDP growth slowed down somewhat to around 2.5% for 2007. In January 2008 the German government reduced its full-year GDP growth forecast to 1.7%, partly as a result of turmoil on the financial markets.
The German residential real estate market has become more attractive to foreign investors. Property prices in other European countries have increased more strongly than rents, causing rental yield to decrease; by contrast, rental yields are stable in Germany and offer relatively high returns on invested capital. Further-more, prices in the German real estate market appear to offer more upside poten-tial than in the other developed European markets, which have already enjoyed substantial price increases. Foreign opportunity funds acquired around 700,000 housing units in Germany over the last 10 years – ie more than 70% of the transac-tions for this period. But their share should fall in coming years, due to the real es-tate bubble bursting in some markets and subprime-related turmoil in the financial markets. The real estate business is currently not in favour with international inves-tors.
Overall, we believe that general economic developments and the sector outlook in Germany are more cloudy than a year ago but are still favourable for TAG‘s busi-ness. German GDP growth is decreasing unemployment and making the long-term investment environment more reliable. The declining supply of dwellings and in-creasing number of households in Germany should raise house prices and rents, benefiting TAG‘s residential real estate business.
General trends in the German commercial real estate market
The German commercial real estate market has been booming for several years. Investment volume in German commercial real estate reached a record high in 2006, doubling from the previous year‘s level to €49.4bn. Investment volume in-creased by another 20% to €59.4bn in 2007, according to Atisreal. The investment volume in German residential real estate increased as well, by around 18% to
€15.2bn in 2007. The general interest in German real estate continued to be fairly
last year, despite the subprime crisis in mid-2007.
More than half of total turnover (52%) in German commercial real estate was in-vested in office space last year. It improved its status due to the positive develop-ment of the biggest German office space locations. The share of retail properties decreased from 40% in 2006, which included the sale of the Karstadt real estate portfolio of €4.5bn, to around 22% for 2007. Logistics properties accounted for 5% in 2007 with a transaction volume of around €2.8bn (€2.9bn in 2006).
Investment volume reached new peak in 2007
German real estate investments in € bn
2005 2006 % 2007 %
Commercial real estate 23.7 49.4 108% 59.4 20% Residential real estate 15.8 12.9 -18% 15.2 18% Total real estate 39.5 62.3 58% 74.6 20%
Source: CBS Research AG, fairesearch, Atisreal
Around 61% of the turnover or €36.1bn was made up of portfolio deals in 2007 compared with 62% in 2006. Investments in individual properties accounted for
€23.3bn or 39%. Around 76% of the investments in German commercial real estate
were made by foreign investors in 2006, falling to around 69% in 2007, and we expect their share to fall further in 2008-2009.
The relationship between interest rates and rental yields in German commercial real estate market still looks attractive relative to international levels. However, rental yields in Germany reached their bottom in 1H07 and have been increased by the subprime crisis since then. Scheduled transactions were delayed or completely cancelled as a result of the distinctly more reluctant stance of banks to lend money in 2H07. In addition, funding costs have increased. After a huge wave of investors driven by the lure of cheap borrowed capital, the buyers now need their own funds to a greater extent.
First-rate commercial real estate and properties on long-term leases should remain in demand. The total investments in the top six locations in Germany (Berlin, Co-logne, Düsseldorf, Frankfurt, Hamburg and Munich) increased by 44% yoy to
€30.7bn for 2007. The best location last year was Frankfurt, where turnover
jumped by 82% to €7.9bn. Next was Berlin, with an increase of 65% to €6.9bn. Munich was up by 37% to €6.7bn, Hamburg 29% to €5.1bn and Cologne by 25% to
€1.8bn for 2007. Only Düsseldorf saw a decline in turnover, by 7% to €2.3bn.
Strong demand in top six cities
Investments in top German Commercial real estate cities in € bn
2005 2006 % 2007 % Berlin 1.75 4.2 140% 6.9 64% Düsseldorf 0.9 2.45 172% 2.3 -6% Frankfurt 3.2 4.3 34% 7.9 84% Hamburg 1.7 3.9 129% 5.1 31% Cologne 0.7 1.45 107% 1.8 24% Munich 1.5 4.9 227% 6.7 37%
Source: CBS Research AG, fairesearch, Atisreal
In 2008 the changed environment due to the subprime turmoil is likely to result in real estate turnover falling short of the records reached in 2007. But turnover could still be at a good level, as Germany is enjoys a relatively favourable pricing level. Rental yields could remain at the current level, with adjustments in different market segments. Take-up volume fell last year in some European urban areas, like Lon-don and Paris, compared with 2006; but rose by 14.5% in the nine biggest German office property locations in the same period. The average vacancy rate decreased
by 3.5pp in 2007 for this group. The average prime rent was up by 4.7% in 2007 for the top nine German cities.
Munich
Take-up volume jumped by 24% yoy to 834,000 sqm in Munich for 2007, the high-est growth rate of Germany‘s nine bigghigh-est cities in terms of office properties, ac-cording to Atisreal. The vacancy rate increased from 8.8% to 9.6% for 2007. The prime rent was up by 5% to €31 per sqm for 2007.
Frankfurt
Take-up volume was up by 1% yoy to 629,000 sqm in Frankfurt for 2007. The va-cancy rate came down from 14.5% for 2006 to 13.3% for 2007. The prime rent increased by 7% to €37.5 per sqm for 2007.
Berlin
Take-up volume declined by 15% to 500,000 sqm in Berlin for 2007 compared with the year before. That was the weakest figure of the nine biggest cities in Germany in 2007. The vacancy rate was flat at around 8.2% for 2007. The prime rent was up by 7% to €22 per sqm for 2007.
Hamburg
Hamburg reached a new take-up record in 2007 with 564,000 sqm, up by 23% and the second-best growth rate of the nine top cities in 2007. The vacancy rate de-creased slightly to 6.3% in 2007 and was again the lowest figure of the German peer group. The prime rent was up by 6% to €25 per sqm for 2007.
German REITs
After long discussions and several delays the government approved a German REIT in 2007. REITs have already found a foothold on the international capital markets and are well known by real estate companies and global investors. The first REITs were set up in the US in 1961.
The legal requirements for REITS differ from country to country. The main legal requirements for G-REITs are follows:
▪
The REIT AG (German public limited company) must have its stock listed on an organised market.▪
The REIT AG must have its registered office and management in Germany.▪
The minimum nominal share capital is €15m.▪
There can be no investment in properties with a share on residential real estate above 50%.▪
At least 75% of the assets must be immovable assets.▪
Up to 50% of the immovable assets can be sold in a five-year period.▪
At least 75% of gross income must be generated from immovable assets.▪
The G-REIT must distribute at least 90% of its profits, calculated under GermanGAAP (HGB).
German REITs are fully exempted from German corporate income tax and German local tax, though the shareholder is liable for tax on the dividends. G-REITs should therefore be especially interesting for foreign investors.
In addition the so-called ―Exit Tax‖ on G-REITs enables commercial real estate sellers to realise part of the capital gains on their sold properties with a 50% re- duction in income, corporate income and local tax payments until the end of 2009.
Most big companies prefer to sell the properties they use themselves to potential G-REITs as to set up their own G-REITs. The companies sale and lease back their properties and can realise part of their disposal gains on the properties with re-duced tax.
Turnaround in 2006
The difficult economic environment in Germany and particularly problems in some German real estate segments (East Germany) led to a net loss of €35.5m for the TAG group in 2005. In particular, the restructuring of the subsidiary JUS AG and the company‘s properties in East Germany placed a considerable burden on TAG‘s liquidity and earnings. JUS AG used to be active in the refurbishing of historical buildings in the Special-Purpose Property core business segment.
The restructuring and realignment of JUS AG led to high impairments with respect to goodwill and a number of properties held by JUS AG in 2005. TAG wrote down loans to JUS AG with a volume of €18.8m for 2007 compared with write-downs of
€7.5m for 2007. JUS AG was restructured and transformed into a real estate
ser-vice provider. It now runs the serser-vice segment for the group as TAG Asset Man-agement.
The TAG group restructured its strategy and management after the JUS AG disas-ter. Its new strategy is a ―buy, build and hold‖ strategy aimed at unlocking long-term value. TAG used the good market sentiment for real estate companies and acquired fresh shareholder funds of €180m in 2006. The reorganisation of TAG led to a net profit of €2.9m and a turnaround in 2006. The capital increase provided the group with resources for acquiring real estate in a planned volume of up to €800m, or a total assets increase to €1.3bn. TAG made its first investments of €250m in 2006.
9M07 figures
The revenues of the TAG group increased slightly in the first nine months of 2007 to €58.3m, up by 1% compared with the same period in 2006. Rental income rose by 50% to €26.4m for 9M07 as new real estate acquisitions led to higher rental income as well. Construction management income more than tripled from €6.2m for 9M06 to €19m for 9M07. This strong increase in management income came from the planned extension of service management for the group and external cli-ents.
On the other hand, the revenues of TAG in the first nine months of 2007 suffered from the switch of group strategy from the development business to being a long-term real estate investor. Revenues from the sale of properties dropped from
€33.8m for 9M06 to €12.85m for 9M07. The share of sales of properties in total
revenues decreased from close to 60% for 9M06 to 22% for 9M07 as a result.
es-Fair-value gains increased by 150% yoy to €23.2m for 9M07. This was a result of ongoing acquisition activities and the related return-oriented purchase prices to-gether with development activities, which aimed at unlocking value in TAG‘s exist-ing portfolio. The company also benefited from the reclassification of ―available for sale‖ commercial properties as investment properties.
Net interest expenses went up by 38% to €12.35m for 9M07. Liabilities to banks rose to fund new real estate acquisitions and the cash position of TAG therefore declined. In addition, increased interest rates until September 2007.
Overall, pre-tax profit tripled to €15.8m for 9M07 compared with 9M06. Net profit after minorities was up from €1.75 for 9M06 to €7m for 9M07.
Income statement (9M07) €m 9M07 9M06 YoY Sales revenues 58.3 57.6 1% Change in inventories 23.2 9.2 >100% Other income 1.9 5.3 -64% Total turnover 83.4 72.1 16% Costs of materials 38.6 44.6 -14% Employment costs 6.8 6.4 6% Depreciations 1.5 0.4 >100%
Other operating expenses 7.9 5.9 34%
Total expenses 54.8 57.3 -4% EBITDA 30.1 15.2 98% EBIT 28.6 14.8 93% Financial result -12.8 -9.6 33% Pre-tax profit 15.8 5.2 >100% Taxes 7.0 2.7 >100% Minority interests 1.8 0.7 >100%
Net profit (loss) 7.0 1.75 >100%
EPS 0.22 0.15 47%
Segment reporting
All segment figures are EBIT in €m.
Segment 9M07 9M06 YoY
Residential real estate 12.8 11.7 9%
Commercial real estate 15.8 2.5 >100%
Services 3.5 1.5 >100%
Consolidation adjustments, others -3.6 -0.8 >100%
Total group 28.55 14.8 93%
Source: CBS Research AG, fairesearch, TAG
Segmental reporting reflected the strategy switch as well as a strong expansion of the commercial real estate portfolio through new acquisitions. The assets of the residential real estate segment were around €425bn at the end of September 2007, almost unchanged on the end of September 2006, while the assets of the commercial real estate segment more than tripled to €361.6bn in the same period. The service segment benefited from an extended product offering to the group and external clients.
Targets and forecasts
TAG‘s future growth strategy has been based on the fresh shareholder funds of
€180m from the two capital increases in 2006. Its target is an equity ratio of around
25%, which would mean total assets of up to €1.2bn-€1.3bn. We believe that TAG can grow at least until 2009 with the current shareholder fund base.
The required changes in strategy and management have had quite a positive effect on earnings development. TAG returned to profit in 2006. It increased its profits considerable for 9M07 compared with 9M06, which were on a low level. Manage-ment released a pre-tax profit target of €31m for FY2007, which means TAG has to double its 9M07 figure. We believe TAG should fulfil its target in light of the real estate business cycle. The fourth quarter has always been the most profitable quarter of the year for both TAG and the sector, and TAG sold one development project at the end of December 2007.
We expect positive earnings development from TAG in the coming years. The new business strategy to actively unlock value of its real estate portfolio and to make new acquisitions should deliver enough profit potential. Investors are quite con-cerned about the future development of capital markets and especially the interna-tional real estate markets, and are likely to remain so for the next few months. But the German real estate market has not deteriorated yet and it does not look like
Management projected pre-tax profits of €31m in 2007
Source: CBS Research AG, fairesearch, TAG
in €m 2005 2006 yoy% 2007e yoy% 2008e yoy% 2009e yoy%
- Sale of properties 121.9 72.7 -0.4 53.0 -0.27 41.0 -0.23 43.0 0.05
- Rental income 27.1 25.1 -0.07 37.0 0.47 42.0 0.14 46.0 0.1
- Construction management expenses and
other 4.6 9.5 1.07 29.0 2.05 35.0 0.21 40.0 0.14
Sales revenues 153.6 107.3 -0.3 119 0.11 118.0 -0.01 129 0.09
Change in inventories 7.5 11.6 0.55 29.0 1.5 28.0 -0.03 26.0 -0.07
Other income 6.4 6.3 -0.02 2.5 -0.6 3.0 0.2 3.5 0.17
Total revenues 167.5 125.2 -0.25 150.5 0.2 149.0 -0.01 158.5 0.06
Cost of goods and services purchased 132.7 85.8 -0.35 75.0 -0.13 66.0 -0.12 67.0 0.02
Employment costs 9.2 10.2 0.11 9.5 -0.07 10.2 0.07 10.5 0.03
Depreciation/amortisation 25.6 2.0 -0.97 1.9 2.17 2.0 0.05 2.1 0.05
Other operating expenses 13.8 10.1 -0.39 11.1 -0.03 11.5 0.05 12.0 0.04
Total expenses 181.3 108.1 -0.4 97.5 -0.1 89.7 -0.08 91.6 0.02
EBITDA 11.8 19.1 1.64 54.9 2.1 61,3 0.12 69 0.13
EBIT -13.8 17.1 -2.24 53.0 2.1 59.3 0.12 66.9 0.13
Share of profit of assocciates -1.1 -0.2 -0.82 -0.8 3.0 -0.4 -0.5 -0.4 0.0
Financial result -17.4 -10.5 -0.4 -20.0 0.9 -26.0 0.3 -30.0 0.15 Pre-tax profit -32.3 6.4 -1.2 32.2 4.03 32.9 0.02 36.5 0.11 Taxes 3.1 1.5 -0.52 13.7 8.13 11.7 -0.15 13 0.11 Tax ratio -9.6% 23.4% -3.44 42.5% 35.6% 35.6% Net profit -35.4 4.9 -1.14 18.5 2.78 21.2 0.15 23.5 0.11 Minority interests 0.1 2.1 20.0 3.7 0.76 4.0 0.08 4.2 0.05
Net profit after minorities -35.5 2.8 -1.08 14.8 4.29 17.2 0.16 19.3 0.12
Number of shares in (mln) 7.6 20.0 32.6 32.6 32.6
EPS -4.65 0.14 0.46 0.53 0.59
Dividend per share 0.00 0.00 0.10 0.15 0.20
RoE pre-tax -39.30% 3.80% 12.30% 12.00% 12.70%
RoE -43.20% 1.70% 5.60% 6.30% 6.70%
Source: CBS Research AG, fairesearch, TAG;
Assets in €m 2005 2006 yoy% 2007e yoy% 2008e yoy% 2009e yoy%
Investment properties 119.00 172.14 45% 590.00 243% 680.00 15% 750.00 10% Intangible assets 0.04 0.03 -25% 0.08 167% 0.10 25% 0.12 20% Property, plant and equipment 4.91 4.82 -2% 4.00 -17% 4.50 13% 5.00 11% Investments in associates 4.31 3.87 -10% 3.50 -10% 45.00 1186% 55.00 22% Other financial assets 1.90 2.27 19% 2.30 1% 2.30 0% 2.40 4% Long-term assets 130.16 183.13 41% 599.88 228% 731.90 22% 812.52 11% Land with unfinished and finished buildings 249.68 338.67 36% 170.00 -50% 240.00 41% 270.00 13%
Other inventories 6.07 5.35 -12% 5.00 -7% 5.20 4% 5.50 6%
Trade receivables 67.88 37.27 -45% 16.00 -57% 18.00 13% 20.00 11% Income tax claims 0.16 1.02 538% 1.50 47% 1.80 20% 2.00 11% Other current assets 12.77 10.56 -17% 20.00 89% 22.00 10% 23.00 5%
Cash and cash equivalents 15.74 113.07 618% 40.00 -65% 20.00 -50% 22.00 10%
Current assets 352.30 505.94 44% 252.50 -50% 307.00 22% 342.50 12% Long-term assets available for sale 0.00 4.18 4.18 0% 0.00 0.00
total 482.46 693.25 44% 856.56 24% 1038.90 21% 1155.02 11%
Equity and Liabilities in €m 2005 2006 yoy% 2007e yoy% 2008e yoy% 2009e yoy%
Shareholders equity 82.20 256.97 213% 267.80 4% 280.00 5% 292.80 5% Minority interests 8.04 31.73 295% 35.50 12% 39.50 11% 43.70 11%
Liabilities to banks 88.15 37.73 -57% 323.00 756% 411.30 27% 469.60 14%
Retirement provisions 2.33 2.19 -6% 2.20 0% 2.30 5% 2.40 4% Other long-term liabilities 0.43 0.42 -2% 0.42 0% 0.44 5% 0.45 2% Latent tax liabilities 1.58 1.48 -6% 7.00 373% 8.00 14% 9.00 13% Long-term liabilities 92.49 41.82 -55% 332.62 695% 422.04 27% 481.45 14% Other provisions 15.91 12.36 -22% 12.00 -3% 13.00 8% 15.00 15% Income tax liabilities 0.98 2.73 179% 3.00 10% 3.15 5% 3.30 5%
Liabilities to banks 238.15 271.12 14% 170.00 -37% 240.00 41% 270.00 13%
Accounts payable for goods and services 16.95 72.41 327% 21.39 -70% 24.21 13% 30.00 24% Other current liabilities 27.74 3.85 -86% 14.00 264% 17.00 21% 18.77 10% current liabilities 299.73 362.47 21% 220.39 -39% 297.36 35% 337.07 13% Liabilities in connection with long-term assets available for sale 0.00 0.26 0.25 -4%
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CBS holds more than 5% interest in the capital stock of the company that is subject of the analysis.▪
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Recommendation System:
Close Brothers Seydler Research AG uses a 3-level absolute share rating system. The ratings pertain to a time horizon of up to 6 months:
BUY: the expected performance of the share price is above +10%.
NEUTRAL: The expected performance of the share price trend is between +5% and +10%. SELL: The expected performance of the share price is below 5%.
Recommendation History for the company analyzed in this report:
The following valuation methods are used when valuing companies: Multiplier models (price/earnings, price/ cash flow, price/book value, EV/revenues, EV/EBIT, EV/EBITA, EV/EBITDA), peer group comparisons, histori-cal valuation approaches, discounting models (DCF, DDM), break-up value approaches or asset valuation ap-proaches. The valuation models are dependent upon macroeconomic measures such as interest, currencies, raw materials and assumptions concerning the economy. In addition, market moods influence the valuation of companies.
The figures taken from the statement of income, the cash flow statement and the balance sheet upon which the evaluation of companies is based are estimates referring to given dates and therefore subject to risks.
Date Recommendation Price at change date Target Price
11
thFebruary 2008
BUY
ing this report are publications in domestic and foreign media such as information services (including but not limited to Reuters, VWD, Bloomberg, DPA-AFX), business press (including but not limited to Börsenzeitung, Handelsblatt, Frank-furter Allgemeine Zeitung, Financial Times), professional publications, published statistics, rating agencies as well as publications of the analysed issuers. Furthermore, discussions were held with the Management for the purpose of prepar-ing the company study. The analysis was provided to the issuer prior to goprepar-ing to press; no changes were made afterwards, however. Any information in this report is based on data considered to be reliable, but no represen-tations or guarantees are made by author with regard to the accuracy or completeness of the data. The opinions and estimates contained herein constitute our best judgment at this date and time, and are subject to change without notice. Possible errors or incompleteness of the Information do not constitute grounds for liability, neither with regard to indirect nor to direct or consequential damages. The views presented on the covered company accurately reflect the personal views of the author. All Employees of the author´s company who are involved with the preparation and/or the offering of financial analyzes are subject to internal compliance regulations. The report is for information purposes, it is not intended to be and should not be construed as a recommenda-tion, offer or solicitation to acquire, or dispose of, any of the securities mentioned in this report. Any reference to past performance should not be taken as indication of future performance. The author does not accept any liabil-ity whatsoever for any direct or consequential loss arising from any use of material contained in this report. The report is confidential and it is submitted to selected recipients only. The report is prepared for professional inves-tors only and it is not intended for private invesinves-tors. Consequently, it should not be distributed to any such per-sons. Also, the report may be communicated electronically before physical copies were available. It may not be reproduced (in whole or in part) to any other investment firm or any other individual person without the prior writ-ten approval from the author. The author is not registered in the United Kingdom nor with any U.S. regulatory body.
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