kwg kommunale wohnen - src research

KB

WG Kommunale Wohnen

Price (Euro) 4.4552 weeks range 5.00 / 3.30

Key Data

Segment Open Market (Entry Standard)ISIN DE0005227342WKN 522734Reuters BIWG.DEBloomberg BIW GYReporting Standard IFRSIPO 2001Ø Daily Turnover in € (3M) 11,551Market Cap (EUR million) 43.7Number of shares (million) 9.8Free Float 35.0%Free Float MCap (million) 15.3CAGR pre tax profits 09-12e 28.1%

Multiples 2009e 2010e 2011e 2012e

MarketCap/ Sales 1.8 1.8 2.1 1.4PE-Ratio 13.4 38.4 4.7 6.9Dynamic PE-Ratio 0.48 1.37 0.17 0.24Dividend Yield 0.0% 0.0% 0.0% 0.0%Price-to-Book ratio 67.5% 66.3% 58.1% 53.6%

Key Data per Share (Euro) 2009e 2010e 2011e 2012e

Earnings per Share (EPS) 0.33 0.12 0.95 0.65Dividends per Share (DPS) 0.00 0.00 0.00 0.00Book Value per Share (BVPS) 6.59 6.71 7.65 8.30

Financial Data (Euro '000) 2009e 2010e 2011e 2012e

Revenues (rental income) 19,762 20,256 21,674 22,108net revaluation result 4,003 1,001 9,006 5,403Total operating income 23,765 21,257 30,680 27,511Operating profit (EBITDA) 9,182 7,020 16,817 13,391Operating Profit (EBIT) 9,102 6,919 16,708 13,280Pre-tax profit (EBT) 3,640 1,368 11,096 7,655Net profit (after minorities) 3,265 1,137 9,303 6,360Adjusted Shareholders' Equity 64,748 65,885 75,188 81,548RoE after tax 5.4% 1.7% 13.2% 8.1%

Financial Calendar

Annual report 2009AGM1H 2010SRC Forum Financials & Real Estate

Main Shareholders

group of core shareholders 65%

Analysts André HüsemannStefan Scharff, CREA

E-Mail [email protected]@src-research.de

Internet www.src-research.dewww.aktienmarkt-deutschland.dewww.aktienmarkt-international.de

May 20105 July 2010

August 201014 September 2010

Sac

19 | April | 2010

uy (Initiating Coverage) Target: Euro 6.50

mall but nice - A German residential story with solid base and great upside - we start the KWG overage with Buy and a target of 6.50 Euros KWG Kommunale Wohnen AG is a long-term orientedowner of residential properties in Germany. The com-pany has a portfolio of about 5k units with a space of285k sqm in Germany. The investment focus is on neg-lected portfolios in fundamentally good regions, whichoffer relatively low prices per square meter (currentlythe average price per sqm in KWG’s portfolio is at 600Euro) and low buying multipliers (initial multiplier: 11.6).The sub-portfolios of Saxony (39%) and NRW (21%)represent c. 60% of the portfolio. On the upside theinvested locations show a solid local economy and astable population, ensuring a constant tenant demand. The acquired portfolios usually show an investmentbacklog and vacancy to work on. Currently the portfoliocan be divided into core and an investment portion, witha vacancy rate of 6.5% and 33.8% respectively. Atacquisition KWG usually does not pay any multiple forthis vacancy but has the potential upside through re-ducing vacancy and enhancing value. This is the maintrigger of the company. Due to its active asset mana-gement KWG was quite successful within its portfolio inthe past. E.g. within its Wolfsburg II portfolio KWG wasable to achieve a return on equity of c. 24% due to itsrefurbishment and rising rental income. The annual rentcould be increased by 112k Euro (after financing costs)through investing equity of 471m Euro. Bearing the33.8% vacancy within the investment portfolio in mind,there is further interesting upside potential like this. Last week KWG announced its prelim 2009 with ahike in net profit from Euro 0.8m to Euro 3.3m. Thegood results came from both cash earnings and reva-luation gains. The rental income jumped by 44% afterportfolio expansion by > 2,000 units in 2008 which con-tributed the first time fully to the yearly numbers. Reva-luation result in our view was also positive in a range ofEuro 3.5m after some successful completion of refur-bishment activities. Equity ratio rose to 34.5% (30.5%). Our conservative DCF model gives us a Fair Valueprice target of Euro 6.50, which is underlined by theNAV and peer group valuation based on 2010 and 2011estimates which all show a Fair Value even higher. KWG will deliver a steady rising rental income(+12% until year-end 2012) and a jump in net incomefor the next year 2011 when current Celle andGelsenkirchen-refurbishments are completed andgo to the P&L. The 2011e PE ratio will then be onlyat a tiny 4.7X. We start coverage with a Buy ratingand a TP of € 6.50 meaning almost 50% upside.

19 | April | 10

KWG Kommunale Wohnen AG

2

SWOT – Analysis Strengths Core investors showed its commitment within the recent capital issues. At the

same time investors (especially Ehlerding family) have a broad experience in

the Real Estate Sector.

Excellent network and relationships combined with a proven track record will

enhance further deal flow with municipalities.

High yielding residential property portfolio in solid fundamental regions with

a proven track record in respect of asset management.

Strong equity ratio of 34.5% as of December 2009 vs. German peers 24%

Very good inner-city locations like for instance in Bochum and Gelsenkirchen

Weaknesses Small market capitalization (only about Euro 50m) of the company leads to

limited visibility at investors with high investment volume.

Low trading volume of the stock, and therefore reserve of investors that fear

iliquidity.

Capital increases are needed for further significant growth The GSW-IPO

(50k Berlin-based residential units) coming in May might give an indication

Opportunities Positive cash earnings property portfolio with further upside potential.

Proven track record makes municipalities confident for further deals with

KWG as reliable partner. This increases the chance off-market transactions.

Market for deals with municipalities has potential, due to the general

economic conditions and low tax income. This might increase the willingness

and the price by selling municipal housing companies.

Fire sale opportunities due to the current financial market crisis. Some

investors from former years until 2007 might be forced to liquidate their

portfolios

Resent change in the Entry Standard will lead to higher visibility and broader

potential investor base. The next step would be the change in the Prime

Standard, which would favor the visibility and investor base further.

KWG started to set up its own property management and already 50% of all

units are managed here. From 1Q 2011 even more than 90% will be managed

by KWG itself. This will lead to a reduced costs base (Euro -0.2m p.a.) and

also to a better tenant structure and to an improved rental success. Threats

Funding of acquisitions and refurbishment projects could become problematic

if financial market crisis continue. But no refinancing needs until 2012!

Typical risks of purchasing properties (higher costs than originally planned).

2 | SRC Equity Research

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3

All valuation methods show Fair Values above € 6.50 per share The sum of valuation leads to an average fair value of 6.84 Euros per KWG share

We make use of three types of models in our valuation: the absolute valuation model Discounted Cash Flow and the relative valuation model based on a sample of peer companies comparable in terms of size, invest-ment focus and/ or corporate strategy. In addition we at NAV development for 2010 and the following years.

The results of all valuation methods are at least 6.50 Euros per KWG share

Source: SRC Research, upside potential is based on a share price of 4.45 Euro

Valuation Method Fair Value Upside

Peer group 7.27 63%DCF 6.54 47%NAV (at 2010e) 6.71 51%Average 6.84 54%

Gererally we weight all three valuation methods equally with 33%. The peer group valuation represents the upper part of the valuation range. The DCF model shows the potential of the company in the future, based on our very conservative asumptions. The combination of the market-oriented peer group comparison, the asset based NAV and the intrinsic value-oriented DCF model results in a fair value of 6.84 Euro per share for KWG.

Initial price target set at the lower end at 6.50 Euros

We set our initial target price at the lower end of above mentioned values at Euro 6.50 which reflects a very good share price potential of almost 50%.!

Peer group valuation The shares in KWG are listed at Frankfurt stock exchange where they are quoted in the Entry Standard. In terms of portfolio and corporate structure, KWG can in our opinion be readily compared with a number of residential property companies listed on the SDAX, MDAX and ATX. Placing the focus on residential activities in Germany, we have compiled a mixture of property holders, sellers (meaning companies with significant trading activities besides the property holding business) and service providers. The peer group thus consists of GAGFAH, Deutsche Wohnen, Conwert Immobilien, Colonia Real Estate and TAG Immobilien.

Comparison index MDAX, SDAX and EPRA Europe

The relevant multiples that we use are EV/ EBITDA and FFO margin. We consider the substance of the company to be reflected in this mixture as well as the profitability.

Multiples: EV/ EBITDA and FFO yield


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KWG is clearly cheaper than its Peer Group although we expect good future cash results to come…

Source: Reuters, Bloomberg, latest company data and SRC Research

ComGAGFDCoCT

Av

F

Peer Group Price as of EV in m MDAX SRCpany 4/16/2010 10e 11e 12e 10e 11e 12e BETA Rating

AH 6.92 7,859 17.7 16.6 17.1 12% 12% 13% 1.16 -eutsche Wohnen 7.26 2,634 18.0 16.6 16.0 7% 6% 6% 1.28 -

nwert Immobilien 9.38 2,223 12.7 13.0 12.4 7% 6% 6% 0.80olonia Real Estate 4.80 684 19.4 18.0 16.3 -2% 3% 6% 1.69 -AG Immobilien 4.19 679 9.4 3.7 3.2 2% 4% 3% 0.69 -

erage 15.4 13.6 13.0 5% 6% 7% 1.13Median 17.7 16.6 16.0 7% 6% 6% 1.16

KWG 4.45 152 15.9 11.4 10.9 6% 13% 15% 0.55

air Value KWG 7.27 4.95 6.48 6.53 4.01 10.56 11.08

EV/ EBITDA FFO yield

Based on our estimates the KWG shares appear on balance to be under-valued. The methods that we have applied reveal a FV of Euro 7.27.

Peer group valuation: FV 7.27 Euro per share

Discounted cash flow model We calculate our DCF with conservative assumptions so far in the light of the global economic turmoil which will lead to only small growth rates for current year 2010 (and probably 2011 as well) after the deep recession of growth numbers and the slump of all real estate transaction markets in the second half of 2008 and -more or less- the full year 2009.

We made our DCF model with rather undemanding assumptions

Due to the fact, that KWG is still in the growth mode, we have extended our DCF model adequately. We have divided the growth modes in three phases. Phase 1 (until 2012e) is based on our detailed financial forecast and on the current refurbishment projects with the highest rental income growth. Especially the recently collected funds from the capital increase will burden the cash flow with net capital expenditure of 4.5m Euro until 2012. On the upside we see a rental income revenues growth of more then 5% due to successful implementation of the new units.

Phase 1 until 2012e: with the high rental income growth

In the second phase we consider that the portfolio improvement measures will slow down and that purchases and disposals will balance out in the port-folio. Nevertheless we see KWG continuing the vacancy reduction in its core (vacancy: 6.5%) and in particular in its investment portfolio (vacancy rate here at about 33%). This should be accompanied by a rental income reve-nues growth of 2.5%. Besides the slow down of the rental income growth we expect KWG to work on corporate efficiency. The transition of portfolio into an internal property management will clearly help here to reduce costs and to rise rental income more quickly than in the past. In the long-term we expect EBIT margins excluding the IAS 40 revaluation gains to be at about 45% or even slightly higher. The last section (phase 3) is the calculation of the termi-nal value.

Phase 2 until 2017e: focus on corporate efficiency


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The Cost of Equity (CoE) we set at 7.9% with a risk free rate of 3.5% and a risk premium of 5.0% and a Beta of 0.9 which comes near the correlation between KWG’s residential real estate peers and the German MDAX index (about 1.1). This might be too cautious as KWG shares itself shows a Beta of only 0.55 with the MDAX.

Phase 3 > 2017: Beta above KWG Beta, sales growth of only 2% and CoL clearly above the current cost of debt. The Cost of Liability (CoL) we set at 5.4% which is clearly on the upper end in

the current low interest environment. Bearing the latest refinancing with a rate of 4.05% in mind, perhaps a lower range of 4.2% - 4.8% would be fully sufficient (see “Capitalization” and “Funding further transactions and invest-ments”). In contrast, we feel more comfortable with a conservative assump-tion here that is slightly above KWG’s current cost of debt (5.03%). We have estimated the target debt ratio here at 65% very similar to the current level.

All in all we come up with an undemanding WACC of 6.3%. Owing to the current market situation and the inflation expectations, we do assume a long-term nominal sales growth of just 2%, which does not reflect any potential through further deal flow and the future expansion of the portfolio to far more than 5,000 units. In total our DCF shows a Fair Value of € 6.50 per share.

DCF model valuation: FV 6.50 Euros per share

Despite conservative assumptions for growth and WACC the KWG-share has a current upside of >40% to € 6.50

Source: SRC Research

WACC (weighted average cost of capital) 6.3% CoE 7.9% (long-term share: 35%)years until first pay-out 0.6 CoL 5.4% (long-term share: 65%)growth rate for Terminal Value 2.0%

Phase 3

Euro '000 2010e 2011e 2012e 2013e 2014e 2015e 2016e 2017eTerminal

Value

Rental income from commercial properties 20,256 21,674 22,108 22,660 23,227 23,807 24,403 25,013 25,512.9rental income revenues growth 2.5% 7.0% 2.0% 2.5% 2.5% 2.5% 2.5% 2.5% 2.0%cash margin on revenues 7.2% 51.7% 35.1% 45.0% 45.0% 45.0% 45.0% 45.0% 45.0%

Operating cash-profit after staff and material expenses and other expenses 1,460 11,197 7,759 10,197 10,452 10,713 10,981 11,256 11,480.8

Tax rate on operating cash profit 15.8% 15.8% 15.8% 15.8% 15.8% 15.8% 15.8% 15.8% 15.8%

Net operating profit after tax (NOPAT) 1,230 9,428 6,533 8,586 8,801 9,021 9,246 9,477 9,666.8+/- Change in Working Capital -2,500 -1,700 -300 -200 -200 -200 -200 -200 -200

Free cash flow -1,270.5 7,728.3 6,233.4 8,386.0 8,600.6 8,820.6 9,046.1 9,277.3 9,466.8

Free Cash Flow margin -6.3% 35.7% 28.2% 37.0% 37.0% 37.0% 37.1% 37.1% 37.1%

Present Value of Free Cash Flows -1,224.9 7,011.2 5,321.1 6,736.0 6,500.5 6,273.1 6,053.7 5,841.8 131,208.3

Total of Free Cash Flows 173,721+ non operating assets 0Enterprise Value 173,721

+ cash and cash equivalents (as of June 2009) 7,800

- interest bearing liabilities (as of June 2009) -116,774

- market value of minorities -500

Current Equity Value 64,247number of shares ('000) 9,822

Fair Value per KWG share 6.54 €

Phase 1 Phase 2


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Sensitivity analysis allows for even more upside…

After we already suggested that our assumptions are rather conservative we choose a sensitivity matrix to give a more detailed picture.

For this sensitivity picture we took WACC-numbers in the range of 5.6-6.9% and Terminal value growth rates between 1.5% and 3.0%.

The best estimate for the long-term Fair Value is between 5.2 and 8.2 Euro


The grey part of the matrix shows the most realistic range for the Fair Value of the share in our opinion

Sensitivity AnalysisTerminal Value growth 5.6% 5.9% 6.3% 6.6% 6.9%

1.5% 7.95 € 6.57 € 4.99 € 3.97 € 3.07 €

2.0% 10.07 € 8.35 € 6.54 € 5.21 € 4.15 €

2.5% 12.87 € 10.66 € 8.25 € 6.76 € 5.47 €

3.0% 16.75 € 13.76 € 10.62 € 8.73 € 7.13 €

Weighted Average Cost of Capital (WACC)

In our view the grey area of sensitivity matrix gives the most realistic picture where the Fair Value of the KWG share is located in a mid- and long-term view. Thus our best estimate projection is a range between Euro 5.21 and Euro 8.25 per share. It is interesting that the upper end of the grey area of sensitivity matrix (Euro 8.25) is very near to our expectation of 2012e NAV per share (Euro 8.30).

Thus our initiating target price of Euro 6.50 is clearly much more on the lower end of this range and still offers at least a 40% upside potential for the share price development. An upside potential near to 100% is also not too far away in our mid-term view.


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NAV still with great potential ahead of the share price With our net asset value method we aim to prepare near-market information based only on the portfolio the company holds. Besides the number of units KWG was able to increase its NAV in the past successfully, due to interesting acquisitions and successful asset management. With this development KWG showed that it is able to integrate the acquired portfolios effectively.

Successful asset mana-gement will boost NAV per share to more than 7.50 Euros at year-end 2011.

There is upside for NAV from the refurbishment and later rise in rental income in the investment portfolio even with an only slightly rising number of flats

Source: company data and SRC Research

92

1,198

2,981

4,937 4,856 4,905 4,954 5,003

0

1,000

2,000

3,000

4,000

5,000

6,000

Dec. 06 Jun/ 07 Dec. 07 Dec. 08 Jun/ 09 Dec. 09e Dec. 10e Dec. 11e0.00

1.00

2.00

3.00

4.00

5.00

6.00

7.00

8.00

9.00

Units NAV per share

We expect KWG to continue this development and that the planned invest-ments and own asset management activities which already started in 2009 will lead to future valuation gains. From 2010e to 2011e where we assume conservatively no significant portfolio expansions. We expect the NAV per share to rise from 6.67 at 1H 2009 to 7.65 Euro as of year-end 2011e.

With a NAV per share of 6.67 Euro the KWG shares are trading at a huge discount of 32% on the basis of a current share price of Euro 4.55. Even if the capital market currently applies a discount of approx. 40% on the NAV of most residential real estate companies for 2010e and 2011e respectively we regard this discount to be too much since KWG has a good track record for refurbishing big residential units and quickly rent it for much higher sqm prices than before (see the Wolfsburg-example at page 15). Thus the com-pany continuously offers rental yields (8% to 10%) significantly far above its financing costs (at 5.0% or even lower with new credit contracts).

NAV year-end 2010e: Euro 6.71 per share NAV year-end 2011e: Euro 7.65 per share

As already explained under the DCF section, we see KWG figures biased, due to the development and growth phase the company’s portfolio goes thru. Hence we expect the NAV at year-end 2010 (Euro 6.71) only slightly higher than at year-end 2009 (Euro 6.59). After completion of the important invest-ment sub-portfolios in Celle (172 units) and Gelsenkirchen (143 units) until year-end 2010 we expect the NAV per share to strongly rise the next year 2011 by more than Euro 1.00 per share to Euro 7.65 (and also of course the rental income by almost Euro 1.5m in 2011).


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Sound capitalization and no refinancing needs until 2012

KWG shows a solid capitalisation in our view. At total assets of about Euro 188m, KWG recorded an equity ratio of 34.5% with its prelim numbers on 14 April and the LTV ratio was at 68% at 1H 2009.

The capitalization is ahead of Peer group, the LTV in-line with peer group, no financing needs until 2012


GPeer Group Capitalization Total assets Equity Equity ratio Loan to value

agfah 9,777 2,458 25% 70%Deutsche Wohnen 3,079 862 28% 62%Conwert Immobilien 2,962 1,280 43% 55%Colonia Real Estate 877 245 28% 63%Patrizia 1,426 285 20% 86%TAG Immobilien 796 219 28% 67%

Average 29% 67%Median 28% 63%

KWG 188 65 35% 66%

With a solid funding base, the average maturity of debt (Euro 116m Euro) is at 4.9 years.

KWG’s funding is also well structured. As per 30 June 2009, KWG recorded financial liabilities vis à vis banks of c. Euro 116m. In December 2009 KWG announced successful extending of credit lines and the restructuring of its loan portfolio so that no further significant refinancing is required until 2012.

KWG was able to refinance at an average interest rate of 4.05%, which matches with the development on German covered bonds combined with iTraxx (see “Funding further transactions and investments”). The average maturity of the financial liabilities is 4.9 years and KWG has divided the funding up into several packages with more than 6 banks which speaks for a rather granulated situation at the loan side. This also diversifies the risk for the banks and will make prolongation negotiations easier. In addition KWG has build up relationships with several financing partners that can be useful in further deals and makes KWG much less dependent on one single lender.

Granulated credit portfolio and very comfortable situ-ation at the credit expiry profile

Very comfortable situation at the credit expiry profile

Source: company data

2.48.6 11.0 9.2

20.114.8

9.93.4

25.6 25.6

0.00.005

10152025303540

2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

Euro million

Prolongation option until year-end 2012


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First refinancing needs are after mid 2011 by a very tiny Euro 2.4m, representing just 2.2% of the total loan portfolio of Euro 116m. We see no major issue

within the financial liabili-ties of KWG until 2014 ! The only mid term risk one could see at KWG’s financial structure is a

position in mid 2012, where KWG has a volume of c. 35m Euro due. But it has to be considered that KWG has the option to extend Euro 25.6m of these liabilities until 2014, which will probably be exercised (option for KWG until year-end 2011). We might also imagine that KWG will exploit the prosperous interest rate environment and negotiate about an even cheaper refinancing

KWG might exercise the prolongation option for a Euro 25m loan in 2012 or even search for a cheaper refinancing… So with volumes of roughly Euro 10m in the years 2012 and 2013 to be

prolonged, the sound rise in cash flows after 2010 and 2011 and the existing sound equity base we see no major issue within the financial liabilities of KWG. In addition the success in fixing liabilities totalling 17.3m Euro in December 2009 (before the capital increase) underlines the good relationship of KWG with its financing banks and the confidence in the business model and management.

Equity ratio and LTV development Despite the already good Equity and LTV ratio, we expect these ratios to improve further.

0.0%10.0%

20.0%

30.0%40.0%50.0%60.0%

70.0%

80.0%90.0%

31.12.2007 31.12.2008 31.12.2009e 31.12.2010e 31.12.2011e 31.12.2012e

Equity ratio Loan to value ratio

Source: Company data, SRC Research


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Funding further transactions and investments

Bearing the planned investments and growth path of KWG in mind, a look at the financing conditions is a must. The development of the PEX yields and the iTraxx Europe show that the general financing conditions have improved in latest months and this will favor KWG’s business case in our view, as we have seen in the refinancing announcement of December 2009. Refinancing interest rates as well as risk premiums are at a low level.

Financing conditions have improved in latest months and this will favor KWG’s business case.

Development of 5 and 10 year PEX-rates

6

5

4

2 1

0

3

Jan. 07 Jul. 07 Jan. 08 Jul. 08 Jan. 09 Jul. 09 Jan. 10

5 yrs 10 yrsSource: vdp.de

In June 2007 when the crisis started, PEX-yields (German Pfandbriefindex) still amounted to 4.74% and 4.85% on 5-year and 10-year Pfandbriefe respectively. However, the current PEX yield on 5-year Pfandbriefe is approx. 2.56% and on 10-year Pfandbriefe approx. 3.52%. This means that yields have decreased by approx. 200 and 100 basis points respectively.

PEX yields are down approx. 200bp and 100bp respectively

At the same time, risk premiums in relation to the peak of the iTraxx Europe at the end of 2008/start of 2009 of over 200 basis points have declined to almost 77 basis points at present.

iTraxx Europe has fallen by approx. 120bp

Development of iTraxx Europe 125

20

50

100

150

200

250

.4.07 2.10.07 2.4.08 2.10.08 2.4.09 2.10.09

Source: Bloomberg

Overall, financing conditions have most recently become more favourable in respect of real estate investments. Although the two above trends also contributed to the positive change in the investment climate, we assume that this may have the effect of a “self-fulfilling prophecy” for the transaction market and KWG can benefit from this development in future investments

F“fm

1

inancing conditions are self-fulfilling prophecy” or the transaction arket

10

and refinancing negotiations.


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Company Profile: KWG on the floor since mid 2006

KWG Kommunale Wohnen AG (KWG) is a long-term oriented owner and manager of German residential properties, with a value-add approach. As the core features of the business model KWG itself states:

- Purchase of selected properties with promising returns

Value-add approach: buying at low prices per sqm with very low multiples.

- Increasing cash flows due to vacancy reduction

- Value enhancing through refurbishment and vacancy reduction

- Solid financial structure with long-term financing and a relatively high equity contribution (and an additional 1.3% redemption per annum).

KWG generates value in its portfolio by purchasing at attractive prices on the one hand, and then developing and improving the individual properties. The actual initial return on the portfolio was c. 9% in 2008. Therefore KWG has a team of experienced real estate and financial experts of 22 people.

KWG has the skills to quickly refurbish newly acquired properties and significantly the lift rental income afterwards with innovative marketing

Within its investment approach KWG focuses on properties in locations that offer relatively low prices per square meter (currently the average price per sqm in KWG’s portfolio is at only 600 Euros) and low buying multipliers (initial multiplier only at 11.6), but where the local economy is still solid and popu-lation development is stable, thus ensuring constant tenant demand for affor-dable accommodation.

These circumstances can mostly be found in so-called B- and C- locations where KWG is represented mainly. In terms of vacancy KWG regards a mo-

K m

BtKf

Plcc

1

WG does not pay anyoney for empty flats

11

derate or even middle level of vacancies at the time of purchase as an oppor-tunity to increase the cash flow through proactive asset management. Here a major factor of success is to make the properties more attractive, thus in-creasing tenant satisfaction and reducing fluctuation.

Bearing in mind, that the transaction prices are usually dependent on rental income multiplied with the market factor, KWG does not pay any multiple for the vacant proportion. Beside the upside from the under rented sqm, KWG has the additional huge upside potential from the vacant space.

eside the upside from he under rented sqm, WG has the potential

rom the vacant space. Originally KWG was created from the shell of the former Carthago Biotech AG. In mid 2006, the company have been structured to change its field of business and renamed as KWG Kommunale Wohnen AG. KWG commenced business operations in August 2006.

Investors honored successful story with providing fresh equity

In order to continue its growth, KWG has done 6 capital increases since 2006. Despite the crisis on the world‘s financial markets, KWG successfully carried out a capital increase in Dec. 2009. In the process, 1.2 million new shares were placed at a price of Euro 4.50.

roven track record eads to repeating ommitment from the apital market.

The successful capital increase shows the confidence of the investors in the company. We see the stable shareholder structure and the repeating com-mitment from the capital market as a significant factor contributing to its continued success.


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The company made several capital increases in the last three years

Source: company data

Capital increase sharesshare price volume

December 2009 1,200,000 4.50 € 5,400,000June 2008 2,500,000 6.50 € 16,250,000December 2007 1,600,000 6.50 € 10,400,000June 2007 1,200,000 10.50 € 12,600,000April 2007 300,000 9.00 € 2,700,000Total 6,800,000 47,350,000

At present KWG does not plan to acquire additional portfolios with these funds. KWG plans to invest 3.1m Euro of this lately collected Euro 5.4m in the investment sub-portfolios in Celle (172 units) and Gelsenkirchen (143 units). The additional 2.3m Euro will be invested in some other sub-portfolios.

Funds are used for refur-bishment investments and not to cover any losses.

Portfolio focused on northern and eastern Germany

The core proportion of the portfolio is almost fully let with a very high occupancy rate of 93.5%.

The Property portfolio of KWG contains 4,827 residential units and 44 commercial units (as of Dec. 2009) with a total usable space of 285 thousand sqm. The large part of the spaces of 39% (110 thousand sqm) is located in Saxony and North Rhine-Westphalia is second with 21% (60 thousand sqm). The total property portfolio value is more than Euro 170m, based on the average value per sqm of 600 Euros (as of June 2009).

The own asset management activities at KWG Wohnwert GmbH already started in 2009 and more than 50% of portfolio is already self-managed which helps to bring down costs and will lead to a better tenant profile / faster letting

Source: company data and SRC Research

Properties in Berlin, Thuringia and Saxony already under own management (> 50% of the total portfolio)

asset


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The company already started to translate its portfolio into own asset management which will help to bring down costs. For example the value-added tax in Germany (19% of all external services) will be saved, meaning approx. Euro 0.2m per year for the full KWG portfolio. Furthermore an own management is more geared to drive the letting success than most of the external real estate managers. The advantage might be also in a better tenant structure and a lower loss of accounts receivables. At the moment KWG has already 50% or more of its portfolio under own management. This ratio will quickly climb to more than 90% until 1Q 2011.

The translation of port-folio into own property management will help to drive rental income and to bring down costs

KWG separates its portfolio into core which stands for 61% (2,985 units) and investment portfolio, which represents 39% (1,886 units). The core proportion is almost fully let with an occupancy rate of 93.5%. The investment portfolio shows at present a much lower occupancy rate of 66.2%. Overall especially the investment portfolio shows a huge rental upside and will effect the cash earnings of KWG in the future positively as KWG will complete the most refurbishment activities in 2010 and 2011.

Areas Units sqm Portfolio % Berlin 386 22,800 8% Bremen 145 8,550 3% Lower Saxony 676 39,900 14% North Rhine-Westphalia 1,014 59,850 21% Thuringia 628 37,050 13% Saxony 1,883 111,150 39% Schleswig-Holstein 97 5,700 2% Total 4,827 285,000

KWG has acquired this portfolio in about 2 years and in quite small pieces. The biggest acquisition has been done in 4Q 2007, with 1.580 units.

Cautious and picky investment approach did lead to a portfolio with an initial yield above 8%.

At the same time KWG concentrates on suburban regions, with less com-petition from big professional competitors and easier access to the decision makes. Over all KWG was quite successful with this strategic approach and has generated valuable business relations to further expand this strategy. This strategic approach might look cautious and picky, but it did put KWG in a position to acquire portfolios with an initial yield above 8% and very often even 9% !

Portfolio development since 2007 Source: Company data

668 163

1.580 204 12528

1.408 4.871

368

Q1 07 Q2 07 Q3 07 Q4 07 Q1 08 Q2 08 Q3 08 Q4 08 YE 09


14

-1,00%

-0,50%

0,00%

0,50%

,00%

1,50%

2,00%

2003/2004 2004/2005 2005/2006 2006/2007 2007/2008

Erfurt Dresden Chemitz

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Portfolio milestones – deal after deal KWG was on the fast lane

The first big acquisition KWG did was in 2007 with a deal of 950 units (c. 50.0 sqm) in Erfurt and Dresden. The purchase price has not been dis-closed. Bearing in mind that this acquisition was less then one year after the company has changed its business model from a biotech firm to a real estate investor, the start was a positive sign of the further development of KWG.

First successful trans-action less than one year after the company has changed its business model already. As already highlighted in the business model of KWG, here KWG was able to

pick fundamentally solid B- and C-locations with good prospects. With a population of approx. 203k Erfurt is one of the top 10 cities in the newly-formed German states. Since 1990 Erfurt is the provincial capital as well as the cultural and economical centre of Thuringia. After the German reuni-fication Erfurt suffered, like the most eastern cities with a population decline by -11% until 2002. Since 2003 the migration stopped and population is growing again.

Dresden is the third biggest city in East-Germany, right behind Berlin and Leipzig. Since 2001 the population is steadily increasing and is currently at 512k. The positive trend continues. As the provincial capital of Saxony, with a Dresden is clearly one of the hot spots in East-Germany with good prospects in our opinion.

Dresden is clearly one of the hot spots in East-Germany with good prospects.

After this deal KWG bought SWG a municipal housing company and ex-panded its portfolio successfully. SWG consists of 569 residential units (30.7k sqm) in Chemnitz and in Glauchau. The average purchase price per square meter of 485 Euro and a net initial rate of return of 8.9% are im-pressive already. But with an additional rental potential from 140 units in the portfolio which have not been rented as they have to be redeveloped, this deal looks like a lucky buy in our opinion.

Glauchau is a small town with 26k inhabitants near Chemnitz (c. 30 km) und Zwickau (c. 15 km). While Chemnitz and Glauchau are not really the top picks at the first glance and the regions are suffering from migration in the recent years, especially the packages KWG bought show upside due to its vacancy proportion. At the same time Zwickau is one of the East-German cities benefitting from the business development stimuli since 1990. In the meantime especially automotive supply industry has settled in Zwickau and attractively refurbished residential units might have the chance to attract commuter from Zwickau.

East-German cities benefit from the business development stimuli since 1990.

Population development in % (y-o-y)

1

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15

Just four months after this deal KWG bought another 800 units in the Rhine-Ruhr area (53.6k sqm in Düsseldorf, Dortmund, and Mühlheim) and increa-sed the company's total portfolio to c. 3,000 units. The majority of this acqui-sition was from Evonik. The average price per sqm of 593 Euro and an initial rate of return of 8.3% excluding operational costs showed an attractive deal for KWG again. Especially knowing that the portfolio had a 10% vacancy to be reduced and the financing was fixed with an interest rate of 5.4% p.a. with a 10 year maturity.

800 units in West-Germany with an initial yield of 8.3% and costs of debt of 5.4%.

After a couple of small acquisitions (see chart on page 13 “Portfolio develop-ment since 2007”) KWG took over the 100% stake of Hainichener Wohnungsgesellschaft mbH (HWG) with 1,083 residential units between Chemnitz (c. 30 km) and Dresden (c. 56km). The purchase price of the deal has not been disclosed again.

1,083 units from HWG were the last big acquisition.

Case studies - Excellent upside, besides the high initial yield

With the deals in 2007 and 2008 KWG has totalled its portfolio with a volume of approx. 5.000 units. In 2009 KWG did not do any major transactions and focused on the upside potentials it had acquired, besides the high initial yield. One interesting case study KWG did perform was in Wolfsburg. In November 2007 KWG bought a portfolio of 160 units here. The average purchase price per sqm was 469 Euro including acquisition side cost. Due to refurbishments with a volume of 1.89m Euro and active asset management KWG was able to increase its rental income by 171k Euro. The arrangements lead to a return on investments of 6% and a return of equity of almost 24%.

Investments in Wolfsburg have a ROE of 24%.

Case study - Wolfsburg II Acquisition date Nov. 07 Units 160 purchase price per sqm 469 Rental income Nov. 2007 470 Rental income Dec. 2009 641 Investment volume 1,840 Thereof equity 471 Thereof liabilities 1,367 Interest on liabilities 4.3% Additional income thru refurbishments 171 Funding costs 59 Surplus 112 Return on investment 6.1% Return on equity 23.9% figures in Euro ‘000

Familiar to this refurbishment KWG plans two interesting projects in Celle and Gelsenkirchen for the current year 2010. With the renovation and isolation of the façade, new windows, a new heating system and the refurbishment of the


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16

Celle: expected ROE of more than 10%.

vacant flats KWG sees the chance to increase current rental income by 305k Euro p.a. and to reduce heating costs for tenants. In total KWG expects a return on equity of more than 10% in Celle.

Case study - Celle Acquisition date Dec. 08 Units 178 Rental income Dec. 2008 599 Rental income Dec. 2011e 904 Investment volume 4,200 Thereof equity 2,000 Thereof liabilities 2,200 Interest on liabilities 4.6% Additional income thru refurbishments 305 Funding costs 102 Surplus 203 Return on investment 4.8% Return on equity 10.2% figures in Euro ‘000

The portfolio in Gelsenkirchen does even show a higher potential. KWG plans to renovate and isolate the façade and the roofs and to refurbish the vacant flats in Gelsenkirchen until December 2011. It is planned, that these steps will increase rental income by 212k Euro p.a. and has a return on equity of more than 15% in Gelsenkirchen.

Gelsenkirchen: expected ROE of more than 15%.

Case study - Gelsenkirchen Acquisition date 2007 Units 147 Rental income 2007 392 Rental income Dec. 2009 604 Investment volume 2,500 Thereof equity 1,100 Thereof liabilities 1,400 Interest on liabilities 3.1% Additional income thru refurbishments 212 Funding costs 43 Surplus 169 Return on investment 6.8% Return on equity 15.4% figures in Euro ‘000


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Movers & Shakers – The management board Stavros Efremidis

Member of the Management Board Sher

Board Member since Febuary 2007

More than 18 years of experience as with development pro-jects and sales business

Tsiv

1

tavros Efremidis is eading KWG – a very xperienced guy from eal estate business

17

Stavros Efremidis studied economics, and can look back on 17 years' experience in the real estate busi-ness. After several years as a sales manager, he worked in management and Board positions for a number of medium-sized companies in the finance sector. In the course of his career, he has been responsible for sales and marketing as well as for property buying and funding, and capital procurement. Before joining KWG, he held an executive position at the German branch of a European property investment company in Berlin.

Stavros Efremidis has been KWG's managing director since February 2007.

Supervisory board he supervisory board tands for a lot of ndustry expertise and a ery profound network

Currently the supervisory board consists of five members. Prof. Dr. Peer Witten is the chairman of the supervisory board. Prof. Dr. Peer Witten is also Chairman of the Supervisory Board of MDAX listed HHLA and member of the Supervisory Board of the Otto Group both located in Hamburg.

Franz-Josef Gesinn is the deputy chairman. At the same time Franz-Josef Gesinn is member of the Supervisory Board of the well-known BHW home mortgage lender and alumnus Director of the DG HYP bank. Thies-Martin Brandt, former board member of the Berlin-based residential company DEGEWO, Björn Engholm (former prime minister of the German state of Schleswig-Holstein) and Hans-Michael Porwoll (school’s inspector) also belong to the KWG supervisory board.

Shareholder structure

65% of the KWG shares are held by core investors, which include a position held by the management and a stake owned by the well-known Hamburg based Ehlerding Family. The remaining shares of 35% are free float.

Free float; 35%

Core shareholders;

65%


18

KWG Kommunale Wohnen AG31/12 IFRS (Euro '000) 2007 2008 2009e 2010e 2011e 2012e

CAGR '09e - '12e

Revenues 3,019 13,706 19,762 20,256 21,674 22,108 3.8%└ thereof rental income residential 3,019 13,706 19,762 20,256 21,674 22,108other oper. income (mainly net revaluation result) 5,666 10,406 4,003 1,001 9,006 5,403Total operating income 8,685 24,112 23,765 21,257 30,680 27,511Expenses for investment properties -396 -3,856 -3,504 -3,950 -3,576 -3,648Cost of material -1,398 -4,995 -6,501 -6,371 -6,116 -6,238Personnel expenses -598 -1,377 -1,718 -1,890 -2,003 -2,023Other operating expenses -2,867 -8,463 -2,860 -2,026 -2,167 -2,211Operating profit (EBITDA) 3,425 5,421 9,182 7,020 16,817 13,391 13.4%Amortization of intangible assets and depreciation of property, plant and equipment and investment properties -31 -49 -80 -101 -108 -111Operating profit (EBIT) 3,394 5,372 9,102 6,919 16,708 13,280 13.4%EBIT margin 39.1% 22.3% 38.3% 32.6% 54.5% 48.3%Income from securities in financial assets 0 68 0 50 50 50Other interest and similar income 310 432 310 304 450 450Interest and similar expenditure -1,065 -4,897 -5,772 -5,864 -6,069 -6,081Minority interests of other shareholders 0 -6 1 -41 -43 -44Pre-tax Profit (EBT) 2,639 969 3,640 1,368 11,096 7,655 28.1%tax expenses 456 -197 -375 -216 -1,753 -1,209Tax rate -17.3% 20.3% 15.8% 15.8% 15.8% 15.8%Minorities 0 13 0 -15 -40 -85Net Profit after minorities 3,095 786 3,265 1,137 9,303 6,360 24.9%Number of shares 4,696 7,490 9,822 9,822 9,822 9,822Earnings per share (Euro) 0.66 0.10 0.33 0.12 0.95 0.65Dividends per Share (DPS) in Euro 0.00 0.00 0.00 0.00 0.00 0.00Book Value per Share (BVPS) in Euro 8.41 7.50 6.59 6.71 7.65 8.30

Adjusted Shareholders' Equity without minorities 39,474 56,143 64,748 65,885 75,188 81,548 8.0%RoE after Tax 5.6% 1.6% 5.4% 1.7% 13.2% 8.1%

Key ratios & figures 2007 2008 2009e 2010e 2011e 2012eGrowth rates in %Revenues n.s. 354.0% 44.2% 2.5% 7.0% 2.0%EBITDA n.s. 58.3% 69.4% -23.5% 139.5% -20.4%EBIT n.s. 58.3% 69.4% -24.0% 141.5% -20.5%EBT n.s. -63.3% 275.7% -62.4% 710.8% -31.0%Net profit after minorities n.s. -74.6% 315.7% -65.2% 718.0% -31.6%

Margins in %EBITDA 39.4% 22.5% 38.6% 33.0% 54.8% 48.7%EBIT 39.1% 22.3% 38.3% 32.6% 54.5% 48.3%EBT 87.4% 7.1% 18.4% 6.8% 51.2% 34.6%

Expense ratios in %Personnel costs quote 6.9% 5.7% 7.2% 8.9% 6.5% 7.4%Cost of material to sales 16.1% 20.7% 27.4% 30.0% 19.9% 22.7%Depreciation to sales 0.4% 0.2% 0.3% 0.5% 0.4% 0.4%Tax rate -17.3% 20.3% 15.8% 15.8% 15.8% 15.8%

Profitability in %net profit to sales ratio 102.5% 5.7% 16.5% 5.6% 42.9% 28.8%return on equity (ROE) after tax 5.6% 1.6% 5.4% 1.7% 13.2% 8.1%

ValuationPE-ratio 6.75 42.43 13.39 38.43 4.70 6.87Price/BVpS 8.41 7.50 6.59 6.71 7.65 8.30Dividend yield in % 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%EV/ Sales 5.03 1.81 1.84 2.06 1.42 1.59EV/ EBITDA 12.76 8.06 4.76 6.23 2.60 3.26

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19

KWG Kommunale Wohnen AG31/12 IFRS (Euro '000)

12/31/2007 12/31/2008 31.12.2009e 31.12.2010e 31.12.2011e 31.12.2012e

Intangible assets 1 179 211 211 211 211Tangible Assets 137 194 153 120 84 46Properties held as a financial investment 93,556 170,642 175,831 176,831 185,837 191,240Deferred tax rebates due 780 2,808 2,819 2,650 2,491 2,341Long-term assets, total 94,475 173,822 179,013 179,812 188,622 193,838

Inventories 7,453 23 55 57 61 62Trade receivables 124 297 363 372 398 406Other receivables and assets 664 2,339 2,843 3,014 3,195 3,387Liquid funds 13,127 7,800 5,627 5,906 6,221 7,028Short-term assets, total 21,368 10,459 8,889 9,349 9,874 10,882Assets, total 115,843 184,281 187,902 189,161 198,497 204,721

12/31/2007 12/31/2008 31.12.2009e 31.12.2010e 31.12.2011e 31.12.2012eEquity capitalSubscribed capital 6,100 8,600 9,800 9,800 9,800 9,800Reserves 28,011 37,970 42,110 42,110 42,110 42,110Revenue reserves 2 2 2 2 2 2Reserves for market valuation 0 -334 -334 -334 -334 -334Group net income 5,361 9,905 13,170 14,307 23,610 29,970Equity capital, total 39,474 56,143 64,748 65,885 75,188 81,548

Long-term borrowings 66,341 107,028 116,580 114,980 110,890 103,080Deferred tax liabilities 972 2,294 2,926 3,084 4,507 5,361third party shares in partnerships 73 85 85 86 88 90Long-term outside capital, total 67,386 109,407 119,591 118,151 115,485 108,531

Short-term borrowings 5,484 9,745 0 1,600 4,140 11,000Trade payables 1,919 4,485 1,260 1,285 1,285 1,311Short-term tax liabilitites 669 142 150 44 159 47Other short-term liabilitites 910 4,359 2,153 2,196 2,240 2,285Short-term outside capital, total 8,983 18,731 3,563 5,126 7,824 14,643Equity and Liabilities, total 115,843 184,281 187,902 189,161 198,497 204,721

Equity ratio 34.1% 30.5% 34.5% 34.8% 37.9% 39.8%Loan to value ratio 76.8% 68.4% 66.3% 65.9% 61.9% 59.7%


20

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SRC Research

- The Specialist for Financial and Real Estate Stocks -

SRC-Scharff Research und Consulting GmbH

Klingerstrasse 23

D-60313 Frankfurt

Germany

Fon: +49 (0)69 – 400 313-79

Mail: [email protected]

Internet: www.src-research.de

Rating chronicle:

Since this report is an initiating coverage no rating chronicle is available for KWG Kommunale Wohnen AG.

Please note:

The KWG Kommunale Wohnen AG share price mentioned in this report is from closing of 16 April 2010. Kommunale Wohnen AG mandated SRC Research for mentoring the KWG share.

Disclaimer © 2010: This equity research report is published by: SRC-Scharff Research und Consulting GmbH,Klingerstr. 23, D-60313 Frankfurt, Germany (short name: SRC Research). All rights reserved. Although we feel sure that all information in this SRC report stem from carefully selected sources with a highcredibility, we cannot give any guarantee for accuracy, trueness and completeness. All opinions quoted in thisreport give the current judgement of the author that not necessarily is the same opinion as SRC-ScharffResearch und Consulting GmbH or another staff member. All in this report made opinions and judgementsmight be changed without a pre-announcement. Within the scope of German regulative framework author andSRC-Scharff Research und Consulting GmbH do not assume any liability for using this document or itscontent. This report is just for information purposes and not a request or an invitation or a recommendationto buy or sell any stock that is mentioned here. Private clients should search for personal advice at their bankor investment house and should keep in mind that prices and dividends of equities might rise and fall and thatnobody can give a guarantee of the future development of equities. The author of this report and the SRCScharff Research und Consulting GmbH commit themselfes on a unsolicited basis to have no long- or short-positions in equities or derivatives related to equities mentioned in this report. Reproduction, distribution and publishing of this report and its content as a whole or in parts is only allowedwith an approval of SRC management board in written form. With acceptance of this document you agree withall regulations mentioned here and all general terms and conditions you will find at anytime at our websitewww.src-research.de.

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