Fastighets AB Balder Is No Longer Undervalued (OTCMKTS:BALDF)

Fastighets AB Balder (OTCPK:BALDF) (OTCPK:FSTGY) has reported a resilient operating performance in recent quarters, but its growth prospects aren’t currently impressive and following a strong share price rally its shares are no longer undervalued.

As I’ve covered in previous articles, I saw Balder as an interesting value play in the European real estate sector, as the company’s valuation didn’t reflect its strong fundamentals. Not surprisingly, its shares have outperformed the sector during the past year, being up by 69% vs. 28% for the sector during the same time frame, as shown in the next graph.

As I’ve not covered Balder for some months, I think it’s now a good time to analyze its most recent financial performance and investment case, to see if it remains an interesting value pick for long-term investors.

Outlook & Q2 2024 Earnings Analysis

Balder has recently announced its Q2 2024 earnings, which were mixed but close to market expectations, as the company was able to report a resilient operating performance, while property valuations continued to be negatively impacted by high-interest rates.

While Balder has a quality portfolio across the Scandinavian markets, Germany and the U.K., its property valuations are naturally affected by the level of interest rates, which has been a headwind over the past couple of years. At the end of last June, its property portfolio was valued at $20.7 billion, which is slightly up compared to its value at the end of 2023.

This is a positive sign that its portfolio value has probably reached a bottom, an expectation that is supported by recent rate cuts in Europe. Indeed, both the European Central Bank and the Sweden central bank have cut rates during Q2, which is supported for property valuations.

According to Bloomberg data, the Sveriges Riksbank is expected to maintain its cutting pace over the coming months, with its key rate expected to decline from its current level of 3.75% to around 2.40% by the end of 2025. Regarding the ECB, the market also expects several interest rate cuts ahead, from its current level of 4.25% to about 2.65% by the end of 2025.

This means that rates are now expected to be a tailwind for property valuations in Sweden, the company’s largest market, and also across other European countries, boding well for its property valuation over the next few quarters.

Higher property valuations are also a positive support for the balance sheet of real estate companies, putting less pressure on leverage ratios through higher asset values, which has been leading to improved investor sentiment toward the sector in recent weeks. As I’ve analyzed recently on Grand City Properties (OTCPK:GRDDY), some real estate companies have been able to recently raise new bonds on the capital markets, after a hiatus of several years, which is a very positive development and reduces worries about potential debt refinancing difficulties.

While Balder does not have meaningful debt maturities in the coming months and does not need to raise new bonds in the short term, the fact that capital markets are now more open to take new bonds is clearly positive for its liquidity management and reduces pressure to sell assets in the near future.

Therefore, while Balder has changed its business strategy, like its peers, to balance sheet management over the past couple of years rather than seeking business growth, it’s now in a position to switch again its focus to growth as the market landscape and outlook for real estate companies has improved following a difficult period during 2022-23.

Taking this background into account, Balder is likely to return to its long-term strategy of property developments and reinvesting its profits in business growth, a strategy that has a good track record over the long term, being only interrupted by the recent market downturn.

As seen in the previous graph, Balder was able to increase its annual profit from property management consistently until 2022, a trend that changed due to lower property valuations and asset sales over the past couple of years.

Despite that, its operating performance has remained resilient, a trend that was maintained in the last quarter. Indeed, its vacancy rate was stable at about 4% in Q2 2024, showing that its properties have good quality and demand from tenants remains strong, and especially considering that some 45% of its properties are in the commercial real estate (CRE) segment. There were some worries from investors that CRE would lead to losses and higher vacancy rates during the real estate downturn, but Balder’s portfolio did not suffer much and maintains high levels of occupancy.

This is justified by Balder’s strategy of diversifying its portfolio across several countries and being present in capitals and larger cities, where the need for housing is stronger. Given that 55% of Balder’s portfolio is in the residential segment, this leads to a defensive and recurring business profile, while in the CRE segment it has some exposure to office, but is also well diversified across, retail, logistics, industrial and other property categories.

Supported by its business diversification and high exposure to residential, its net rental income has maintained a positive growth trend in recent quarters, being also supported by inflation indexation. In Q2 2024, its rental income amounted to $306 million, up by 8% YoY, and its net operating profit was also up by 8% to $228 million in the quarter. On the other hand, due to higher interest rates and funding costs, its profit from property management declined by 5% YoY to $143 million.

Regarding its balance sheet, it had more than $1.8 billion of available liquidity at the end of last June, which is more than enough to finance debt maturities over the next fifteen months, while the company expects to return to the capital markets over the coming months, both in SEK and EUR bonds, to raise more liquidity and maintain good coverage of debt maturities.

Despite that, Balder wants to reduce its debt levels, given that is leverage position is not great and one of its strategic goals is to maintain an investment grade credit rating. Its net debt-to-EBITDA ratio was 12.2x at the end of Q2 (vs. 13.7x in Q2 2023), and Balder wants to reduce this ratio to about 11x. This means that a good part of its earnings should be retained to reduce its leverage, a trend that is likely to be maintained over the coming quarters.

This also means that development projects should be maintained on hold for some more time, as new projects have been quite slow in recent quarters. Despite that, Balder has some property developments under way, in Sweden, Norway, Denmark and Finland, mostly in the residential segment.

At the end of Q2, it had about $243 million of properties under development and these are expected to be completed until the end of this year, thus its capital expenditures are expected to decline significantly ahead. This was already visible in Q2, considering that capex amounted to $110 million, representing a decline of 67% YoY. While lower capex is positive for its cash flow generation in the short term and helps to reduce its balance sheet leverage, it means its growth ahead will be lower than compared to its history.

Indeed, its capex is expected to be around $200-250 million over the next three years, which is quite low compared to $1.5 billion in 2022 and more than $700 million in 2023, showing that Balder’s strategy has changed significantly over the past few quarters, and balance sheet deleveraging is still its main business priority.

Regarding its valuation, Balder is currently trading at 0.95x NAV, a higher valuation than compared to when I covered it a few months ago (0.78x NAV), and is now much closer to its historical average over the past five years of about 1.1x NAV. This means Balder is now much closer to ‘fair value’ and compared to its peers, is now trading at a premium, given that some of its peers, such as Castellum AB (OTCPK:CWQXF) or Aroudtown (OTCPK:AANNF) trade at lower valuations, making Balder less attractive than compared to some months ago.

Conclusion

Fastighets AB Balder is an interesting company in the European real estate sector, due to its strong fundamentals and good growth history, but its strategy has changed due to the market downturn to balance sheet management and its growth prospects are not much more muted than compared to its history. Moreover, following a strong share price rally over the past year, its shares are no longer undervalued, thus its risk-return profile is no longer attractive to long-term investors.

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