Monitoring bond issuer developments (2)

Financial Article 514 by Edward Rizzo - Nov 30, 2017

Last week’s article was the first in a series of articles covering the important financial metrics of bond issuers listed on the Malta Stock Exchange.

In this second article, I am providing an overview of the property sector. There are various bonds exposed to the real estate sector (two of which invest outside Malta) that have bonds listed on the MSE. It is important to distinguish between the different categories of issuers within the property sector. Some companies are predominantly property development companies such as MIDI plc, Pendergardens Developments plc, GAP Group plc and Von Der Heyden Finance plc. Other companies own commercial developments and, should the properties be fully leased out, such companies receive a fairly stable level of rental income on an annual basis. Companies within this category include Hili Properties plc, Plaza Centres plc, Stivala Group Finance, Central Business Centres plc and to a certain extent also Mediterranean Investments Holding plc. One may also consider Hal Mann under this segment given that the main business of the Hal Mann group is directly related to the property market and the group has also embarked on a property development project for rental purposes.

Given the erratic financial performances of property development companies from one year to the next as a result of their dependence on the timing of sales of their properties, the interest cover in a single year is not reflective of the strength of the issuer in servicing its financial obligations. Moreover, the net debt to EBITDA multiple for property development companies is also not an ideal indicator. Instead, the traditional gearing ratio showing the relationship between the level of indebtedness and shareholders’ funds is a better indicator of the extent of leverage.

MIDI plc has been warning that its financial performance in 2017 will be weak in view of the fact that the final deeds of sale of the apartments within the Q2 development will take place in 2018. Meanwhile, MIDI recently announced that ‘The Centre’, in which it has a 50% shareholding, has recently opened its doors and most of the rentable area has also been leased out. This should lead to additional income from its commercial properties. In recent weeks, MIDI also announced that it submitted a revised master plan for the development of Manoel Island. MIDI’s interest cover is expected to be negative in 2017 but should rise to 9.4 times in 2018 following the expected sizeable increase in profitability as a result of the final deeds of sale of the Q2 residences. MIDI is expected to have net borrowings of €61.6 million as at 31 December 2017 and total shareholders’ funds of €61.5 million. The gearing ratio works out at 50%.

Pendergardens Developments had launched two secured bonds in 2014 that are due to mature in 2020 and 2022. In recent years, the company consistently reported that most of the new properties that had been launched were subject to promise of sale agreements and therefore the performance of the company should improve substantially once the final deeds of sale are entered into in the years ahead. Investors should be comforted by the strong demand for property in the St Julian’s area and should the company continue to dispose of all its available properties, it should raise sufficient funds to repay bondholders in full in 2020 and 2022. Pendergardens is anticipating an interest cover of 0.85 times in 2017 and a gearing ratio of 77%

In September 2016, Gap Group plc issued a €40 million bond maturing in 2023. In May 2007 the same shareholders had issued a bond under GAP Developments plc on the Alternative Companies List to fund the purchase of the site on which the Fort Cambridge in Sliema was to be developed. Meanwhile, Gap Group plc, a recently incorporated company, has five other property projects located in Mellieha, Gharghur, Qawra, Zebbug and Luqa and the bonds are secured by hypothecs over various pieces of property and land. Similar to the other property development companies, the financial performance of Gap Group plc is very volatile from one year to the next as its financial results depend on the timing and accounting treatment of property sales. Meanwhile, the gearing ratio is projected to be 89% by the end of 2017 and improve to 80% in 2018.

Von der Heyden Group Finance plc launched a bond issue in January 2017. This special purpose vehicle is the finance arm of the Von der Heyden Group which in turn has interests in various property projects located in Germany, Poland, Spain and Malta. Furthermore, the Group owns four hotels and manages a further ten hotel properties (some of which are still in development stage) under its IBB Hotel Collection brand. Despite the considerable expansion in business over the years, the prospectus shows that the Von der Heyden Group is anticipating a loss of €0.53 million during the current financial year ending 31 December 2017. However, as various projects gather momentum, the financial performance of the Group is expected to improve in the years ahead. In fact, the Group is expecting to generate an EBITDA of €1.51 million in 2018 compared to a forecasted EBITDA of just €0.54 million during the current financial year ending 31 December 2017. The gearing level as at 31 December 2017 is estimated to be 48.2%.

Hili Properties has a portfolio of 25 properties which had a carrying value of €98.7 million as at 30 June 2017. The Hili Properties group generates over €7 million in rental income annually which equates to a gross rental yield of 7.4%. Just over 27% of the total annualised rental income (equivalent to €1.97 million) emanates from related companies of its parent company Hili Ventures. The property portfolio represents a mix of office spaces (58%), retail areas and shopping malls (24%) as well as restaurants (16%) across five jurisdictions: Malta, Romania, Latvia, Lithuania and Estonia.

Hili Properties conducted an acquisition in Romania in May 2017 for a total consideration of just under €30.6 million and given that this property is already fully leased out, the performance in 2017 will be boosted by the initial contribution from this large property. In fact, the financial forecasts published in June 2017 reveal that the group is expecting revenues to increase by nearly 35% to €6.53 million and EBITDA to surge by almost 52% to €4.76 million. However, the forecasts also include the contribution from a potential additional property acquisition for a value of €8 million which still has not yet materialised to date. Hili Properties reported that its net debt amounted to €83.8 million as at 30 June 2017 and is expected to reach €95.7 million as at 31 December 2017 including the potential acquisition of another property for €8 million. As a result, the gearing ratio (calculated as total debt divided by total debt plus equity) is anticipated to increase to 76.2% from 68.6% as at the end of December 2016. At this level of gearing, the ability of Hili Properties to take on additional debt might be limited in view of the negative pledge obligations. However, the company held an Extraordinary General Meeting recently during which shareholders approved the capitalisation of a €7 million shareholder’s loan thereby increasing the company’s share capital.

Plaza Centres plc is the only issuer within the property sector without an obligation to publish a Financial Analysis Summary (and hence financial forecasts) due to the fact that when it launched its bond issue last year, it was structured with a minimum investment of €50,000. This is one of the exemptions within the Listing Policies enacted by the MFSA in March 2013. Plaza’s financial performance in 2017 should benefit from a full year’s contribution of the Tigne’ Place business centre acquired towards the end of last year.

Stivala Group Finance plc is a new entrant to the bond market this year. It is the finance arm of the Stivala Group and is also the holding company of Carmelo Stivala Group Limited which is the guarantor of the bonds and the principal property-holding company of the Stivala Group. Over the years, the group acquired a significant portfolio of real estate valued at over €140 million as at 28 August 2017 (mainly in the Gzira, Sliema and St Julian’s areas) that incorporates commercial and residential properties for leasing as well as hotels and hostels. The group is mostly engaged in acquiring, developing and retaining real estate for long-term investment purposes and for generating regular rental income rather than for the business of acquiring/developing property for resale. The prospectus provides pro-forma financial forecasts for the current financial year ending 31 December 2017 (assuming that the group existed in its current form as from 1 January 2017) as well as financial projections for 2018. The 2018 projections reflect the new structure of the group following the reorganisation that took place prior to the bond issue as well as the first contributions from the various properties that the group is expected to acquire from the proceeds of the bonds. These show that the group is expecting to generate an EBITDA of just over €7 million in 2018 which translates into an interest cover of 3 times. On the other hand, the net debt to EBITDA multiple is estimated to be 8.4 times for the financial year ending 31 December 2018. The Stivala Group possibly has the lowest gearing ratio of all property related companies at a projected ratio of 31.5% for 2017 and this is only expected to deteriorate slightly to 32% in 2018. Furthermore, the bonds are secured mainly through a first ranking special hypothec on a number of properties.

Similarly, Central Business Centres plc (owned by the same shareholders of the Cortis Group) invests in commercial property with the aim of generating rental income. Currently the company has three properties including one in Zebbug which is fully leased out. The property in Gudja is also complete and approaching full occupancy. Meanwhile, the St. Julian’s property was scheduled for completion in the third quarter of this year with rental income starting with effect from the current quarter. Furthermore, Central Business Centres is now developing another site in Zebbug which has recently been leased out to LIDL Immobiliare Malta Ltd. The interest cover in 2017 is expected to be 2.8 times and should improve to 4.9 times in 2018. The company’s gearing ratio is forecasted to be 40.5% in 2017 and 46.5% in 2018.

Mediterranean Investments Holding plc is an associate company of the Corinthia Group and the company’s financial performance has been rather weak in recent years as a result of the very difficult conditions in Libya. Two of the three bonds in issue of MIH are now guaranteed by the Corinthia parent company, Corinthia Palace Hotel Company Limited. Earlier this year, MIH issued a new bond to refinance the 7.15% bonds (issued in three currencies and due for final redemption in July 2017) and the company reported that the occupancy within Palm City residences was once again improving. Despite the fact that two of the three bonds are now guaranteed by the Corinthia Group, bondholders should continue to monitor announcements being issued by MIH to gauge the progress being achieved in the level of occupancy (which improved to nearly 35% as at 30 June 2017 from 11% as at the end of 2016) and the resultant impact on the financial performance of the company.

Hal Mann Vella Group is mainly involved in manufacturing of tiles and pre-cast elements, importation of marble, granite and natural stone as well as general contracting services. Additionally, the group is also involved in a number of property development projects and is the owner of two hotels in Bugibba.  As such, the main operations of the Hal Mann Group are largely dependent on the state of the property market, particularly in Malta. The group has passed through a challenging period and in fact reported losses in 2015 and 2016. After a number of restructuring measures, including exiting the fashion retail segment, Hal Mann is now expected to recover and report profits once again as from the current financial year. The interest cover is projected to be almost 1.5 times whilst gearing is anticipated to reach 56.5% by the end of 2017.

The property sector is by far the most dominant when it comes to bond issuers. As explained earlier on, while some companies own commercial properties and receive a relatively stable income stream on a yearly basis, many others are pure development companies that are dependent on the success in marketing the developments and concluding the sales of properties. While most companies have reported that a large amount of their stock is subject to promise of sale agreements, it is of utmost importance that the large majority are translated into final deeds of sales which will enable these issuers to repay bondholders. As such, investors having exposure to such bonds need to keep track of updates by each of these companies to ensure that the sale of properties have indeed materialised.

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Rizzo, Farrugia & Co. (Stockbrokers) Ltd, “RFC”, is a member of the Malta Stock Exchange and licensed by the Malta Financial Services Authority. This report has been prepared in accordance with legal requirements. It has not been disclosed to the company/s herein mentioned before its publication. It is based on public information only and is published solely for informational purposes and is not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. The author and other relevant persons may not trade in the securities to which this report relates (other than executing unsolicited client orders) until such time as the recipients of this report have had a reasonable opportunity to act thereon. RFC, its directors, the author of this report, other employees or RFC on behalf of its clients, have holdings in the securities herein mentioned and may at any time make purchases and/or sales in them as principal or agent, and may also have other business relationships with the company/s. Stock markets are volatile and subject to fluctuations which cannot be reasonably foreseen. Past performance is not necessarily indicative of future results. Neither RFC, nor any of its directors or employees accept any liability for any loss or damage arising out of the use of all or any part thereof and no representation or warranty is provided in respect of the reliability of the information contained in this report.