September 25, 2013 - 8:29pm EST by
2013 2014
Price: 19.00 EPS $1.08 $1.48
Shares Out. (in M): 313 P/E 17.6x 12.8x
Market Cap (in $M): 5,941 P/FCF 17.6x 12.8x
Net Debt (in $M): 4,968 EBIT 796 913
TEV (in $M): 10,909 TEV/EBIT 13.7x 11.9x

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  • REIT
  • Brazil
  • Negative Sentiment
  • Commercial Real Estate (CRE)


Note all figures in Brazilian Real
BR properties (BRPR3.SA) presents a situation where real macro and micro headwinds have impacted the fundamental prospects of the Company, but the drawdown in the stock is almost certainly an overreaction. The market may also be overly focused on their more glamorous Rio and Sao Paolo properties and less aware of the unsexy yet attractive industrial leasing business. The dislocation has presented an opportunity to buy a best in class real estate owner in a market with attractive long term fundamentals at a ~10% forward cap rate. I believe there is at least 30% upside to the equity with downside that should be fairly mitigated.

Company Overview:

  • BR is the largest commercial property Company in Brazil, with ~2MM sq ft of Gross Leasable Area (“GLA”) across 123 properties
  • The Brazilian real estate industry is relatively fragmented with top 10 property owners accounting for ~12% of total GLA (BR is the largest with ~5% of total GLA).
  • Brazilian real estate equities (along with much of the rest of the market) have been pressured by concerns over monetary tightening and rising rates. Property stocks in particular have been vulnerable due to rate exposure as well as signs of rising vacancies and pricing softness exacerbated by a meaningful supply pipeline.
  • The company is particularly exposed to AAA office space in the generally attractive Rio and Sao Paolo markets. They also have significant exposure to the attractive industrial leasing space.  Rio AAA accounts for ~31% of revenue, SP AAA accounts for ~10% of revenue, and industrial accounts for ~35% of revenue. They also derive 14% of revenue from SP non-AAA, 8% from Rio non-AAA and the remaining ~3% from retail leasing and other regions.

Financial Summary:

MM R$ 2009 2010 2011 2012 2013E 2014E 2015E 2016E 2017E
Net revenues 113 204 343 631         935     1,055        1,135        1,191        1,251
Cost of goods and/or services sold 0 0 0 0 0 0 0 0 0
Gross profit  113 204 343 631 935 1,055 1,135 1,191 1,251
Administrative expenses (25) (36) (49) (94) (131) (137) (136) (143) (150)
Other operating income/expenses 1 2 (4) 1 (9) (5) (6) (6) (6)
Operating income (EBIT) 88 170 290 538 796 913 993 1,042 1,095
Net Interest (42) (76) (224) (364) (439) (427) (411) (394) (374)
Other non-operating income/expenses 205 1,049 443 1,740 0 0 0 0 0
Income before taxes 251 1,144 509 1,914 356 486 581 649 720
Taxes and provisions (84) (323) (174) (686) (18) (24) (29) (32) (36)
Income/(loss) before minority interest 167 821 335 1,227 338 462 552 616 684
Minority interest and other 0 0 0 0 7 0 0 0 0
(-) Non-recurring gains (losses) 122 718 228 1,082 1 0 0 0 0
Recurring net income 45 103 107 146 337 462 552 616 684
Recurring EPS, local currency, fully diluted 0.71 0.75 0.67 0.60 1.08 1.48 1.77 1.97 2.19
   % growth   6% -11% -11% 81% 37% 20% 12% 11%
P/FFO         17.6x 12.9x 10.8x 9.6x 8.7x
EV/EBITDA         13.6x 12.0x 11.0x 10.5x 10.0x
Profitability/ income statement ratios 2009 2010 2011 2012 2013E 2014E 2015E 2016E 2017E
EBITDA  88 170 290 555 801 913 993 1,042 1,095
FFO  45 103 107 146 337 462 552 616 684
EBITDA margin 78% 83% 85% 88% 86% 86% 88% 88% 88%
Net margin 40% 50% 31% 23% 36% 44% 49% 52% 55%
FFO margin 40% 50% 31% 23% 36% 44% 49% 52% 55%
G&A % of sales 22% 18% 14% 15% 14% 13% 12% 12% 12%
Operating data 2009 2010 2011 2012 2013E 2014E 2015E 2016E 2017E
Accumulated GLA ('000 m2) 631.9 1,133.3 1,136.6 1,866.6 1,952.0 2,012.7 2,012.7 2,012.7 2,012.7
Average rent/m2 30.4 38.1 42.8 66.6 80.6 88.8 92.6 97.2 102.0
Occupancy rate (%) 98% 92% 97% 97% 97% 96% 96% 96% 96%
Change in implied rent   15.7% 23.6% 38.6% 15.0% 10.0% 7.5% 5.0% 5.0%

Situation background:
The stock is down ~24% YTD (~double the decline in the broader index) as macro concerns about Brazil, as well as slightly increasing vacancies in Rio/SP have spooked the market. I believe these concerns are overblown and the stock presents and attractive opportunity here.

Key Points:
Over the past several years, BR AAA offices in Rio have tended to be in low single digits (<5%) while rents have been stable. A pipeline of new developments in the process of coming on-line has put pressure on vacancy and rent levels for the overall market. These new projects will contribute the equivalent of ~20% of exisitng Class A stock over the next 18 months. This is bad for BR's class A exposure, but should have a more moderate impact on their AAA exposure which is a much larger segment for BR (33% of overall revenue v 8%). It is worth pointing out that existing stock of office space in Rio is not particularly suited for an increasingly global city with only ~3% of the market considered AAA and only 14% A. Almost half the overall office space market lacks central A/C so BR is playing in a small niche here. It is worth pointing out that all office leases in Brazil are adjusted for inflation on an annual basis. Additionally, all leases contain a mark to market provision enabling either the landlord or tenant to open the lease basis to market repricing every three years. Given the strength of the market, this has worked in BR's favor and so-called lease spreads have yielded increases of 20-30% above inflation. Also, note tenants generally have the ability to cancel a lease with 3 months notice and 3 months of rent payments so a landlord effectively has 6 months to find a replacement tenant (a situation BR recently experienced in Rio).

SP AAA has a similar dynamic, with BR's historical AAA vacancies <5% and stable to slightly growing rents. Like Rio there is new capacity being added here, but it also tends to skew away from AAA class (and represents ~15% of exisitng A stock over next 18-24 months). BR's AAA spaces in SP are in a niche with only 6% of total stock considered AAA. One potential area of concern is a new project they have opened and have seen slower than expected lease-up rates. This is a function of their unwillingness to offer discounts on leases and there appears to potentially be a disconnect on pricing, but the demand ought to be there.

While perhaps the least glamorous part of their portfolio, the industrial leasing business (which accounts for ~29% of revenue) is arguably the most attractive. Most industrial properties are built to suit with long term leases. Vacancy rates here have remainder <2.5% over the past few years which reflects the customized nature of these properties and the long term duration of the contracts. Importantly, rents here have also been strong with average rent increasing ~9%/year. It is important to note that unlike the office market, built to suit leases don't have the same cancellation provision and while a tenant can get out of a lease, there will be large penalties (essentially the remainder of the lease payments due). This is a very stick market and should provide ballast to the higher risk Rio/SP AAA markets.

The market here seems to be implying either a meaningful decrease in rent rates or an increase in vacancies. Given the fact that lease spreads have been pacing +mid teens in office and + high single digits in industrial, seeing rent rates actually decline seems far fetched. BR is trading at 0.8x book which is below their 3 year average of 1.0x and below peers that trade ~1.4-2.3x book. This doesn't make much sense considering the relative attractiveness of BR's portfolio (esp industrial and AAA skewing). Even a modest re-rating towards BR's LT average of 1x yields a $26 stock price.

P/E Iguatemi BR Malls Sao Carlos CCP Brazil Avg BR Prop Implied BR Prop at avg
2012 13.5x 5.3x 9.4x 11.8x 10.0x    
2013 22.0x 22.0x 16.1x 18.4x 19.6x 17.6x R$ 21.17
2014 16.0x 15.3x 17.5x 16.4x 16.3x 12.9x R$ 25.09
2012 2.0x 1.1x 2.2x 2.8x 2.0x 0.7x  
2013 1.8x 1.1x 2.3x 2.7x 2.0x 0.7x R$ 51.45
2014 1.7x 1.0x 2.2x 2.7x 1.9x 0.7x R$ 50.91

Key Risks
-It will be necessary to keep an eye on emerging supply and lease-up rates. The introduction of new supply is real and while this capacity tends to target BR's non-core single A market, there could be a ripple effect into AAA demand and pricing. Also, it is possible a disconnect is emerging in pricing as tenants appear reluctant to pay the rates demanded by property owners (ie in BR's new JK Towers). This could be a temporary blip while the market clears or it could be indicative of potential pricing pressure to come.
-Macro risks are obviously a factor here. Brazil's economy isn't exactly a picture of strength with general China exposure as well as a potentially dicey consumer credit environment. This risk ought to be at least partially hedgable.
-The company is fairly levered with ~6x of leverage. This debt is adjusted for inflation but so is their rent base so while there could be a timing mismatch in a period of major changes in inflation rate, the difference should balance out over time. But financial leverage could eventually be an operational constraint.

I do not hold a position of employment, directorship, or consultancy with the issuer.
I and/or others I advise hold a material investment in the issuer's securities.


-Market panic about Brazil subsides as investors realize some babies have been thrown out with the bathwater.
-Absorbtion of new properties in SP and Rio doesn't crush occupancy rates or asking rents.
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