Description

Summary

• For many years Heijmans (ticker HEIJM) was a typical forgotten and ignored homebuilder/construction stock. It suffered a big decline in its homebuilding business in the years after the financial crisis, including write-downs of the value of their land bank. In the years after that, infrastructure project caused further decline in shareholder trust and institutional interest. The current market cap is close to EUR 500m; liquidity is surprisingly good. The current shareholder base seems to consists of a lot of Dutch retail investors who are mostly focus on the dividend, and who have perhaps not fully grasped the potential upside.
• With new management and a better risk management culture, financial results of Heijmans have improved markedly in the last 4 years. Just as important, the company made a transformational acquisition in summer 2023 which in our view has doubled its earnings power, while becoming a more diversified and predictable business as a whole.
• Even with still high mortgage rates the Dutch housing market is currently very strong again, laying the ground conditions for a renewed boom in Dutch house prices if/when ECB rate cuts come through.
• The investment case has inflected so quickly that even after a 50% performance this year the stock still trades at only 7x 2023 EPS (we deduct the May2024 89c dividend from the current share price). Our base case price target of EUR 32 assumes 9x 2024 cash EPS providing 90% upside. Our bull case assumes 10x 2025 cash EPS and a target price of EUR 45, or almost 170% upside from current levels.

Business Profile

Heijmans is a Dutch property developer, homebuilder and construction company with more than 5000 employees and a 100% focus on The Netherlands. Its activities are organized in 4 divisions, which we cover below.

1) Van Wanrooij

Acquired by Heijmans in 2023 for 298m EUR. Van Wanrooij is a Dutch homebuilder with a land bank for 14k homes on its balance sheet, which is currently valued at EUR 259m. Selling 1000-1200 homes per year, of which 600 are built by its internal construction company. At the time of acquisition (June 2023), the Dutch housing market was at its trough,  and near-term guidance of 30-40m annual EBITDA was provided. However, the Dutch housing market has since then improved rapidly and during 4Q23 results a 2024 guidance of 50-70m EBITDA was provided. In the medium term, the guidance is that this should increase to 70-90m.

We believe there is substantial further upside to this number if Dutch house prices keep increasing because 1) Van Wanrooij already owns the necessary land and 2) labor and material costs would increase at a slower pace than sales prices. Together these 2 factors mechanically could lead to a further increase in added value. For (1) an overview of the Dutch housing market and (2) an explanation of the impact of the PPA accounting around the acquisition, see appendix 1 and 2.

2) Heijmans Property Development

Historically selling ~2200 homes per year, but only 1800 in 2022 and 2023 due to the macro situation. However, 600 houses sold in 4Q23 reflect rapidly improving demand. Land bank for 15k houses, valued at 79m. Margins per home sold are lower than at Van Wanrooij because 1) more sales of apartments vs land-based houses and 2) a 50/50 split of sales to consumers and institutional, whereas Van Wanrooij is almost 100% focused on consumers. 2023 held up relatively well considering the macro environment. We expect 1H24 to be still weak, with an improvement in the second half and especially 2025 – even without ECB rate cuts. See appendix 1 for information on the Dutch housing market.

3) Building & Technology

Construction and service company with 50% exposure to residential, 50% exposure to non-resi like healthcare, data centers, offices etc. >30% of revenues is recurring in the form of long-term service contracts. On the residential side, an exciting development is the opening of the timber frame factory with a capacity of standardized 200 homes, which can be increased to 1000 homes per year. Standardization should improve margins in 2024 and beyond (the timber frame factory had a few million EUR start-up losses in 2023 as well). Renovation of homes has become a larger part of the residential business, which should have higher margins than a typical construction project as it is in effect a more opaque service business. The strong market outlook is reflected in the order book of 1,481m by the end of 2023, an increase of ~25% on the year before.

4) Infra

Construction contractor in areas like Mobility (mainly road maintenance and renovation), Energy and Water-related projects. Spending on public infrastructure is set to increase due to the energy transition and general population growth in the Netherlands. Inflation is actually helpful as higher labor costs are easily passed through, leading to higher nominal revenues without margin pressure.

The Dutch construction industry went through difficult years from 2015-2019 which led to large project losses for BAM and Heijmans. Since then, the industry as a whole has become much more focused on risk management which has resulted in solid margins for both BAM and Heijmans in recent years. The Dutch government has also become less aggressive with regards to tenders and are more willing to split up big projects into lower-risk, smaller projects. Another factor is the importance of a sustainable way of working and increasing regulation, which is difficult to do for smaller players so big companies like Heijmans and BAM gain market share.

The vast majority of projects are small/medium size (5 to 30m) and low risk. In 2023 Heijmans Infra contracted only 1 larger project in the range of up to EUR 70m – a dyke reinforcement. The company sounds very confident on the current quality of its Infrastructure order book.

Note that the higher margins in 2022 and 2023 were caused by a provision reversal of the Wintrack file; we exclude these releases from our definition of Economic Underlying EBITDA.

Financial Overview + Comments

• A crucial point here is that earnings/cash generation potential has grown at a much faster clip than Adj EBITDA because the vast majority of capex and leases are in the more capital-intensive Infra and B&T divisions. Van Wanrooij capex is only in the low-single-digits.
• Heijmans 2024 guidance is for EUR 2.5bn revenues and an Adj EBITDA margin of at least 6.5%. There is no guidance for 2025 yet. Our EBITDA growth is driven by the improving housing market which should already become visible in the second half of 2024, but especially 2025 and beyond.
• Heijmans conservatively includes its operating leases (~EUR 90m) in their definition of Net Debt. We prefer to look at EBITDA-capex-leases as a starting point for valuation and cash generation potential and exclude leases from Net Debt.
• In our view the balance sheet is very strong today, considering the potential net cash position (excl leases) by the end of 2024 and especially when taking in consideration the massive land bank – just the Van Wanrooij land bank is valued at >250m.
• See Appendix 2 for an explanation of the Van Wanrooij fair value step up and how we treat it for valuation purposes.

• Higher capex in 2023 related to Wanrooij acquisition and the build-out of the timber frame factory.
• We believe working capital will be positive in the coming years as we expect the company decides to slowly run down its large land bank. Growth in the construction business can also generate positive working capital due to the project nature of that business – with prepayments etc.
• Heijmans will be a normal tax payer from 2024 onwards, whereas in 2022/2023 they could still benefit from DTA.

• On capital allocation: Heijmans currently has a pay-out ratio of 40%. Their stated goal is to become net cash in 2026, but already in the 4Q23 conference call they admitted that this goal is not ambitious at all. At the same time their definition of Net Debt is conservative, as we explained above.
• As a result, we believe the company easily has the balance sheet strength to increase its pay-out ratio from a current 40% to 60% or more. Especially since this still represents a relatively small part of its cash generation potential.
• In our view, Heijmans should follow its big brother BAM by starting a buyback program, which could be communicated during its upcoming CMD in May 2024 (see catalysts).

Why Heijmans and not “big brother” BAM?

There are 2 listed construction companies in The Netherlands. Heijmans has always been a (much) smaller company than its big brother BAM (ticker BAMNB). Part of the Heijmans share price performance this year has probably been driven because BAM finally “started to work”: BAM delivered solid results and guidance and announced a buyback program. A natural question for many investors will be: why Heijmans and not BAM?

Currently the market cap of BAM is about EUR 1.1bn vs Heijmans at 450m. BAM’s revenue is indeed twice that of Heijmans and EBITDA is higher as well, although margins are a bit lower. However, we believe the market might be overlooking the much higher capital intensity of BAM – especially since Van Wanrooij is a very capital light business. On an EBITDA-capex-leases basis it becomes clear that Heijmans might actually generate more cash than BAM -- especially since BAM has guided for working capital outflows vs inflows for Heijmans.

Risks

• Dutch housing market could go into decline again, especially if inflation returns and mortgage interest rates increase again
• Problem projects could come to light in the Infra business, leading to losses
• Heijmans could remain unclear on its capital allocation policies/priorities and/or make an acquisition at a valuation multiple higher than its stock

Catalysts

• Capital Markets Day coming up (May 2024) where company will present targets until 2030 and perhaps a capital allocation framework that better fits its new business profile: higher dividends and a buyback program
• ECB rate cuts could result in lower mortgage rates, boosting home prices, volumes and margins for Heijmans

Appendix 1 – Dutch Housing Market

Dutch mortgage rates are typically priced off the 10Y Dutch government bond yield with a mark-up of 100-150bps. This lead to mortgage rates going from <1.5% to >4.5% in about 12 months, starting from early 2022.

The quick increase of mortgage rates led to declining house prices from medio 2022 to medio 2023 – see chart below (source: CBS). Remember – Heijmans bought Van Wanrooij in the summer of 2023, which with the benefit of hindsight looks like great timing.

Since summer 2023 house prices are rising again, while mortgage rates have come off slightly (to about 3.8%) but they are still high in a historical context. What explains this?

1. The Dutch housing market has been tight for a long time. A quick Google search for “Dutch housing crisis” should be convincing. In effect there is a large supply-demand imbalance which leads to house prices that clear at the maximum level that people can afford.
2. The longer-term background for this is the strong decline in number of homes built after the financial crisis. In the 70s and 80s yearly production was >100k homes per year, which declined to 40k at the trough in 2014. We are now back to about 65k which is a far cry from the current official policy goal of 100k per year.
3. Higher wages started to kick in and have of course contributed to more financial firepower for everyone.
4. From a demand perspective, another important factor for the current is accelerated net immigration – see chart below. In general The Netherlands is a very popular country among students and expat young professionals, who also benefit from an income tax reduction policy. The war in Ukraine has led to a further influx.
5. The knee-jerk government response has been to help homebuyers with a variety of subsidies and higher mortgage limits for energy-efficient homes (in practice a subsidy on newbuilds), which in effect is boosting financial firepower and leading to higher prices.

With the ECB primed to start cutting rates in 2024, there is the potential for 10y mortgage rates to come down further in the near future. It’s also important to realize that given inflation, the housing market is not close to its peak yet in real terms. We believe lower rates will lead to a red-hot Dutch housing market, which would boost both volumes and margins for Heijmans substantially.

Appendix 2 – Van Wanrooij Fair Value Step-Up Accounting

Van Wanrooij’s property development portfolio was carried at a value of EUR 117m at the time of acquisition. However, the acquisition led to a purchase price allocation exercise that led to a revaluation of EUR 142m, bringing the total asset value to EUR 259m. While this shows that the acquisition was a great deal for Heijmans, the higher land values will act as a damper on IFRS profitability, as the higher land values will increase COGS as the land is utilized

In our view, the right way to look at profitability is to exclude the revaluation of the land as 1) the lower land values and higher profitability would have been normal business profits for Van Wanrooij on a stand-alone basis 2) it is the nature of a property development business to acquire land and make a profit on it after development 3) the increased land values lead to a cost that is non-cash in nature.

In the words of Heijmans CFO on its 4Q23 conference call:

Catalyst

• Capital Markets Day coming up (May 2024) where company will present targets until 2030 and perhaps a capital allocation framework that better fits its new business profile: higher dividends and a buyback program
• ECB rate cuts could result in lower mortgage rates, boosting home prices, volumes and margins for Heijmans