Description

Long Glenveagh PLC (GLV ID): Irish scale homebuilder operating in a structurally undersupplied housing market trading at 0.7x trailing TBV and 8x forward earnings (2021).  

• After a decade-long depression in the homebuilding industry, housing remains structurally under-supplied in Ireland, as reflected by rising rents and rising entry level home prices.
• Glenveagh is taking advantage of the currently fragmented competitive landscape to build dominant scale in entry-level homebuilding. As GLV ramps its delivery volumes from 1000 in 2020 to 3000+ longer term earnings should compound from 0.03c per share in 2019 to ~0.18 to 0.20c per share in 2023
• The market is attributing zero value to Glenveagh Living (a multifamily apartment / PRS developer) but a forward sale agreement on the first major apartment development (East Road) in Fall 2019 should give the market more visibility on future profits. Given 4% cap rates on stabilized Irish PRS buildings there is enormous profit embedded in GLV’s multifamily development pipeline.
• Management is highly incentivized for the stock price to move higher given Founders Share grants. The next grant threshold is a price on GLV above €1.42 in Q2’20, or 100% higher than current trading levels.
• No aspect of a no-deal Brexit (NDB) outcome is likely to change the structural undersupply of housing in Ireland. On the contrary, NDB is likely to accelerate the movement of jobs and FDI from London to Dublin, worsening the undersupply situation to GLV’s benefit. Glenveagh has zero exposure to the border counties (with Northern Ireland) or the SME agribusiness sector, the two points of Irish vulnerability to NDB.
• Longer-term, a reasonable valuation on the fully ramped business is 1.5x on 2022 ending book value of ~1.30, implying 1.95 per share and yielding a 40% IRR to 6/30/22 and 180% total return from current trading levels. 2023 numbers are relevant in that the final shareholder TSR hurdle to determine the ultimate payout on the Founders Shares is measured between 3/1/22 and 6/30/22, and presumably the stock will be trading 2023 numbers at that time. A change of control for the company prior to 6/30/22 also can also trigger a performance test for the Founders Shares (and payout for management if the price is above the 12.5% TSR hurdle rate). Management’s business plan at the time of the IPO in 2017 was designed to hit the maximum Founders Shares payout within 5 years (price above 1.80), and it’s likely that they will get there via share price appreciation if the market recognizes their execution or a sale of the company if the market does not.

Background:

The homebuilding sector in Ireland is still only just recovering from a decade-long slump that was triggered by the global financial crisis of 2008. The industry in Ireland pre-crisis was composed of small, family-owned homebuilders that were dependent on local banks to finance their operations (as opposed to larger entities with capital markets access). When the financial crisis impaired the country’s banks, access to financing dried up and most of the local homebuilders went out of business. As the banks foreclosed on the homebuilders and the government subsequently nationalized the banks, the Irish government itself ended up as the largest owner of development land in the country via the National Asset Management Agency (NAMA). Homebuilder insolvency in turn resulted in a 95% drop in the annual supply of new homes in Ireland from 2007 to the trough in 2013. Similarly, the volume of new mortgage lending across Ireland decreased 95% from peak to trough.

Irish new home completions (in 000s) 1980 to present:

Despite the collapse of the homebuilding and banking industries, the population in Ireland continued to grow naturally over the last decade. As the Irish economy has recovered in the last few years, net inward migration has increased as well, leading to an acute undersupply of homes. Annual new housing demand has remained at approximately 36,000 units, compared to a new housing supply of 18,000 units in 2018, estimated supply of 22,000 units in 2019, and a trough of 5,000 units in 2013. Ireland continues to have the lowest median population age in Europe, the highest rate of natural population growth, and a very high level of in-migration related foreign direct investment in the country (e.g. Google and Facebook placing their European headquarters in Dublin). Recognizing this market opportunity, a group of government, finance, and homebuilding industry executives created Glenveagh in 2017 to help institutionalize the homebuilding industry. Chairman John Mulcahy was formerly the head of NAMA’s portfolio management group that was responsible for disposing of its development land. CEO Justin Bickle was formerly the head of Oaktree’s European Private Equity team and managed investments in real estate. COO Stephen Garvey founded and ran Bridgedale, a Dublin area residential construction firm. Just as the early, politically connected buyers of real estate assets from the Resolution Trust Corporation in the US in the 1990s made fortunes, so the team behind Glenveagh appears to be uniquely qualified to capitalize on the market opportunity in Ireland.

Since its IPO in 2017, Glenveagh has made significant progress by assembling a land bank of ~13,000 units and generating a profit in the second half of 2018 on 269 homes sold. The company is on track to multiply its profits by delivering more than 725 homes in 2019, 1,000 homes in 2020, and up to 2,000 homes in 2023 in its homebuilding segment. Glenveagh Homes is oriented to the starter home market, where pent-up demand from the last decade is greatest. Notably, all of GLV's 725 units targeted for sale in 2019 were either sold or under agreement for sale as of June 7th this year.  While there is no definitive measure of the “undersupply” of housing, if the percentage of Irish employed workers still living at home with their parents reverted to 2011 levels, then 45,000 people would need new accommodation –approximately 2.5 years of new supply required at 2018 levels.

Source: Davy Research

While the company’s traditional homebuilding business offers attractive returns to investors, it also has a mixed-use, brownfield redevelopment arm called Glenveagh Living that we expect will super-charge profits in the medium term. Thanks to the company’s expertise in sourcing government owned land, Glenveagh Living has assembled a portfolio of urban development sites in Dublin and Cork. As a result of the scarcity of Class A commercial real estate investment assets in Dublin, pension and insurance companies have expressed interest in forward sale agreements on buildings that Glenveagh develops. In this model the institutional investors contribute cash for the working capital (construction costs) of the project, which allows Glenveagh to earn a developer fee and profit on contributed land without taking balance sheet risk. In return, the pension and insurance investors are able to purchase Class A commercial real estate assets at attractive cap rates that would not otherwise exist.

The first planned project is a 556-unit apartment building in Dublin’s North Docklands district, and Glenveagh expects to reach a forward sale agreement on it after receiving final planning approval (likely at some point this Fall). Although revenue would not be recognized until early 2022 (upon delivery of the finished building), the company should be able to effectively lock in significant development profits this year, which would give the market much greater visibility on the forward earnings trajectory. The company has three other projects with deliveries scheduled for 2022-2023, and a pipeline of mixed-use and social housing developments behind that. The economics of apartment development (or PRS as it is called in Ireland) are extremely attractive given the 4% market cap rates on stabilized apartment buildings and high NOI yields (gross-net ratios) of 75-80% given that tenants typically pay for utilities. Irish apartments are some of the highest yielding CRE assets in Europe at the moment and the Dublin market is awash in pension & insurance money looking to source yielding assets via forward sale agreements.

Management Incentives / Founder’s share grants: At the time of the IPO Justin Bickle (CEO, Glenveagh Living) and Stephen Garvey (COO, Glenveagh Homes) were granted 90mm Founders Shares. Chairman John Mulcahy was granted 20mm Founders Shares. These shares are convertible to ordinary shares if certain total shareholder return thresholds are met on the underlying stock price. Basically, the GLV shares need to be trading above a price implied by a 12.5% compound shareholder return as of each date in order to trigger any grants per the table below:

 1.00   10/10/2017

 1.125 6/30/2018

 1.266 6/30/2019

 1.424 6/30/2020

 1.602 6/30/2021

 1.802 6/30/2022

In the event that the closing price of GLV trades above the hurdle rate for 15 or more consecutive days in a given measurement period, then management is entitled to founders shares worth 20% of that TSR for the period. TSR simply means the increase in market capitalization of the company in €mm plus any dividends or distributions. GLV management passed the first milestone on 6/30/18 and received ~19mm founder shares based on the highest average 15 consecutive closing prices of 1.16 in the period from 3/1 to 6/30 of that year versus the initial IPO price of 1.00, or a return of 16.1% on 667mm shares outstanding in the first annual hurdle rate. My understanding of the calculation works as follows:  €107.4mm total shareholder return from IPO to 6/30/18 (market cap appreciation), of which the Founders receive 20% or €21.5mm, divided by 6/30 closing price of 1.147 = 19mm shares issued.

So if GLV management can get the stock price above the 12.5% hurdle rate via execution (or a sale to a strategic buyer) over the next 3 years then the three executives will share the 20% of shareholder return in €mm between the future trading price and the current high watermark of 1.16 per share… the financial incentive to realize value in the stock price is enormous for the three executives running the company between now and 6/30/22. In some investor circles there is significant angst regarding the size of the potential payout to management; we like the fact management’s incentives are aligned with ours (e.g. shareholder returns).

Common concerns / push back / why is the stock down here?

“Irish home prices are falling”:  This is true only at the high end of the Dublin residential market, and even then only slightly true in 2019 to date. This perception is based off the commonly referenced Central Statistics Office residential price index, and the fact that the Dublin component of the index has fallen from 107.8 in October 2018 to 105.4 in May at the latest reading. The reality is that the market is buoyant at the first-time homebuyer price point of €300k-400k ASP but weaker at higher end pricing of €500k+. Data from the Property Services Regulatory Authority shows transactions up 18% in the first-time buyer price band year to date in 2019, but down 12% above €500k. At lower price points, prices continue to rise at ~4% per year, which is approximately in line with household disposable income growth. Meanwhile the higher-end of the market is weaker due to its reliance on consumer confidence & the impact from Brexit uncertainty (e.g. move-up buyers have more discretion in choosing when to purchase) rather than household formation per se. The higher end of the market also has a significantly smaller buyer base. By way of example, the 2Q’19 MyHome.ie property report showed four bedroom detached home prices in South Dublin down 4.8% y-y to €595,000 (move-up product) but three bedroom semi-detached homes in North & West Dublin +5.8% y-y to €349k and +3.2% to €275k respectively (first-time buyer product).  

The reason that the Dublin market is bifurcated around the €400k price point is due to restrictions implemented by the Central Bank on the quantum of mortgages that can be made with a loan-to-income ratio > 3.5x. The rationing of mortgage supply was done to prevent a repeat of the mistakes from 2005-2007 in Ireland when lots of mortgages were issued to highly indebted borrowers. The unintended consequence of the policy preventing first-time buyers from paying much above €400k is to effectively price that demographic out of owning units in downtown Dublin. However, there is no such constraint on rent-income metrics, and as would-be first-time buyers still need a residence, the predictable result has been that Irish apartment rents have risen dramatically in the last two years. The rise in rents and high cap rates on Irish CRE (in a European context) has attracted institutional capital to the sector. As a result, the ownership of new housing in central Dublin has simply been transferred from first-time buyers to pension and insurance funds who purchase housing in bulk and rent the units out.

The strongest argument in favor of the undersupply of housing in Ireland is the fact that rents are rising. Data from the Residential Tenancies Board showed rents +7% nationally in 2018 and 7.8% in Dublin. Hence the headlines about the decline in high-end Dublin prices are simply capturing the effects of the Central Bank’s macro-prudential rules rather than a change in the supply/demand for entry-level housing.

Glenveagh’s response to this situation is to simply develop single family detached homes for first-time buyers on the periphery of Dublin at ~€350k on average and to develop apartments for sale to institutional investors in the Dublin core at 4% cap rates. For illustrative purposes, a €2500 monthly rent, 80% gross-net margins (NOI margins) and a 4% cap rate implies an “average selling price” of €600k in apartment developments, showing how Glenveagh can deliver urban units at much higher effective price points than would be implied by simply capping prices at 3.5x income.

“Irish construction costs are rising faster than home price appreciation”:  This concern primarily arises from comments made by smaller local builders to the Irish press (https://www.irishtimes.com/business/construction/ballymore-founder-warns-soaring-build-costs-biggest-risk-1.3643829). While the concern is that building cost inflation (wages and materials) will rise at GLV in line with the 7-10% rate referenced in the articles, for its part GLV has actually seen build cost inflation of around 3-4%. GLV is building on 16 sites currently to deliver 1000+ homes in 2019 versus smaller builders producing homes at a rate of 50-200 per year. As a result of its scale, GLV achieves significant bulk discounts on materials purchasing (particularly pre-fabricated timber frames and hardware like doorknobs, etc) as well as lower rates with key subcontractors. GLV is contracting labor in the multi-year term market where the volume to subcontractors is guaranteed but the rate of wage appreciation lower, while its smaller competitors are effectively contracting in the spot labor market. GLV estimates that on the larger multi-year development sites that they operate they are delivering homes 10% cheaper versus smaller sites. Over the medium term we expect price appreciation of 3-4% for entry level homes and cost inflation of 3-4%, with gross margins in homebuilding stable at ~20%. The upside in earnings comes from volume leverage on SG&A.  

“No-Deal Brexit (NDB)”: This is a complicated but important topic given the emergence of the “hard Brexit” or no-deal Brexit scenario as a reasonably likely outcome. Fears and hedging activity around NDB have been the driver of share price declines in GLV since summer 2018. No-deal Brexit simply means that the UK leaves the EU without any pre-existing trade deal after October 31st of this year and reverts immediately to WTO tariffs and “third party” regulatory status with the EU. As many small businesses in both the UK and Ireland have not adequately prepared for the impact of tariffs and potentially new regulatory requirements, pretty much all economic forecasters have predicted a negative macro shock of varying degrees in the immediate aftermath of NDB. Analysts’ views on the topic appear to be heavily influenced by their political desires & orientations (e.g. Leave or Remain, UK or EU based). Leave analysts generally predict limited to no impact on the UK in a NDB but a significant hit to Ireland (hence the “need” in their eyes for the EU to fold in negotiations) while Remain analysts talk about 2008-2009 recession levels and potential food/pharmaceutical shortages in the UK in the event of NDB (hence the "need" to Remain). Since any Brexit outcome other than full-Rambo NDB is great for GLV, we have focused our analysis on that worst case scenario.

As far as we can tell, all economic predictions for NDB’s impact on Ireland are derived from multivariate models based on historical economic relationships between the UK and Ireland. E.g. simplistically if UK GDP declines by X% then Ireland will decline by Y% because historically that’s how things worked out. The issue with this approach is that the data is heavily influenced by 2008 when the UK and Ireland both experienced a banking sector collapse, which is arguably not relevant at all to today’s tariff induced circumstances. Ireland’s 2008 recession was not caused in any way by the UK, but both countries had a severe recession at the same time. In other words, the regressions are picking up correlation, not causation, in the data.  Even still, the projections are not for recession in Ireland in 2020, but rather reduced GDP growth of +0.9% rather than+ 2.7%.

What we do know is that the actual economic hard linkage between the two countries is trade (12% of Irish 2017 exports went to the UK) with collateral damage to business and consumer confidence resulting in deferred investment decisions. The single largest category of Irish exports to the UK is food and livestock (beef and dairy exports), followed by pharmaceuticals. The issue with assuming that these exports “go away” is that it so happens that people in the UK eat those imports on a daily basis and are not likely to do without the 20% of total UK food supply that is imported. Nor is it likely that the UK population will simply stop using the pharmaceutical imports. We understand that DEFRA in the UK is prepared to “lift and shift” existing EU regulations into new UK-only law post the UK’s departure so that things like Irish beef and cheese will still comply with domestic UK phytosanitary regulations, making the question one of price rather than availability. Since the UK will be exiting not only its trading relationship with the EU but also all trade agreements that the EU has negotiated with other countries, Ireland will start NDB at the same point as all other agricultural exporters to the UK. Hence, it’s not obvious that Irish agricultural exports lose share. At the end of the day it’s our guess that the UK consumer will bear the burden of tariffs and simply have to pay more for food after NDB.

Given that no country has ever attempted to undo decades of trade policy overnight, there is plenty of uncertainty about the impact of NDB on Ireland. All we are trying to argue is that NDB is not likely to be the disaster for Ireland that is regularly promulgated by Leave-leaning UK publications. But fear of NDB has been a huge headwind for GLV shares in the last year as many investors have chosen to sell the stock rather than deal with the uncertainty. We don’t think anything in NDB changes the structural undersupply of housing in Ireland, the desire of families to have their own place, or the availability of mortgage credit in Ireland. Frankly, nothing could be as bad as what the Irish homebuilding industry just experienced in the last ten years. We do think any economic pain in Ireland will be primarily felt in the SME agribusiness sector, but that sector only represents 4% of total employment. Pharmaceutical exports are primarily controlled by multinational corporations who will simply pass price increases to the UK consumer. A public company in Ireland who actually has direct exposure would be AIB given their SME loan portfolio to the agribusiness sector (and to a lesser degree loans to businesses operating in the border counties). BIRG has some exposure as well, but primarily as a result of owning a UK bank. Other banks like Ulster, KBC, and PTSB appear to have no exposure to agribusiness SMEs.

Irish exports to the UK over time as a % of total

“Why not Cairn?” We think Cairn is also likely to benefit from everything written in this GLV writeup, and that investors will do well there. However, the management teams of GLV and CRN have taken somewhat different approaches to longer term strategy. At the risk of mischaracterization, we read CRN as a vehicle set up by old school property developers to play a Dublin land market appreciation cycle from 2015 to 2019. Their view was to scale up land purchases as much as possible in 2015/2016, develop the properties to the highest margin use (apartments in Dublin primarily), and then shrink the company back again as the super cycle in land profits normalized. As a result, CRN is scaling back its land purchases and activity going forward with the goal of returning 35-40% of the company’s market cap in cash to shareholders in the next 3 years, leaving a smaller ongoing enterprise producing 1500 units per year. GLV meanwhile is focused on being the scale builder in Ireland for the first time buyer segment, creating a “machine” set up to deliver volume at the lowest cost with 3000+ homes or 10% national market share in the medium term. We view CRN therefore as a lower risk, lower reward investment given the relatively near-term return of principal via special dividends and less reliance on the terminal value for capital appreciation (but still a good investment!). GLV believes that the homebuilding opportunity in Ireland is less about a one-time land appreciation play but rather using the current lack of competition to establish a market position as the dominant scale player for first time buyers in perpetuity (e.g. building the ‘machine’); we think the company can generate 20c in EPS and command a 2.00+ per share valuation longer term which represents massive appreciation from today’s pricing. Therefore, the return in CRN vs GLV is really about reinvestment rates for a given investor; GLV is reinvesting shareholder capital at what we think are high IRRs while CRN requires shareholders to reinvest elsewhere since they are returning a large portion of the principal.  Said differently, GLV simply has more exposure to our thesis regarding the structural undersupply of housing. CRN principals have also received their payout already in their own Founders Share scheme while GLV principals have not.

In summary, we think GLV is a great buy at these levels. Our guess is that resolution of Brexit in any form would be a positive catalyst for the stock, but a strategy of a half position now and half position post Brexit also seems reasonable.

Catalyst

Full year 2019 results

Forward sale agreement reached on East Road

Resolution of Brexit one way or another