VGP is a pan-European logistic project developer which I am very excited about, as the company offers everything I expect from an ultimate buy-and-hold stock: secured dividends, a fantastic proven business model, and an attractive valuation despite the latest run-up in its share price. Over the past years, VGP, which is listed on Euronext Brussels, has clearly outpaced its Belgian benchmark and after an interview with its CEO last week, I steadfastly believe the best is yet to come. VGP’s market cap currently stands at 1.44 billion euros.
(Source: Google Finance)
- Hamish Maertens = HM
- Jan Van Geet = JVG
1 - HM: Before we dive into the financial numbers and outlook, how would you describe VGP’s business model and structure, because on the one hand we categorize the company as a real estate developer, but on the other hand we’ve got the joint venture with Allianz to generate incremental rental income.
JVG: It’s actually exactly as you describe it: we are standing on two legs. On the one hand, we have a sort of REIT and that’s our Joint Venture with Allianz which covers Germany, Slovakia, Czechia and Hungary and has a targeted value of 1.7 billion euros (which will be completed by the end of this year). Furthermore, we are going to set up a second Joint Venture that will cover the other countries we’re now operating in such as Italy and Spain. Selling our assets to the JV is a business model which has been working very well over the past years as we still retain a 50% stake in the JV.
The idea behind such structure is to generate stable rental income of which the cash flows can be used to payout growing dividends. On the other hand, we are a pure real estate developer focused on top locations as everything starts with location, which is also the name of our magazine that we publish from time to time. We try to do that on our own balance sheet to keep all the development profits. I am a big believer that in today’s society, digitalization and new consumer patterns are changing the real estate market dramatically. There’s certainly a lot to be developed courtesy of a robotizing and automatizing production environment like the one you have in the car industry. Our customers ask us frequently to make their buildings even more customized, though, that’s sometimes difficult to establish in existing buildings. And of course, e-commerce remains one of the fundamental drivers behind the thriving logistic real estate market today.
2 - HM: 2018 was another record year for VGP across all its metrics: annualized rental income hit 104 million, the land bank grew to more than 4.4 million square meters, net income increased by 26%, Return on equity came in at 22.8%, we’ve got the entry into four new markets, you’re now active in 12 different countries. Moreover, rents are rising across the board, so broadly speaking, what are your expectations for this year?
JVG: This year, the main challenge is to keep the developments well financed but also to secure the appropriate land plots because we are growing so fast at the moment and have signed a lot of pre-leased agreements so far this year. We have huge amounts of capex in front of us and 2019 will undoubtedly be another record growth year for VGP in terms of projects developments, but whether that will translate into record net profits will depend on the prime yields. Being in four new countries and leveraging our presence in the existing ones, we are going to grow substantially this year. We already saw that trend being reflected in our results over the first months of the year with 17 million euros in new rental income compared to 34 million euros over the past 12 months.
3 - HM: Given VGP’s unique company structure and its way of recycling invested capital, what should we pay attention to in valuing VGP’s current market cap of € 1.4 billion? There’s actually a wide gap between VGP’s gross rental income and its net profit courtesy of a development gain of 35%, so it may be unclear to what extent investors should take into account the revaluation gains from completing closings with the Joint Venture.
JVG: Yeah, we have three different types of income and in order to understand VGP’s model you have to split the company into three parts. Our first revenue stream boils down to the development profits, other than in the REIT space, while disposing assets to the Joint Venture (we are going to sell almost all of our assets to JVs), we still retain a 50% in those investment vehicles. We realize our extra development profit as margins compensate for the money we have to put back in the JVs. A big part of that is cash. Just to give you an idea, we did transactions worth 1.16 billion euros with Allianz when it comes to transferring our assets to the JV and we recycled more than 700 million euros in cash to fund our expansion into other regions. We remain very profitable and keep on investing. The second leg of income streams is rental income. Last year, when taking our proportional part of the JV on a look-through basis, you’ll notice that we earned 43.4 million euros in recurring rental income, up 10.8 million euros from FY 2017. The third leg we are standing on is management fees derived from property management for our tenants (1.5% to 3% of our rental income) and asset management for the JV. Also, administrative payments for the lease agreements provide additional cash flows. All of these supplementary income sources totaled to 10.0 million euros last year and become increasingly important. Instead of looking at the NAV which you would do to evaluate REITs, investors should value our cash flow generation and ability to post double-digit growth rates.
4 - HM: Last year, VGP commenced to distribute a regular dividend with a targeted payout ratio of 40-60% of its recurring income. Backed by robust earnings growth, the Board decided to hike the dividend by 16%, representing a payout ratio of 32% based on a net profit of over 121 million euros. Is it still management’s intention to gradually lift dividend distribution rates over the next couple of years?
JVG: That still is our intention as we paid out 35 million euros last year and now roughly 41 million euros. We are going to hike our distribution rates gradually. Because we are growing so fast at the moment, we want to be a little conservative with our dividend payout ratio to re-invest our funds received from selling assets to the JV back in the pipeline. My idea of being a CEO is to payout 40% to 60% of our recurrent income, so the management fees and rental income from assets on our own balance sheet and the proportional stake of 50% in the JV. What we gain through capital recycling will be re-invested in new developments. So instead of being forced by law to pay out 80% of our EPRA earnings like our peer WDP (OTC:WDPSF) has to do, we have the luxury of keeping the cash inside to fund future growth.
5 - HM: During the conference call of FY 2018, you mentioned that other proceeds from divesting own developed buildings will be utilized to acquire new land in order to counter shortages in big European metropolitans. Into which countries would you like to expand this year?
JVG: We have a couple of big projects in Germany. On top of that, we are exploring various opportunities in all the countries we are exposed to. Everything is identified today as most of the land plots have already been contracted. The best land we are going to buy is located in Bratislava, Göttingen and other big European cities. We plan on securing those additional plots in the course of this year and we’re also looking to expand our activities into Portugal and Spain (which is actually our most profitable market today). We’ve recently entered the Italian market which offers a lot of opportunities going forward. The Romanian market remains in good shape, but the number one market will remain Germany since it is the largest European economy. France is number two, but we haven’t seen any meaningful opportunities there so far, though, it’s going to come anyway.
(Source: FY 2018 Presentation)
6 - HM: In September of last year, VGP issued new retail bonds with a coupon of 3.50% and maturity date in 2026 for an aggregated amount of € 190 million to refinance older bonds and new projects in Italy. Since then, global interest rates have come down significantly. As such, are you exploring the possibilities of issuing more bonds in the near term to fund future pipeline growth?
JVG: We have no plans to issue new bonds in the near term. We are very well financed at the moment with a lot of cash on the bank account. We prefer our JV structure to auto-finance new projects and remain conservative with our leverage of around 34% and a Loan-to-Value of 38.9%. Both metrics are well below our covenants of 65% and 75%. Subsequently, we don’t need to tap the bond market at this moment.
(Source: FY 2018 Presentation)
7 - HM: And last but not least. Despite geopolitical and economic uncertainties facing the world economy, logistic real estate is expected to weather these threats in 2019, which is remarkable given the fragile economic data of Italy and Germany. To what extent would a potential recession put a damper on VGP’s financial performance?
JVG: I still remain very confident in the future, but I do have some doubts about the things that are going on today, that’s for sure. When I read the newspapers, it’s all about sentiment. There are so many things changing, whether they occur in the e-commerce industry or in the car industry. I believe logistics is the asset class best positioned to weather the next storm, otherwise I wouldn’t be buying such a huge land bank. I’m not only the CEO but also the largest shareholder which reflects my strong alignment of interest with other shareholders as well.
Interesting Items At The AGM
During the Annual Meeting, there were some elements I didn’t know of that captured my interest. First of all, over the first four months VGP delivered 61,646 m2 of lettable land which is already completely let. For the second half of the year, management expects to complete another 500,000 m2 and that’s is in contrast to the average analyst expectation of approximately 500,000 m2 for the whole year. At the end of April, 30 buildings were under construction, translating into a future annualized rental income in excess of 28m. If you recall that VGP’s annualized rental income totaled to 104 million euros last year including the joint venture at 100%, there’s definitely more room to grow as big new lease agreements start to kick in. For instance, the group recorded a new lease agreement worth an annualized 24 million euros, whereas its latest quarterly update only took into account 9 million euros.
CEO Van Geet also pulled a rabbit out of the hat by announcing the biggest lease agreement ever for the group (Park München, 255,928m2 for KMT). The total investment will be 450 million euros and enables VGP to cash in on 30 million euros of annualized rental income. And the best part about it is that these excellent news items are not already baked in today’s share price. The landbank grew to 5.6 million square meters at the end of April which is a good proxy for robust growth in the next three years. And as CEO Van Geet stressed during the interview and the presentation of FY 2018, management’s highest priority is to keep all projects well-financed. Interest costs are under control with the average cost of debt amounting to 3.73% at fixed rates.
The European Logistic Real Estate Market
Over the long haul, the imbalance between supply and demand has had a relatively modest impact on rents, which have increased by a little over 8 percent in the past five years. Furthermore, we now see more sizeable growth in big metropolitans Milan and Berlin. E-commerce appears to be a major driver for much of the growth in occupier demand. JLL found that demand for e-fulfillment space was up 68 percent in H1 2018, year–on–year.
From a capital markets perspective, lower cap rates and core return requirements create a tailwind for rental growth. Land shortages in urban locations and demand for last–mile delivery facilities widens the gap between supply and demand, driving prime rents to unprecedented levels.
However, the potential for a global trade war is making some investors nervous. For developers, there is also the much more immediate effect of rising costs. The combination of increasing demand and a shortage of skilled labor in some jurisdictions is seeing construction costs skyrocket.
VGP, a Belgian semi-REIT and pure real estate developer, is evolving rapidly and I’m a big fan of its business model which consists of three income pillars. The dividends are well covered by its recurrent income and I believe investors who want to gain some exposure to the booming logistic real estate and e-commerce business should consider buying VGP to generate alpha beyond what an ordinary REIT offers today. Shares offer a nice dividend yield of 2.85% right now. It's management's intention to maintain a double-digit growth rate without issuing new shares to finance new deals.
Disclosure: I am/we are long VGP, WDPSF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.