The financial crisis of 2008 was a massive blow to the real estate sector as the stock funds reported a substantial loss of 47%. The subsequent 2 years did mark a period of mitigating losses; however, the increment in the funds index could not be characterized as full recovery. On the other hand, the situation has changed now as the economy takes a route to recovery. In Europe, the rock bottom real estate prices seem like an ideal entry time. In Asia, as the developing economies catch up with the global trend, real estate seems to be the blooming sector. In the United States, the real estate sector has shown a marked recovery. A stable stream of dividends via increment in rents is expected given the recovering trend. Outside the U.S. this investment comes with higher risks. Nonetheless, individual and institutional investors are willing to forget the past and try their luck in the recovering sector.
Another aspect that explains the recent inclination of investors towards real estate is the relative superior performance of the property market. Property returns have been higher than the equity investment by a considerable margin. The DJ US Real Estate Holding and Development Index went up by 24.17% this year. Kennedy-Wilson Holdings Inc. (KW), an international real-estate investment and services firm is a player to watch out in the given market. This small-cap company seems to profit from the improving trend in the real estate sector as well as the increase in the small-cap index. S&P Small-Cap 600 went up by 28% this year.
In this article, I would analyze the growth potential in this small-cap stock by discussing in detail its growth prospects and its current situation.
What the Company Does?
Kennedy-Wilson Holdings is an international real estate investment and services firm incorporated in 2007. On November 13, 2009, KW Merger Sub Corp., a wholly-owned subsidiary of Prospect Acquisition Corp., merged with Kennedy-Wilson, resulting in KW becoming a wholly-owned subsidiary of Prospect Acquisition Corp. The business specializes in providing various commercial and residential real estate services, including property management, asset management, brokerage and marketing. Its operations are spread in the United States, the United Kingdom, Ireland and Japan catering to institutional investors, financial institutions, pension funds, and developers. Kennedy-Wilson, through its joint venture investments, acquires, renovates and resells commercial and residential real estate, and invests in loan pools and discounted loan portfolios.
In 2012, the enterprise continued to indulge in strategic acquisitions in the core U.S. markets as well as in Ireland and the U.K., completing $3 billion of acquisitions worldwide. From 2010 to 2012, KW exceeded its stated goal of $6 billion worth acquisitions in these markets. The low interest rates of 2012 enabled the company to undertake a long-term debt position worth $1 billion at an interest rate of 3.8% in the United States and Japan. The loan is expected to expire in 6 years.
The business reports its operations in two core segments namely KW Investments and KW Services. KW Investments invests both equity and debt capital in real estate-related assets including multifamily properties, loans secured by real estate and office and residential properties. On the other hand, KW Services specializes in providing a full array of real estate-related services to investors and lenders. Clientele in this segment is focused on institutional investors. The company relies on managerial and financial expertise in both these categories.
The company's operations are diversified in United States, Japan, Ireland and UK. In the KW Investments segment, capital is invested in real estate assets and loans via joint ventures, separate accounts, commingled funds, and wholly-owned investments. The business also invests its partner's capital of up to 5%-50% and has managed to secure returns at least up to its capital contribution. Equity partners range from financial institutions to high net worth individuals. Revenue generation in the KW Services segment comes from commissions and fees charged through its three business lines namely investment management, property services and conventional sales. The two segments of the business are complementary in nature with KW Services playing a critical role in supporting its investment strategy by providing local market intelligence and real-time data for evaluating investments.
The company's adjusted EBITDA increased by 41% to $100.3 million in 2012, one of the highest in its operational history. The positive change comprised of a 3.6% and 5.9% increase in its rental revenues and net operating income, respectively, whereas leasing revenues declined by 0.2% for the same year.
Strong financials are vital to operate in a risky sector such as the real estate and KW has been able to deliver in this regard. The recent quarter revenues showed a tremendous increase of 83% in 2013. Last year's revenues too showed a modest increase of 1% despite the volatility in the economic climate. The operating income, however, shows a series of losses to a declining trend. The recent quarter losses amounted to $5 million an increase of 25% quarter-over-quarter. The average three year revenue growth touched -9% while the industry average reported positive growth. The company however was able to maintain positive net income in the past three years. The dividend yield stands at 1.27% with a projected dividend per share of $0.28 this year.
The liquidity position of the company improved substantially in 2012 despite a decline in its earnings. The 2008 crisis has made the management more conscious about of cash inflows. The small-cap company raised its market capitalization to $1.3 billion in the recent quarter. The company maintains a strong asset base with a reported increase of 62% in 2012 as the management takes a more conservative stance. The increase in capital was backed by both equity and debt financing.
The optimistic view about the future has made the management more confident to expand its operational portfolio. The recent economic, capital and credit markets events continue to create tremendous discounted opportunities. Asset deployment is likely to be expected from highly leveraged property owners, asset loans from financial institutions and a reduction in real estate portfolios of companies. All these aspects strengthen the future prospects for an expanding enterprise like KW.
Since the company is geographically diversified, it is only rational to discuss the growth prospects by region. The company increased its capital expenditure to one of the highest in its operating history amounting to $119 million last year.
Ireland and The U.K.
Ireland and the U.K provide an opportunity for strategic acquisitions given the low real estate prices. Opportunities to acquire real estate in the London market at discounted prices are relatively scarce and investments therefore have been more stable than other European markets. Secondary markets outside of London also show a decline in property prices. The deleveraging trend in Ireland provides the company with similar acquisition opportunities. The management plans to deploy a substantial amount of capital in these markets this year.
The Japanese economy was relatively unscathed as compared to the other developed economies all thanks to strong intervention of the central bank. The changing demographic trends in Japan work in favor of the business as the economy undergoes an increase in housing infrastructure. The high demand for housing is expected to generate supply shortages culminating in an increase in rents. Furthermore, the low interest rates in Japan enable the company to further improve its liquidity position cushioning against unforeseen losses.
The U.S. market seems most promising given the recovering market scenario. Signs of market stabilization can be witnessed as the Dow Jones and S&P 500 reached all-time highs and job growth continues. Liquidity has returned to the US market, however, not to the levels that existed pre-crisis. The housing market in the U.S. has continued to show signs of improvement as U.S. home re-sales edged higher in 2013. An increase in rents is right around the corner providing KW with a stale source of income.
The business faces direct competition from real estate brokerage and auction companies on the services side whereas on the investment side it competes with property management and leasing firms. Westfield Group and Hendersons are the two giants that present themselves as competition. The company's advantage lies in its complementary nature of business by providing full service, investment oriented structure. Its transaction experience and extensive relationship and sourcing network enhance its efficiency. Given its history of successful acquisitions, the company continues to capitalize on this experience in the future. Lastly, it operates a vertically integrated platform across all the 4 regions.
KW currently trades at $17.3 with a total market capitalization of $1.3 billion. The projected P/E ratio is expected to touch 37.4 in the coming quarter. The P/B and P/S ratios stand at 2 and 13, respectively. The enterprise multiple for 2013 equals 18.64 with the projected ratio to reach 18.11 in the next 12 months. The favorable market trends and the management's decision to profit from lucrative opportunities are likely to translate in higher earnings.
After conducting the in-depth analysis of this small cap-company, I would say KW is an attractive investment. For more risk-averse investors, the stock provides a stable stream of dividends with expected increase in projected yield. Nonetheless, a long position in the stock comes with a substantial degree of risk emerging from the volatility of the real estate sector. The internal risk of the company, however, is well-cushioned through its conservative approach. However, the recent decision to offer senior notes expiring in 2019 increases its risk exposure.