Buying Centurion: benefiting from better worker accommodation

Growing real estate company generating high returns & trading at a discount to NAV. Niche might be seen as risky but I see a structural growth opportunity.

Centurion is a real estate company focused on worker accommodation & student housing. The company has not been harmed by higher interest rates. The company has been performing & even with the share price doubling since the start of 2023 the stock still feels cheap.

This stock was brought to my attention by an article of Myles Kuah. A younger me would have stopped after seeing a move up like me. I would think I had missed it. Appreciating the value of upward business momentum, I decided to look a little further.

Business momentum

Business momentum was already visible in the year end numbers of 2023. Looking at the numbers of H1 2024 Centurion has shown a continued strong increase in their accommodation revenue.

Strong operational performance of Centurion is coming from more beds & higher rents. Demand for worker accommodation is coming from a diverse base of industries. Still construction, a very cyclical sector is dominant with 53%.

Regulation

An important consideration with both immigrant worker & student housing is regulation. Many cities & countries have strong regulation in place for the housing of both. Most of these regulations are quite nimby (not in my backyard) in nature. They limit the amount of construction. This tends to have a favorable impact on pricing. Something governments are slightly less concerned with given that the people harmed are not an important political group.

After covid-19 health and worker circumstances became a more important factor for governments. In Singapore this resulted in stronger regulation forcing employers to organize worker accommodation. This clearly boosted demand and helped Centurion.

Still given the shortage of accommodation & the lack of incentives at the government level to push rents down I think it is likely that current rental rates will persist.

Valuation

Given that Centurion is a real estate company the value of the assets is of critical importance.

Discount to assets

NAV is S$1.12. This means that the stock at 0.70 is trading at a good discount to the value of the assets. The core earnings per share at 5.77c for 6 months also shows that the earning power of the assets is quite good.

Centurion has a decent dividend yield (4.3%) with good growth prospects & low payout ratio. I find it likely to get a 2.0c final dividend for year end. Leading to an expected dividend yield of 5.0%.

Are Centurion properties undervalued?

Looking at the high core earnings compared to the fair value got me thinking. The fair value is likely still undervaluing the properties in my opinion. This is rather unusual. Most of the time I think properties are worth less than the stated value.

What are the reasons for potential inaccurate valuation:
Strong rent increase not fully incorporated in the value of the properties. Likely in my eyes. Higher value come with a lag given that valuation officers tend to be slow in updating the value.

Higher interest rates lead to higher discount & capitalisation rates. Likely, but justified.

Niche assets require higher discount rate. This is normal, but not something I’m a big fan of. I like renting to both students & migrant workers more than an average rental business. The ability to increase rents quickly and the specialized knowledge needed to run such an operation both appeal to me.

So, undervaluation is likely. Let’s check the details in the annual report of 2023.

2023 shows a strong net fair value gain of S$85M. This looks quite significant but look at the rental income.

In 2022 the properties traded at 12.57 times net rental income.
In 2023 this declined to only 10.45 net rental income. The margins also increased which usually is correlated to the quality of the earnings.

Looking into even more detail we see the results per country.

UK: fair increase in the capitalisation rate. Would classify between 5.8%-7.0% as fair for student rental properties. At least a lot more conservative than the 5.7% Xior Student Housing puts on their portfolio. Roughly in line with what Google gives me as normal 6.1%-6.6%.
Singapore: Most important market (51% of value). Strong increase in value. Rents have shot up due to high demand and strict regulation. 6.8%-7.5% feels fair to cheap to me. Given the interbank rate in Singapore since the end of July dropped from 4.05% to 3.70%. In addition, office cap rates in Singapore are between 3.0%-3.5% (what on earth). This leaves the worker accommodation with a decent premium.

Malaysia: Decrease in value due to sale and leaseback construction with a Malaysian pension fund (S$$65M). This deal selling to a Malaysian pension fund and renting back for 15 years is quite positive. It shows larger investors close to the government see worker accommodation as a force for good. Taking that into account the valuation is roughly flat. Capitalisation rate of 7.5%-8.5% is very reasonable given the 3% interest rate in Malaysia and its economic status.
Australia: Very small increase. Quite surprised here with the minimal increase in value. The discount rate of 9.4% seems excessive to me (capitalisation rate of 6.3% is quite lenient). No value given to the expansion possibilities (increasing with 575 beds from 887 beds).

Conclusion on valuation

The valuations rates used are conservative which leads to good earnings & cash flows at current valuation. The company is focused on a niche which has some favorable characteristics in my view. Them being that the term of rent is relatively short & that the user in many cases is not the one paying.

New valuations at year end 2024 are likely to be higher again given the increase in rent that Centurion was able to get & lower interest rates. Leverage is very acceptable at 34% and allows Centurion some room to grow through investments without raising capital. Being able to buy these assets at a significant discount is attractive to me.

Risks

Cyclical

Not a surprise to anyone but immigrant worker accommodation is cyclical. If unemployment in Singapore increases significantly and demand for immigrant workers dries up this is bad for Centurion. That being said I do think that in a scenario with a modest increase in unemployment demand for immigrant workers will not be that badly affected.

Student housing has very different dynamics. People can be incentivized to study longer when unemployment is high. In addition, people might stay longer in student housing if they cannot find a well-paying job. Student housing does work as good diversification for the company.

Management

Given the significant ownership by management I think shareholders interest are fairly well aligned with management. Management is clearly aggressively looking for ways to expand & grow faster. The company clearly tries to grow in a more capital light fashion. This to boost growth & shareholder returns. Disclosure is somewhat limited. On face value I would say a sale and leaseback construction with a Malaysian pension fund could be an interesting way to recycle capital while holding onto a significant part of the earnings.

A student housing fund like the one in the US looks attractive as well. I’m afraid we will not see a second US student housing fund and the first one is in the process of winding down. Will be interesting to see what the returns are when it closes.

Growing in China

The company started this year with student & worker housing in Hongkong. This makes sense and is in line with the companies core competencies. Given the real estate market in Hongkong I imagine there might be good opportunities.

More recently it moved into a JV for a long-term rental of an apartment building in Xiamen. Build to rent apartments for young professionals looks like a more normal rental business. I don’t see how this relates to their known skills.

An exception would be if the apartments would be rented by the employer instead of the employee. So far, I have not gotten the indication that this is the case.

That being said I think it is probably a good time to sign long term rental agreements for apartment complexes in China. If Centurion can get good deals and ringfences the risk in China, the rewards of the investments in China can be great.

Conclusion on management

Management is enterprising & clearly focused on growing the business while keeping a focus on returns. Management focuses on two specific niches which allow for above average returns. Investments in China are interesting & given management track record get the benefit of the doubt for me.

Summary

Worker accommodation is cyclical but given the migrant housing shortages in Singapore & the regulatory framework probably less cyclical than you would think on first glance. Real estate valuations are conservative & investors are able to buy in at a nice discount. Leverage is very acceptable & management is enterprising & focused on creating shareholder value.

I initiated a position myself before the H1 results at S$0.63. Thinking about increasing what is now a 3.5% position.

Disclaimer: These are my ideas and not personal investment advice. I might own shares discussed and can sell those shares at all times. I don’t know your financial situation. Do your due diligence and do not blindly follow an article on the internet.