Deutsche Wohnen: the P/E 7 stock that defied the analysts

Deutsche Wohnen: the P/E 7 stock that defied the analysts

When does a German property company trading at a P/E of 7 and paying dividends stop being cheap? That is the question hanging over one of the most repeated investment theses of recent years: Deutsche Wohnen, the German giant in senior residences, clinics and — above all — rental housing. The company, owner of a portfolio of more than 100,000 apartments in Berlin, has for years been the perfect example of that asset analysts call "undervalued" while the market decides whether to listen to them.

The thesis is easy to state: a company that makes money, with little debt, growing rents and trading at multiples that would cause panic in other markets. P/E 7, P/E 8, P/E 9: the range comes up in every earnings update. The price targets from the big investment banks — Credit Suisse, Societe Generale, Morgan Stanley, Berenberg, Warburg Research, UBS — have always run ahead of the share price, with figures that in some cases exceeded 44 euros per share.

The analyst consensus that never fails (until it fails)

The consensus data is overwhelming. In February 2017, the list of recommendations was a parade of buys: Bankhaus Lampe at 34 euros, DZ Bank at 36, ABN Amro at 35, Deutsche Bank at 37.50, UBS at 37, Morgan Stanley at 39. Only Goldman Sachs dared to issue a sell with a price target of 28.20 euros. The stock, at the time, was hovering around 32 euros.

The optimists' argument rested on three pillars: rent growth in Berlin, the possibility of selling assets with accounting gains, and a solid balance sheet. Credit Suisse summed it up in 2016: "the property group has the highest-quality portfolio in the German sector." Societe Generale raised its price target to 44 euros, upside of more than 35% on the then share price.

Some argue that consensus was too optimistic. The stock, after touching multi-year highs on several occasions, has alternated corrections and rebounds. In April 2018, Barclays raised its price target to 39.60 euros but kept its rating at equal weight — neither buy nor sell — a sign that the upside was starting to run out. Berenberg, for its part, raised its target to 43 euros with a buy that sounded more like inertia than conviction.

Why does a profitable company trade at a P/E of 7?

The short answer is that the market doesn't always pay for current profits. The long answer has to do with the sector: German property companies trade at structural discounts to their European peers because of rental regulation, political risk and the perception that Berlin housing prices cannot rise indefinitely.

The company, meanwhile, has kept expanding its business. In recent years it has invested in 30 new nursing homes, has paid dividends in the form of scrip dividends — shares instead of cash — and has maintained a policy of rental growth that, according to available data, has translated into consistently good quarterly results.

The detail that doesn't quite add up is the share price performance. Messages celebrating a "new multi-year high" alternate with others talking about "corrected and at a P/E of 8." The stock has gone up, yes, but not at the pace the price targets suggested. A calculation circulating among trinc of the stock points to a cumulative two-year return of 100% — a figure that, while not bad, falls far short of the returns the most enthusiastic analysts were promising.

The German property sector: growth or value trap?

The comparison with Spain is inevitable. A company managing 100,000 apartments in Berlin and trading at a P/E of 7 has no equivalent in Spain, where REIT-type socimis trade at far higher multiples. The difference has to do with the size of the German market, the stability of rents and the absence of a property bubble comparable to Spain's.

But also with regulatory risk. Berlin has been the scene of debates about rent freezes that, if implemented, would directly hit the company's revenues. That is the argument the sceptics make: a company that depends on rent increases in a politically tense market is not as safe as it seems.

The classic value investing thesis — buy cheap, wait — has worked only halfway. Those who got in in 2016 and held on have seen their investment grow, but not in a straight line. Corrections have been frequent, and so have the scares. The question nobody answers with data is whether the P/E of 7 reflects an opportunity or a warning.

Quarterly results: the movie that keeps repeating

Every earnings release trinc the same script. The numbers are good, FFO grows, rents rise, debt stays under control. Analysts update their price targets upward. The stock rises a little. And back to the start.

In November 2016, nine-month results showed FFO growth the company described as solid. In 2018, annual results beat expectations again. The company has been, for years, a machine for meeting forecasts. In the investment world, that is rarer than it seems.

What hasn't changed is the multiple. It remains around a P/E of 7-8, no matter how much the stock rises. That means profits are growing at the same pace as the share price, which in theory is good — no multiple expansion — but it also implies the market isn't quite buying the story.

The dividend as an argument (and as an alibi)

The shareholder payout policy is one of the pillars of the thesis. The company has paid dividends consistently, in some cases in the form of shares, which allows reinvestment without cash outflows. For a long-term investor, that detail matters: the scrip dividend dilutes less than it seems and keeps cash flow within the company.

The payout ratio, according to available data, is around 38%. Not an aggressive payout, but not conservative either. The company balances growth with shareholder returns, a strategy that in the German property sector is more the exception than the rule.

The problem is that the dividend alone doesn't justify an investment. If the stock doesn't rise, the return is limited to the income yield. In a low interest rate environment, that yield may be enough. In a high rate environment, it isn't.

What those who have trinc it for years say

The conversation about Deutsche Wohnen trinc a recognisable pattern. Every time the stock corrects, the "it's cheap" argument appears. Every time it rises, out comes "it's heading for new highs." The P/E of 7 is repeated like a mantra, almost as a guarantee that the market is wrong.

But sometimes the market isn't wrong. It's simply pricing in things analysts don't see: regulatory risks, shifts in housing demand, competition from other assets. The story of Deutsche Wohnen is, in that sense, a lesson in the limits of fundamental analysis.

The company keeps making money. It keeps growing. It keeps trading at multiples that look low. And it keeps, year after year, generating a debate that never gets resolved: is it an opportunity or a trap? The answer, as always, depends on when you get in and when you get out.

In the end, the only thing that is clear is that the P/E of 7 has not been enough for the stock to perform the way the analysts promised. And that, in the investment world, is about as close to a warning as you can find in an earnings brochure.