Metrovacesa (OTC:MRVCF) is a Spanish residential developer company with more than 36,000 residential units in its land bank. Its market cap is c. €910 million ($1,075M) at the current price of €6 ($7.1) per share.
The company was made public in February 2018 at a price of €16.5 ($19.5) or €2,500M ($2,950M) and since then, it has only lost value, down to a minimum of €4.8 ($5.7) at the end of March, at the centre of the COVID crisis in Europe, and roughly the same level at the start of November.
Since then, it has recovered part of the lost ground, but it is far from the €9-10 ($10.6-11.2) per share it was trading in February before the virus hit Europe.
With only €90 million ($106M) of net financial debt as of September 2020, the enterprise value of the company is c. €1,000 million ($1.180M).
For that amount what you buy a portfolio of assets that was appraised at €2,626 million ($3,098M) as of June 2020, the last available appraisal.
Therefore, the current EV implies a 62% discount to the estimated market value of those assets.
Discount per se does not imply a good opportunity. It is the specific alignment of the company’s business plan and its controlling shareholders that make this discount interesting.
Assets of the company and Gross Asset Value (GAV)
What you get for those €1,000 million ($1,180M) is the following:
A fully permitted land bank with a market value estimate by latest appraisal of €1,596 million ($1,883M). Fully permitted means the plots are fully urbanized and the company can present to the respective city halls the project they want to build, within the fully consolidated parameters for each plot, to obtain the construction license. This process takes anything between 1 and 9 months (c. 3 months in average). The process is fully technical, and uncertainty is only linked to each city hall’s bureaucratic efficiency.
In the fully permitted land residential land bank you find:
- Work in Progress, or WIP, where development already started on 88 different projects with a combined 5,400 residential units’ capacity at an estimated average price of €303,000 ($357,500) per unit or €1.6 billion ($1.9B) in estimated revenues.
- Land reserve for additional c. 19,000 units of fully permitted land plots, which, together with the previous WIP projects, account for the bulk of the company’s assets and 61% of their GAV as of latest June 2020 appraisal (52% at the time of the IPO).
Non-fully permitted residential land-bank reserve with a total estimated value by latest appraisal of €450 million ($534M), or 17% of latest appraisal (21% at the IPO) which requires some degree of urbanization and urbanistic approval process. In other words, you cannot build whenever you want because there is management to be made and capex to be put in place before being able to do anything else in those plots. There are different degrees of distance to a fully permitted condition.
At the IPO, the company disclosed all the appraisal details, and you could see that the plots in this part of the portfolio were classified as:
- Non-urban: those are pieces of land that cannot be developed unless there is a change in their state to be provided by the relevant government. Those changes are rare and take a long time. The only location with some value in the IPO perimeter was a group of plots called Valdepolo at the North of Alcorcon village, a very interesting location for middle class residential in Madrid, with a combined GAV of €104 million ($122M) or 4% of the total company’s GAV. As far as I know, these plots have remained non-urban for a long time. The signees of the IPO prospectus declared that they were, in fact, non-urban but that the City Hall of Alcorcon had initiated the process to review the General Plan which might allow for a change in the condition of the land. This should be taken with a “pinch of salt”.
- Developable: those are pieces of land (you do not even have plots at that stage) where the only thing that the owner knows is a generic buildable area but still does not know which mix of uses he will get and where they will be located and even less what kind of product it will be able to build. The owners (typically projects are big and shared by several of them) have to agree on what to do, where to do it and to get their idea approved in a lengthy process with political risk, especially if the project is notorious or there has been some social noise in it. As of the IPO, there were assets in this category with an estimated market value of €246 million ($290M) equivalent to 10% of the IPO’s perimeter by value, and an estimated capacity of c. 5,700 units.
- Organized: those are plots where the use mix is already known, and the buildability is already defined for each use. The owners already know what they have. There are different degrees of advance here and is anything from urbanization to be approved to urbanization pending to be finished or pending to be delivered. Political risk is already greatly diminished but it still can take anything from 1 to 2 years to get to fully permitted status. As of the IPO, there were plots with an estimated market value of €203 million ($240M) equivalent to 8% of the IPO’s perimeter by value. Those plots accounted for 5,330 residential units.
And finally, a Commercial land-bank comprising a group of quite interesting projects, mainly in Madrid and Barcelona mostly in offices and some hotel exposure. The most relevant ones are summarized in this table:
Source: 2020 Quarterly Reports of Metrovacesa
The total GAV in commercial assets by the latest appraisal is €580 million ($684M) or 22% of the company’s total GAV (27% at the IPO). The company already achieved some disposals on this part of the portfolio since the IPO (c. €100M – $118M) and in general, I don’t see any problem with the company being able to sell all of this portfolio at values around the appraisal.
At the time of the IPO, the only time I have been able to find full detail of the appraisal by each asset category, the GAV breakdown can be summarized as follows:
Source: 2018 IPO Prospectus of Metrovacesa and my own calculations
A little bit on nomenclature:
- GBA goes for Gross Buildable Area and is normally only the area above the ground. Obviously, there are many types of “areas” but this is generic and necessary reference for any plot.
- Units only consider residential units and not collateral units as garages or retail units that may come in the plot. That is why I do not include the unit reference for commercial assets.
- GAV goes for Gross Asset Value and is the outcome of the appraisal, that is, the estimated market value of the assets.
- GDV is what the appraisals consider the selling value for the finished product could be for each plot’s location, given the specific characteristic of each plot. It is a very useful reference where all the DCF of the valuation starts.
- GDV allows us to know the ASP or Average Selling Price by unit which depends mainly on location quality and demand. It does not depend on the urbanistic condition. That explains why ASP for non-urban land can be higher than fully permitted land.
- GAV psqm or per square meter of GBA is also a very used metric in real estate. Normally, value should be higher as more advanced is the urbanistic process but it is also a question of location.
- Land to GDV is the ratio of GAV to GDV, or how much does weight the estimated value of the land (which at the end is a DCF or a residual value estimate) to the gross development value. This should be lower as further away from development is the land group as better locations bring higher GDV and higher GAV. This is the case in the valuation of Metrovacesa for the IPO, as we can see in the chart.
Source: 2018 IPO Prospectus of Metrovacesa and my own calculations
The company’s land bank is reasonably distributed across Spain. Probably, the weakest locations are Canary Islands (Islands are always difficult to deal with), and some inner regions like Castilla León, Aragón and the North West region of Galicia. In all those, the dynamics of the markets are way slower than in the rest of the regions where Metrovacesa is present.
Source: 2020 Quarterly Reports of Metrovacesa
Gross Asset Value (GAV) and Net Asset Value (NAV)
There have not been significant changes in the GAV and NAV of the company since the IPO.
Essentially, the GAV increase since then is mainly linked to the WIP capex in the ongoing projects, at least until December 2019, which is mostly compensated in NAV terms by the increase in net debt.
Some decreases in GAV in like for like terms happened in June 2020 and some additional adjustment should be expected by the end of this year as the COVID crisis has delayed projects evolution, which diminishes NPV values and has also cast significant shadows on the country macroeconomic balances.
Source: 2018 Prospectus and 2018-20 Reports of Metrovacesa
It is probably too soon to determine if the impact in the residential market will be permanent, as the obvious negative impact from the crisis seems to be compensated with more household saving and more preoccupation for increasing the quality of housing.
Putting that aside, it is clear that land liquidity has diminished and that anybody in the urge to sell a land plot will face a tough market right now. This has to be reflected somehow in the appraisals, but it is not the situation in which Metrovacesa is.
As of June, the NNAV of the company was €2,507 million ($2,958M) which divided by the current number of net shares (after recent buyback figures) yields a NNAV of €16.7 ($19.7) per share or close to 3x the current share price.
Metrovacesa is not a story of value creation or growth. It is a story of slow liquidation or asset to cash conversion that can be bought at a significant discount to the estimated market value of those assets.
Since the IPO, the company has been able to consolidate significant advances in some of the land plots that were not fully permitted as of that date. The two most significant cases have been la Seda in Barcelona and ARPO in Madrid. Both cases are significant either by size or location.
Source: 2018 Prospectus and 2018-20 Reports of Metrovacesa
La Seda, in Barcelona, is located in the southwest of Barcelona city, close to the airport. It is not a great location, but given how constrained by the city and mountains Barcelona is, any well-connected expansion area, as this is, is a good asset to own if the price is right.
The appraisal value of this asset at the IPO was €50 million ($59M), equivalent to €283 per square meter which is a great entry price. Quite probably, there are pending urbanization costs to be incurred but even with, let’s say, €150 psqm of capex, the resulting fully permitted cost would be an excellent €440 psqm, which is a very good entry price for the outskirts of Barcelona.
Besides, the plot is relevant because of its size, as it allows for the development of close to 1,600 residential units. Quite probably that location is ideal for “build for rent” operations or ideal to sell some part of the asset to third-party developers as a tool to advance faster than on its own.
The investor in Metrovacesa today would be buying this asset at fully permitted condition (post urbanization capex) of c. €150 psqm, given the discount in the share price to GAV.
The second most significant advance has been ARPO in Pozuelo. Way smaller by size and half the value of la Seda, this plot is significant because of its location. Pozuelo is one of the wealthier villages in Spain, very close to the city, with good connections and high quality of living, in general.
Together, with the rest of the plots where there has been some advance, a total GAV of €97 million ($114M) or 18% of the land under need for management, has improved somehow. So, without buying any land, the company has made it more certain that a total of c. 2,400 units with an estimated GDV of €641 million ($756M) can be built and sold in the market.
As of today, there is no news about any change in the Valdepolo-Alcorcón situation, so they certainly remain as non-urban land. Would somebody buy those plots for €104 million? Certainly not. But it is not crazy to assume that they will become urban one day as the town needs more housing and that area is a natural expansion of Alcorcón. Take it as it is. With a long business plan, they might become real plots. If that does not happen, the impact is of €0.67 ($0.81) per share.
A simplified DCF
As I have said other times, I am not a big fan of DCFs as they bring a false sense of precision to the intrinsically uncertain and subjective work-art of valuation. But there are some cases when it makes some sense not using EV to cash flow or EBITDA/EBIT multiples or relative valuation methods that I normally use.
I think this is one. The perimeter of the company’s assets is defined, as it is what the company will do with those assets. Metrovacesa is not a company that tries to replenish its asset base at any moment (or at least that moment is very far by now), so it does not make sense to compare the company multiples with other development companies, notably Aedas and Neinor Homes.
The company is more like a venture capital fund but with no hurry to liquidate its assets and without a defined end-date.
Some significant inputs for that DCF are available to us from the detailed appraisal disclosure made by the company for the IPO. We know that the combined residential GDV was estimated at €8,596 million ($10.148M) and that the present value of that cash flow, net of construction and other development costs discounted at a risk adjusted return was €1,893 million ($2,234M) which is equivalent to 22% of the GDV.
I have made two additional assumptions to be able to figure out an average P&L for the whole residential portfolio of the company:
- That the company will spend an average of 4% of GDV in marketing and other costs beyond construction cost.
- I have set a construction cost per square meter of buildable area equal to €1,600 psqm ($1,900 psqm).
The construction cost and the marketing and other costs provide a gross development margin (before overheads) of 20.4% of GDV, equivalent to €1,757 million ($2,073M). With that, the average P&L account for all the residential assets in the portfolio can be estimated as follows:
The cash flow that the company will generate is nevertheless higher than that, as Metrovacesa does not need to reinvest the cost of land sales into new land plots. So, what shows as a cost of goods sold is, in fact, cash flow available for the shareholders. Adding back the cost of land to the margin, we get to a cash flow from residential activity of €3,650 million ($4,310M), or 42.5% of the GDV, before overheads, interest expenses, and taxes.
Now, for the DCF, it is only just a question of how and when we get that cash.
The company has provided some guidance on units since the IPO. Their main guidance has been the free cash flow to be obtained from 2020 to 2023 which is €1-1.3 billion ($1.18-1.5B). That combines commercial land sales, some opportunistic residential land sales, and, of course, residential development.
As of September 2020, the company has 7,429 active units, of which, 5,406 units are already in commercialisation and of those, 3,639 units are in construction. Given construction times, the maximum number of deliveries (if 100% of the units are sold) for the coming 18 months is probably in line with the units in construction, that is c. 3,600 units, and if we consider 24 months, it is probably more in line with the c. 5,400 units in commercialisation.
I have set the volumes, so from the rest of 2020 to 2022, 5,400 units are delivered and that a run-rate of 3,000 is achieved in 2023 for a few years before coming down to a more long-term stable level of 2,000 units per year that remains constant until 2036 when the current units in the portfolio of the company (c. 36,000 units) are fully sold and delivered.
These volumes are below what the company has been targeting, but I am a bit doubtful about the run-rate of 4,500-5,000 units that the company declared in the IPO. By now, they have only delivered 289 units in 2019 and 289 units in the first 9 months of 2020.
Of course, all of the COVID thing and some changes in the mortgage proceedings that were new in 2020 have not helped, but I prefer not to bet on the company reaching 5,000 unit level soon.
With those figures in mind and if the 17.1-39.1% margin cash is evenly distributed among all land plots, the cash flow from the residential development would be the following:
For those figures, I have also assumed the following inputs:
- CPI of 2%, constant for all years. 25% corporate tax rate.
- Indexation of 100% of CPI of ASP and development costs.
- Overheads of €16 million p.a. growing at 100% of CPI.
- All cash flow from a unit sold is obtained at delivery. In real life, part of the unit price is prepaid by the future owner, but this loss of precision has barely any effect in a 10-20-year DCF.
- All construction capex is financed by development loans. Therefore, there is a constant presence of development debt that is linked to the future volume of units under construction for future delivery. Again, the loss of precision in a 10-20-year DCF is minimal and we avoid complicating the model.
- Cost of debt of 2.5% p.a. Given how lowly levered the company is and the willingness of banks to finance development, with the final will of getting the final client mortgages, I think the 2.5% is a very reasonable cost of debt level.
Discounting cash flow at 10% rate yields an NPV of the residential development business of €1,547 million ($1,830M), which is equivalent to 75% of the residential GAV as of June 2020.
The difference from NPV to GAV has to do with taxes, interest expenses, and overheads, all of which are not taken into account in an appraisal but are part of any business. Adding an NPV of each of those lines, the difference from the DCF’s NPV to the GAV is minimal which makes everything quite coherent.
Regarding the commercial portfolio, there are €580 million of that kind of land as of September 2020. The company has made several disposals already with margins that go from 0% to 10%. I have assumed that all the portfolio is sold in 6 years, starting in 2021 and that selling price is equal to GAV and with a 10% margin that pays taxes.
The NPV from the commercial side is €410 million ($483M), discounted at 10% rate.
If all the above assumptions are reasonably right, then the DCF of the company’s assets would yield a value per share of c. €13 ($15):
I have made a conservative approach in terms of construction cost, volumes, or indexation, so this reference should provide enough margin of confidence.
Inflation from economic growth has a natural way to put pressure on house prices, by means of demand pressure for more housing from higher employment and higher household creation. Inflation from low forced interest rate environment, like the one we are living in right now, also has a natural way to find house price pressure through too cheap to believe mortgage rates.
Long-term mortgages, notably if they are fixed rate, are really the only tool individuals have to play the same game that governments play with inflation and national debt. Get today’s currency and pay with the same nominal currency, but devalued in real terms, 5-10-15 years down the road.
All of this to say that housing is not a bad haven for a higher inflation scenario. As of today, inflation is mostly noticed in debt security prices and some equity securities, but at some point, the continued efforts by central banks might make it through the financial system and more general inflation could start to develop. Banks have become much more dovish in their policy framework and now the 2% has become not only a target to reach but a symmetrical target, meaning central banks want inflation oscillating around that target, above and below.
I honestly don’t have a clue if significant inflation will develop or not, but I think it is certainly a risk and I prefer to invest in business that can overcome that effect or even that can benefit from it. I think that residential is not a bad place to be in that scenario.
Controlling shareholders and dividends
The company is controlled by Banco Santander (NYSE:SAN) and BBVA with c. 49% and 21% of the capital.
A significant capital turnaround has taken place as the original investors in the IPO have lost their shirts with Metrovacesa. The defaults in delivery plan by Neinor Homes, the first developer to hit the market, did not help, and the environment of construction cost inflation that developed in 2018-19, either. COVID fears in the subsequent economic crisis made the rest in 2020.
Some opportunistic funds and real estate investors have already stepped in at different price levels in the last months.
The banks sold shares at €16.5 at the IPO and also kept a significant exposure to a declining share price. With the price at €6, they have probably resigned on expecting more share placements or M&A to dilute away their stake.
The good side of that for minority shareholders is that quite probably the only thing that banks have left to focus on is dividends. If you cannot sell it, and if you cannot merge it with a bigger pie, then let the company pay all the dividends it can.
And this is happily aligned with my interest in the company. The company halted dividend payments in 2020 with the COVID risk running wild and they already announced that the dividend of 2019 (cash flow – c. €40 million or €0.26 per share – $47M and $0.31 per share) that was to be paid in 2020 will be paid in the first semester of 2021, normally meaning June.
I don’t discard that if things improve, that dividend could be grossed up with 2020’s cash flow, which was €28 million ($33M) by the 3Q of 2020 and should increase with the last quarter deliveries.
The dividend that would come out from my previously calculated DCF would be as follows:
As you can see, the 2021 cash flow available for dividend payment has been increased from €50 million to €90 million ($60 to $106M) from the accumulation of the 2019 cash flow of c. €40 million ($47M) that the company did not pay in 2020 due to the COVID uncertainty.
If the company followed that simple rule of paying up all the cash flow that it generates, and if my assumptions were right, the current share price could be recovered already by 2024 and would pay back again by 2027.
A pay-back in 4 years implies a 25% return for that period. An additional payback in 3 years, from 2024 to 2027 implies a 33% return for that additional period.
The return, if price stays at these levels, is simply phenomenal. Obviously, that will not happen. If dividends do materialize anything like my estimates, share price will notice. The company just needs to show that it can deliver at least 2 to 3 thousand units per year.
Share buybacks and other possible scenarios
The company already approved a share buy-back program of €50 million (c. $60M) at the beginning of 2020. In 2020, the company has bought 1.1 million shares at a price that I estimate at roughly €6.5 ($7.7) per share which is equivalent to a 60% discount to latest NNAV.
I do not think buybacks will be the main thing here. I do not see the banks eating away all of the free float just for the sake of NNAV revaluation. It will be there, but I do not see it as the main character of the story.
It could happen that one of the opportunistic funds told the two main banks to take the company private. But those funds would ask for a squeeze-out price that is as close to their entry price as possible while the banks will not be happy taking the company private at such a significant discount to the IPO price. It is a question of image in front of the market even that banks probably do not have a lot of responsibility for where the share price is.
The potential from the current €6 ($7.1) per share price to €13 ($15.3) is marginally higher than 2 times. Even at the DCF valuation, the investment would yield an annual 10% rate of return which is still a reasonable return to get from an equity investment and it would not be illogical to assume higher prices for less return demanding investors.
The potential is significant, but it is not a mouth-watering opportunity. The beauty of the investment is how low downside risk it has:
- Its assets cannot be moved and do not deteriorate over time. They are even inflation protected.
- Besides, you as an investor would be buying those assets at a 62% discount to its estimated market value, which is equivalent to buying all the portfolio landbank at a cost of €180 per square meter ($212). A lot can happen to the market and to the value of the assets before you start to be concerned about it.
- It is not a complicated business. It requires professionalism and knowledge, but we do not have to trust the management in inventing the next big thing in order to have a positive outcome.
- Besides, after two years of management track record, it is very probable that they have already passed the turn-in phase and all of the weak spots have been solved. Word on the street is that the CEO is very capable, understands the business, and has a good leadership.
- They do not even have the need to find replacement for the land plots they sell once they have built the houses on them.
- Metrovacesa debt is minimal and linked to WIP. The company does not need debt, it just helps a little to accelerate the BP at the start and increase, marginally, the ROI, if that was a measure relevant in this case.
- Residential prices could go up or down, but the company makes a 40% cash-margin, so it is not so much concerned about the minor price changes.
In other words. There are very few things that can go wrong. That is what I like about this investment. And when you have an edge on a bet and the downside is small, as I think it is in this case, the Kelly criterion is clear on what to do: you should bet big.
I do not apply the Kelly formula to size my positions, I just attach to its logic.
I think Metrovacesa is one of those opportunities where upside is good but the little downside risk is even better.
The company would simply need to sell all its assets at 62% discount in order to pay back 100% of the market cap to the shareholder, or only 38% of its assets at 100% of its appraisal, or any combination in between. It is just too easy to justify the current valuation, which implies that the actual risk of losing money is very low.
But, of course, one thing is the business side of things and another one is what share price can do along the way. I am happy to take my chances at these asset implicit prices.
Disclosure: I am/we are long MRVCF. 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.