As a reminder, this is the first ToffCap publication on Substack. All you ToffCap subscribers have automatically been moved to toffcap.substack.com. Also, ‘short’ does not necessarily indicate my position, just what I think about the company – crappy.
Long-term readers of this blog know that I generally tend to focus on short-term (event-driven) trades or cheap companies with significant upside over a two/three year period. That said, in my daily research I regularly come across some pretty bad companies. Though I rarely short, I will nonetheless spend more time going forward highlighting some pretty obvious examples of crappy companies. Let’s take a look at one which in my opinion has a pretty decent change of going kaputt.
So, today everybody and their grandmother knows about the impact of rising interest rates on banks’ balance sheets; if you have lots of HTM securities in your book, but cannot actually hold them to maturity, you might have a pretty big problem if rates rise ferociously. But banks are clearly not the only companies impacted by higher rates. Obvious cases are highly levered companies which sooner or later have to refinance their debt. There are plenty out there that will see earnings drop a lot, and with share prices not yet fully reflecting this risk.
That said, I like to take it a step further. Even better (worse actually), are companies that are highly levered and offer large, expensive products, of which the eventual sales price also depends on interest rates. Case in point, Atenor.
Atenor ($ATEB, € 320m market cap) is a Belgian real estate development company. The company has a presence in ten European countries, including France, Luxembourg, Germany, and several Eastern European nations, with a focus on capital cities. Its core operations involve identifying and acquiring land, developing real estate assets and then disposing of these assets. So they buy land, request and (wait to) obtain building permits, construct the assets, and eventually sell the assets a few years down the road.
The company operates as a non-turnkey developer, which means that Atenor assumes the risk of buying the land and building the asset before selling it. They don’t build and sell the assets themselves, but rather employ contractors for construction and brokers for sales.
As guided back in 2019, Atenor is aiming to develop 1.8 million m2 of projects by 2026, maintaining a gross margin of around € 400 per m2. As of December 2022, Atenor's portfolio consisted of 35 different projects, representing 1.3 million m2, primarily concentrated on office developments (74% of its portfolio) and residential (20%). While most real estate developers are aware that paying a lot now to hopefully make more in a few years is risky business if you’re not careful, Atenor apparently missed the memo as projects have aggressively been financed with debt. Depending on what you think the company will do this year, leverage is sitting at ~8x ebitda.
Now, looking at all this from a (small) distance and thinking about current interest rates should make you pause. Here we have a company with little earnings and no cash flow generation so far, constantly acquiring assets with a LOT of debt, hoping to make a decent margin a few years down the road. How are they going to make this work in today’s rate environment? The answer is, probably not.
First of all, the rise in asset prices over the past years – driven by cheap money – is reversing, and there’s plenty of data indicating that European office and residential prices are under pressure. That € 400 per m2 gross margin that Atenor was assuming... that’s never going to happen. They’ll be lucky to get € 300 per m2 in my opinion. Funny thing, despite all that happened in the markets over the past years, Atenor has maintained its € 400 per m2 guidance for the past five years (i.e. red flag).
Secondly, financing of growth and refinancing of their debt will be way more expensive, and this is a big issue. The only way Atenor will be able to make it work is if it can continue to make up for all the debt that will be due. And for that the company needs to continue to grow, a lot. As a back of the envelope calculation (you know I like to keep things simple), based on their very generous € 400 per m2 gross margin and let’s say 500k m2 sold over the next three years (see picture above), that’s € 200m. 40% of their ~€ 900m debt is due this year, and most of the rest over the next couple of years. And you still need to finance projects and refinance the debt.
Clearly Atenor was built for a declining interest rate environment. As long as financing becomes cheaper, it’s easier to finance new projects, cheaper to refinance debt and asset prices increase. Now that rates exploded, the flywheel is going the other way. It worked, until it didn’t.
Also, this is excluding a lot of other non-negligible issues, such as:
Demand for (new) office space is already drastically diminishing, with estimates floating around that as high as 70% of the anticipated European office supply for 2024 has been either delayed beyond 2024 or entirely abandoned.
Increased financing costs and inflation are pressuring developers. Development costs have gone up, a lot, and construction costs account for ~50% of Atenor’s expenses.
Labour shortages have become a significant challenge for new developments. Developers are forced to offer higher salaries to ensure project continuity.
Projects are increasingly facing (permitting) delays. Remember that Atenor still has to sell the assets, so delays are very costly.
Despite all this, Atenor’s share price is still ‘only’ c. 20% below since rates skyrocketed. My guess is, not for long anymore. The company might screen cheaply compared to peers, but relatively cheap is still expensive if there’s a decent chance the company will go bust. Meanwhile the upside is ~30% compared to the perfect rate environment. That’s just ugly.