Well positioned for cyclical recovery
#themes: Improving macros, stronger property demand
Balwin Properties (Balwin) is South Africa’s leading developer of large-scale sectional title residential apartments with estates in Gauteng, the Western Cape and KwaZulu-Natal. The company operates a build-to-sell model and typically sells between 2,500 and 3,000 apartments each year, with a strong focus on quality, environmental efficiency and affordability. Structural growth drivers for the company include the move to safe estate living, quality and innovative construction and the provision of properties in the major growth areas of South Africa.
The first half of FY25E is expected to be operationally challenging for Balwin after several years of strong property sales as the company delivered on pent-up demand following Covid and as buyers took advantage of relatively low interest rates. Higher interest rates into CY23 coupled with poor consumer sentiment have dampened demand for apartments, particularly in Gauteng. With lower levels of load shedding, a more stable political outlook and the commencement of the interest rate cutting cycle, consumer sentiment is expected to further improve. The outlook for buyers of and investors in residential property is therefore beginning to look more positive.
The company is currently trading at both low PE and price-to-book multiples, based on depressed earnings, and our forecast of a rebound in earnings into FY26E and beyond is not currently reflected in the share price, in our view. With a strong focus on returns, together with improving tradability, we believe these discounts will be reduced. The loan-to-value ratio for Balwin is currently 40% and this should decline to 28% over our forecast period as the company unlocks value from developments under construction.
The residential property sector remains small compared to the much broader real estate sector in South Africa, but the dynamics of growing demand for affordable housing, reducing interest rates and improving consumer sentiment should result in strong returns for investors wanting exposure to this sector.
Management recently announced an expanded strategy to grow its residential rental market and complement its existing build-to-sell portfolio with a number of proposed developments to be built on unused land already owned by the group. Still in the early stages of formulation, this strategy will create a more defensive asset class and diversify the group’s revenue stream as the level of annuity revenue is currently low.
Despite the still challenging operating environment expected in FY25E but helped by working capital improvements and cost containment measures, we forecast net debt to decrease from R2.8bn in FY24 to R2.3bn and R1.9bn in FY25E and FY26E respectively. We do not expect a dividend to be declared in FY25E but expect a moderate dividend of 19c in FY26E.
We initiate coverage of Balwin Properties with a fair value range of R1.86 to R2.86, providing an estimated total return of -9% to 40%. The three valuation methodologies used were residual income, discounted cash flow and intrinsic value. We forecast FY25E and FY26E dHEPS of 44.4c (-8%) and 56.1c (+26%) respectively, with DPS over the same period of zero and 19.0c respectively.
Risks: Macroeconomic challenges regarding interest rates and consumer sentiment, impact of weak unit sales on cash flow generation, delays in obtaining planning and regulatory approvals, reliance on key suppliers and contractors and excessive growth in land bank and number of apartments to be developed. Increased funding costs may also be an issue.
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