Adler - Development vs. Yield - Model Update
All,
Please find attached our updated analysis of Adler here.
Property sales are booked at balance sheet value these days, a far cry from previous years, and we increasingly agree with those remaining development values. While that part of the market is bottoming out, we have had to reduce our value of the ADO portfolio, due to the rise in Bund rates since Merz’s debt bazooka. The real estate market is overall more blasé about this, but not so the Adler 2Ls, keeping a safe distance of 20% IRR from a potential 2028 realisation of book value in a sale.
Investment Rationale:
- We may be exiting our Adler 1L exposure early in the new year. We continue to hold 3% of NAV in the New Money 1L PIKs. The bonds have done well, but are now trading around 4% PIK yield, which is great in relative terms, but a little low for us. We also have not sold our 3% of NAV strip in the SPV Notes (Sub + Perp). The 2Lns will trade according to the success of the land bank liquidation and otherwise as derivatives of Bunds, which have widened since Germany unveiled its debt bazooka.
- The vast majority of assets is now made up of the tightly priced ADO portfolio in Berlin, which would have fantastic growth prospects, but is slowed down by the Mietspiegel. Another driver will be the speed with which Adler consolidates its vast expense items. Management has not yet been visibly focused on its cost structure, and it's arguably still the least important in the scheme of things.
- We consider the 1Ln and 1.5Lns value covered, whereas we see the 2LNs as fulcrum. The 1Ln is much further in the money than the 1.5Ln, and the 2.2% of extra yield on the 1.5Ln has to compensate for the 20% extra LTV through that paper. We had been toying with the idea of rotating into the 1.5LN, because it too is relatively safe, but given the tight yields overall, we will probably just be exiting.
Key Conclusions:
- The yielding portfolio remains operationally stable, as expected, with cash flows broadly in line with model assumptions and no near-term asset-level stress evident (Model).
- The cost base remains materially oversized. Management has not articulated a credible or quantified cost-reduction plan beyond vague references to FTE cuts. While near-term cash conservation would be prudent, it is not a priority for now; a meaningful portion of excess costs appears to sit in advisory and professional fees rather than core operations (Model).
- Upside in the 2L instruments is largely a bet on rates. If Bunds stay flat, returns are merely around 9%; if 2-year Bund yields were to compress to ~1.8% by 2028, total returns could reach c. 20% IRR, though this could be replicated elsewhere (Model).
- The 1L PIKs can be paid down only as quickly as cash flows from the development assets allow, implying limited deleveraging potential absent a material improvement in asset performance (Model).
- We had previously agreed with the post-write-down book values of the yielding assets. However, the >500 bps rise in Bund yields in 2025 following Merz’s defence and infrastructure spending programme drives another downward valuation adjustment, at least until clearer growth prospects emerge. We note that the market is largely indifferent to this shift (Yielding Assets).
- During the most recent restructuring, development asset values were written down to levels that Adler is now broadly achieving in disposals, close to book value, lending some credibility to the €700m valuation for its development assets (Development Assets).
- Forward Sales and Build-to-Sell projects are largely prepaid. As such, completion should primarily unwind prepayment liabilities rather than generate incremental cash inflows, limiting their usefulness for deleveraging or liquidity support (Development Assets).
Fun fact:
- Development vs. Yield: We now value the Development Assets closer to BV than the ADO portfolio.
Here to discuss this name with you,
Wolfgang
E: wfelix@sarria.co.uk
T: +44 203 744 7003
www.sarria.co.uk