Introduction

While most companies have seen their share prices recover, the performance of commercial REITs is having a negative impact on the total performance of the Nest Egg Portfolio. Not only are the share prices spiraling down, it also will be tough to expect reasonable dividend payments from the REITs. Most REITs will have to pay a minimum dividend to continue to satisfy the regulatory requirements, but on the one hand I’m expecting the REITs to postpone dividends until 2021 to make sure balance sheets remain robust, and on the other hand, I wouldn’t be surprised if some of the REITs will issue a stock-only option to satisfy those requirements. In case you missed the previous Nest Egg Portfolio article, you can re-read it here.

In this edition of the Nest Egg Portfolio, Orange Belgium (OTC:MBSRF) (OTC:MBSRY) is re-appearing in the portfolio. After an initial strong performance about two years ago, Orange Belgium was sold at a profit in 2019 but the recent 30% price drop and strong free cash flow in the first semester makes the company appealing again. Orange Belgium’s website mainly contains “direct download” links, but you can find all relevant information and documentation here.

Orange Belgium: Time for a re-entry in the portfolio

Orange Belgium is a Belgian telecom provider which made tremendous efforts to expand its product offering. What started out as being a mobile telecom provider has grown into a one-stop shop where consumers can sign up for TV and Internet offerings as well. An additional interesting feature is Orange Belgium’s purchase of the distribution rights to the Belgian soccer competition for a period of five years from August 2020. As occupancy rates in the stadiums are just a fraction of the capacity (usually 10%-20%), more fans will be trying to see games of their favorite teams at home. Having a signed distribution agreement clearly won’t harm Orange Belgium.

Source: company presentation

And although Orange Belgium’s financial performance in the first semester was excellent (note: the free cash flows I will discuss here below don’t include the payment for the Pro League contract yet), its share price has been sliding since the start of this year:

Source: Yahoo Finance

Orange Belgium does have an OTC listing, but considering that listing is very illiquid, I’d strongly recommend to use the Euronext Brussels listing to trade in Orange Belgium’s shares. The ticker symbol is OBEL and with an average daily volume of almost 50,000 shares, the volume is definitely much better.

The total revenue of the company in the first semester came in at approximately 637M EUR which is in line with revenue in H1 2019. We do notice an interesting increase in convergent service revenues but a subsequent decrease of the mobile only revenue as well as the wholesale segment. Orange Belgium also was able to keep its costs under control: Whereas the direct costs decreased, the labor expenses and indirect expenses increased. Nonetheless, Orange Belgium’s EBIT more than doubled which definitely is a satisfying result.

Source: half-year results

On an after-tax basis, the net income came in at 20.4M EUR or 0.34 EUR per share. Definitely not great, but that doesn’t matter as Orange Belgium is a free cash flow story: Its free cash flows are higher than the net income, and those strong cash flows represent the main appeal of this stock. I also wouldn’t be too negative about the lower mobile revenue: Orange Belgium explained this is predominantly related to the lower sales result of actual devices. Hardly a surprise given the mandatory closure of stores in Belgium during the second quarter which obviously had a major impact on the sales results. In fact, one could actually expect the result of actually selling devices will increase in the current semester as there will very likely be some deferred consumption.

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As mentioned, I always have been – and still am – drawn to Orange Belgium for its strong cash flows. In the first semester of 2020, the company generated an operating cash flow of 188.7M EUR but this includes a 20M EUR contribution from working capital changes. On an adjusted basis, the operating cash flow was 169M EUR, and decreased to 144M EUR after also deducting the lease payments.

Source: half-year results

The capex in the first semester was about 65M EUR, and this resulted in Orange Belgium posting a positive free cash flow result of 79M EUR or 1.32 EUR per share.

This means that on a normalized basis, Orange Belgium is making approximately 2.6-2.7 EUR per share in free cash flow, indicating the company is very cheap at 14 EUR. However, that’s not the case. The capex mentioned in the half-year report is the normal sustaining capex and excludes the license fees to be paid to the government when it acquires a new part of the spectrum. That’s also the main uncertainty right now, as the exact price to be paid to be awarded with a part of the spectrum at the next auction is uncertain. The auction was originally scheduled for earlier this year but has been postponed due to the COVID-19 pandemic. Reports from 2018 indicate the Belgian regulator was aiming to raise about 700M EUR (in total, from all three mobile operators and not just Orange Belgium) from the spectrum auction. In any case, the normalized free cash flow of around 150M EUR per year will be more than sufficient to cover the annual dividend of 0.50 EUR (30M EUR) and the purchase of additional portions of the spectrum at the next auction. The current dividend yield is approximately 3.5% but I expect Orange Belgium to increase its dividend once it has more visibility on the purchase of the spectrum. With net debt of just 181M EUR, the balance sheet is in excellent shape as this represents a debt ratio of just 0.6.

Investment thesis

Although I was positively surprised by Orange Belgium’s performance in the first semester as the cash flow result increased thanks to higher subscriber numbers and a lower capex (which I expect to increase in the current semester), this doesn’t mean the company is out of the woods yet. The risk of another entrant in the mobile telecom space remains realistic (the Belgian government has been trying to attract a new player to boost competition so Orange Belgium needs to hope potential acquirers of a new mobile license would consider the Belgian market too small to be worth their while), while additional investments in new licenses (the upcoming spectrum and 5G auctions) will be a cash drain.

That’s why I’m keeping the investment in Orange Belgium limited at this point by purchasing 100 shares and writing one put with a strike price of 14 EUR, expiring in March 2021. Should the situation change and Orange Belgium can provide additional visibility on future earnings, I will be happy to review the position size, but for now, the re-entry in Orange Belgium is a careful move.

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New orders and incoming dividends

As we have had three option expiry dates since the last edition of the Nest Egg Portfolio, it’s about time to see which options expired in the money and which ones have fallen off.

We had three written options expiring in the past months: A Call 32 on Flow Traders (OTCPK:FLTDF) expiring in July while September was a little bit busier with two written put options: one on Klepierre (OTCPK:KLPEF) and one on Total (TOT) with respective strike prices of 17 EUR and 26 EUR.

The put option on Total expired out of the money, and we were able to collect the 0.44 EUR in option premium. However, Klepierre had to deal with general weakness in the European commercial real estate sector as Unibail (OTCPK:UNBLF) (OTCPK:UNRDY) (OTC:URMCY) confessed that it’s planning to raise 3.5B EUR in a rights issue while earmarking an additional 4B EUR in asset sales. So shareholders will be facing a dilution of about 70%-100% (depending on the price of the rights issue) while an additional 10% of the balance sheet will be liquidated. The combination of both will very likely push the dilution over the 100% range as Unibail shareholders will end up with more shares, owning fewer assets. This was a drag on the commercial REIT space and other commercial REITs like Klepierre were hurt as well and the P17 expired in the money. I register a 1703 EUR cash outflow related to the purchase of the 100 additional shares of Klepierre.

The Flow Traders C32 for July expired in the money, and the sale of 100 shares boosted the cash position by 3197 EUR (including a 3 EUR transaction fee). In hindsight, the timing of this sale wasn’t ideal as Flow Traders paid a 4 EUR/share dividend just a month later. Fortunately we still have 50 shares of Flow Traders which did receive the dividend (see later).

The three expirations resulted in a net cash inflow of 1494 EUR (excluding the option premiums which were already included in the previous cash position).

As mentioned in the InstaBlog post earlier this week, I wrote 1P 10 on Klepierre for December for an option premium of 1.03 EUR (net cash inflow of 100 EUR), 1 P 27.50 November on Total for 0.96 EUR (93 EUR cash inflow) and a P6 on Wereldhave expiring in December for an option premium of 0.35 EUR (32 EUR cash inflow).

Dividends

Although several companies are suspending or postponing dividends, we still have a relatively decent incoming cash flow from dividends in the Nest Egg Portfolio and this obviously is a big help.

Total also declared a dividend of 0.68 EUR but what’s more intriguing is the stock dividend option. Shareholders can convert dividend rights to acquire new stock at 28.80 EUR per share (a discount of 10% to the average opening prices during a pre-determined time window). This means that per 42.353 dividend rights, shareholders will receive one new share. With 130 shares in the Nest Egg portfolio, we will receive three new shares and a cash payment of around 2 EUR. However, given the 12.8% dividend withholding tax which will be applied on the total payout, there was a net cash outflow of 9 EUR to account for the dividends.

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The other incoming dividends are summarized in the table here below. Rubis (OTCPK:RBSFY) has declared a 1.75 EUR dividend, while we also need to record two incoming dividend payments from Atrium European Real Estate (OTCPK:ATRBF). On both occasions, we took the Atrium dividend in new shares as I’m happy to add to the position at a substantial discount to the book value and fair value of Atrium while taking the dividend in stock also helps the REIT’s balance sheet. You can find all incoming dividends in the table here below. Also interesting is the recent dividend announcement of Acerinox (OTC:ANIOF) which confirms it plans to pay a 0.50 EUR dividend in December of this year. I will have a closer look at Acerinox in the next few weeks to determine if I need to increase the position as it currently only accounts for about 1% of the portfolio.

Source: table compiled by author based on dividend payment schedules

The Portfolio

The portfolio is based on the closing prices of Tuesday, Sept. 22:

Interesting news from Europe

BT Group (OTCPK:BTGOF) remains a very weak position in the Nest Egg Portfolio and I expect the relative weakness to continue as the dividend will remain suspended for the foreseeable future. Fine with me (I argued in a previous article a dividend cut would be irrelevant to my investment thesis) because although the dividend was obviously very welcome, I had a holistic approach for BT Group. And if the incoming free cash flow (because don’t worry, BT remains a very strong free cash flow performer) and spending that cash on reducing the debt and pension liabilities will make the company stronger as a whole. There have been some buyout rumors lately but nothing has gotten more concrete lately so, for now, BT Group remains in the portfolio.

The commercial REITs Eurocommercial Properties (OTC:EUCMF) and Wereldhave (OTC:WRDEF) also remain in the portfolio but it’s clear their ultra-weak performance is keeping the total performance of the portfolio down. I remain firmly convinced Eurocommercial’s performance warrants the stock to stay in the portfolio (you can re-read my entire in-depth thesis here). Wereldhave has lower quality assets and will need to keep an eye on cash retention to ensure its balance sheet remains manageable.

Conclusion

It’s clear the exposure to the commercial REITs is hurting the portfolio big time while the major integrated oil and gas companies also remain poor performers with both Total and Royal Dutch Shell (RDS.A) (RDS.B) and adding to the disappointment is the dividend cut which also reduces the cash inflow. Some other positions have been gaining back some of the lost ground with, for instance, the Dutch and Belgian postal services putting in an excellent performance. The markets remain volatile, so we’ll have to see what the future brings.

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Disclosure: I am/we are long MBSRF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I also have a long position in ANIOF, ATRBF, EUCMF, KLPEF, RDS.A, RDS.B, WRDEF and BTGOF.



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