Adler - Internal drivers

All,

Please find our updated analysis of Adler Group here. 

Boring is not yet the right word, but it is good when something becomes more boring - the yields are allowed to tighten. Adler yields have tightened, but we find the structure overall adequately valued and not aggressive in any way. In contrast to other REITs, however, the company still has some internal drivers that can propel investor returns. We are taking a little more.

Investment Rationale:

- We continue to hold 3% of NAV in the New Money 1L PIKs and would be committing pro rata to the tap to refinance the ARE26s. The bonds have done well, but are now trading around 7% 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. 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. 

- 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 2.5% of extra yield on the 1.5Ln has to compensate for the 20% extra LTV through that paper. We are toying with the idea of rotating into the 1.5Ln because it too is relatively safe.

- On our math, the 2Lns are not aggressively valued, but trade in line with our valuation of both portfolios and approximately with the company's valuation, once we apply the €330m provisions Adler have taken.

Key Conclusions:

- Adler’s yielding assets remain stable and, following 18% in total write-offs since 2021 and a stronger Bund, are now credibly valued (Model section; Yielding Assets section).

- Operating expenses are disproportionately high, mainly due to advisory fees. Management has yet to present a concrete cost-cutting plan beyond vague references to FTE reductions. Cash conservation is advisable but asset sales are still more urgent (Model section).

- With Bunds stable, 2Ls offer limited upside; a drop in 2-year Bunds to 1% could yield a 20% return, though this is replicable elsewhere (Model section).

- Consus asset cash flows should pay down the 1L only as fast as the tap for the ARE26s and its meaty PIK will grow it. We expect no material reduction over time.

- Speculative development asset valuations remain questionable, especially the “No Bids Yet” bucket—comprising unzoned land plots with little market interest and high development costs (Development Assets section).

- Forward Sales and Build2Sell assets are largely prepaid; their completion will reduce Prepayment Liabilities rather than generate cash inflows (Development Assets section).

Background:

- For the first time in a long time the 2024 accounts were again audited on time, now by a collection of auditors. The company has since sold its holdings in BCP and is in the process of selling down its landbank - primarily at Consus. Proceeds should prevent the expensive 1L debt from PIKing out of control, but in the long-run the recovery on the new 2L structure will be driven by German Bund rates, which are underlying the valuation of its yielding assets - now concentrated in Berlin. 

Fundamental drivers that determine returns:

- Bund Yields (looking good)

- Development Activity (not so good, but Adler has three years, also moves with Bunds)

- Cost Cutting (would benefit from a plan)

Here to discuss this name with you,

Wolfgang

E: wfelix@sarria.co.uk
T: +44 203 744 7003
www.sarria.co.uk