We were all students once, but investing in your old accommodation to try and relive your uni days isn’t a smart decision. Which is why I’ll be looking at Unite Group as a business case to see if this is a long term investment, or debt explosion waiting to happen.
What Does Unite Do?
Unite group, which you likely know by their trade name Unite Students or even Liberty Living, is the UK’s largest owner, manager, and developer of purpose-built accommodation for university students.
Source: Unite FY 2019 Report
With a growing number of 18-year-olds going to university and roughly 80% of these students requiring some kind of accommodation, there is a clear demand for a provider who appeals both to students and universities.
Unite primarily focus on collecting rent on their beds. They will build or outfit a building as student accommodation, either as an independent place for the students to live (prime location) or in partnership with the university (in some cases guaranteeing rentals.)
I mentioned two brand names before. In 2019 Unite Students brought Liberty Living. The combined force and synergies mean they can offer even more beds and share their successful strategies between the brands.
Source: Unite FY 2019 Report
If you have had the pleasure of staying in these properties you would have personality experienced what is, for most, excellent service and fantastic living space. That said this isn’t cheap student accommodation, and Unite faces strong competition from home shares. It is, therefore, no surprise that Unite targets “high and mid-ranked Universities”, i.e. places where the students are more likely to be able to afford additional services and a higher standard of living.
Source: Unite FY 2019 Report
What sets Unite apart is its strategic universities partnerships. In a highly competitive environment, universities increasingly recognise the
importance of high-quality accommodation in their ability to attract and retain students and ensure their satisfaction. Universities typically seek to guarantee accommodation for all first-year and international students, recognising that housing helps students settle.
What has impressed me with their business is the expansion into apps and digital offerings. Going beyond just a comfortable place to live, into an ecosystem, think WeWork with their communities and how they handle businesses. Anything which means you can manage more people/beds with less staff and overheads, plus get faster feedback and engagement, as well as push for student referrals to drive even more business, are all fantastic signs.
As you know, going to university is a multiyear endeavour. However, accommodation is normally only offered for first years (halls) and then you move out with friends.
Source: Unite FY 2019 Report
Luckily only 35% of the beds been occupied are only on a year contract. All bed contracts include an annual increase to match inflation as well. Reservations for the 2020/21 academic year are currently around 73%, even with COVID-19, this high number is being driven by the success of their local marketing operation in China. These aren’t cheap beds, so they focus on the value add, easy of use, the ecosystem, to justify additional value beyond a bed and four walls.
The Risk Of COVID-19?
It’s rare these days to find that COVID-19 isn’t the biggest risk or concern for a business in the short term. Due to the nature of higher education, everything is still planned to go ahead.
In the immediate term cancellation requests mean Unite is forgoing rent on around 43,000-46,000 beds representing around 62-65% of all owned and managed beds. This is going to pose a heavy hit to their quarterly income. For that reason, the credit facilities have all been drawn down and all executive pay cut.
While Unite hasn’t furloughed any staff (contractors all gone though) they have applied for COVID Corporate Financing Facility which they hope will bring in an additional £50m, as of the time of writing the BoE has confirmed they are eligible but not for how much.
All 2020 projects (new builds where they are converting it into student accommodation) has been suspended. This impacts three different lots, while two lots have been pushed into 2022. This creates a £67m saving right now, but it has only been delayed.
Looking ahead, however, reservations for the 2020/21 academic year are currently at 80%, compared with 81% at the same time last year. Unite is seeing healthy levels of demand from UK students. While they still get enquiries from international students the demand has slowed.
Nomination agreements account for 70% of reservations secured for 2020/21 with over two thirds now contracted, including multi-year agreements and single-year extensions which have already been signed. Additionally, a few universities have already begun to allocate students to Unite for the new academic year.
If Unite ends up with beds are not taken up by universities, they will shift the sales focus to a direct-let basis. Targetting students who are living in house shares, which is an existing marketing angle. I suspect it will mean deeper discounts to ensure beds are not empty.
I mentioned COVID-19 isn’t the biggest issue this year for Unite and the reservations allude to this as well. Brexit is the issue.
The UK is the second most popular international destination for students (after the US). Applications for international students are up 8% for the 2020/21 academic year. The government has become more supportive of growth in international students, setting a target to increase international students by a further 115,000 students (a 25% increase) by 2030 and extending post-study work visas to two years. Most importantly of all EU students funding arrangements for the duration of their study confirmed for 2020/2021.
However, international growth is not going to be coming from the EU. Not for Unite. Following Brexit, there is a risk that tuition fees for EU students will rise from £9,250 to the higher rates currently paid by non-EU students, as well as EU students no longer having access to a tuition fee loan. As a result, Unite is forecasting a 30% decline in EU undergraduates by 2023, equating to a fall of around 2% of total students. Long term this is the biggest risk to Unite’s model. That and debt.
What About The Fundamentals?
Now we know a bit more about what Unite does, let’s see how that translates into facts and figures.
Source: Genuine Impact
All things considered, this is a relatively poor shape for a company to be in. Getting the fundamental ranks gives me a relatively high level feel for the company and what I need to double-check. In this case, there are a lot of red flags. Poor quality, poor value, and a poor momentum rank.
Starting with the quality aspects, the financial strength and shareholder returns, they have entered COVID-19 with the wrong foot.
Source: Unite FY 2019 Report
Unite has enjoyed reliable revenue growth until recently. They were hit by Brexit uncertainty and then again by buying Liberty before COVID-19. The last three years the gross profit has increased, they have a gross margin of 78.87%, this is a strong position to be in and speaks volumes about the effectiveness of their operations.
In previous years the company was talking additional revenue outside of their core rental business. Operating expenses were reported as negative, which results in profit margins above 100%. Historically they have shown a strong balance sheet but this is two expensive years back to back.
One of the first images I’ve included shows 20/21 the 18-year-old population is at its lowest. While this also impacts universities who will be trying to attract overseas students, it means the pressure is on for Unite as well.
Source: Wallmine Dividend
In terms of paying back to shareholders, they do have a dividend which is increasing. Two payments a year with a yield of 3.82% isn’t bad, it’s not the best in the market but it’s above average. The dividend is still on the table for now, but if 20/21 represents a poor year for international students I would expect management to bite the bullet and cut the dividend. Though the pressure of having nine years of dividend growth is a lot to give up.
I’ve mentioned debt a few times as well. Unite targets an LTV ratio of 35% and net debt to EBITDA of around 7x. Right now they are in excess due to bringing onboard Liberty.
Source: Unite Group Debt Information
I do like the fact that no more than 20% of Unite’s debt matures in any one year and they maintain a weighted average unexpired term of between 5 and 10 years. Debt control is a big focus for the business due to how leveraged their operations can be, refitting and redoing buildings is a long term bed filled with shorter-term residents.
Source: Google Finance
Even with a post-COVID-19 dip we have not seen the share price fully recover, and looking at the value ration we start to see the risks investors are not so confident with.
We are looking at a forward P/E of 50.51x, and price to sales of 15.71x. This is an expensive purchase, even in this market. What will make you wake up in the morning is their assets. While they measure their debt against revenue, we haven’t touched on the assets they currently hold.
With over £5bn in assets, this is their biggest strength. The book to share ration is a punchy 848.97x. While the earnings and the price you are paying might not make this an attractive purchase, you might sleep better knowing that the buildings and sites they own have retained their value.
Even if we account for COVID-19 and Brexit and say we wipe out 30% of the market value of their assets, we are still worth more than the outstanding shares. Keep in mind this number recently almost doubled due to the Liberty purchase.
In terms of future growth and returns, even with a poor value offering on show, and a tougher period ahead, the future does look bright for Unite.
Source: Genuine Impact
With above-average share price growth, along with above-average EPS and revenue growth, this is encouraging to see. Even with Unite reducing some of their estimates for FY2020, we are still seeing growth.
Source: Market Beat
Currently, the average target price sits around £10.76 per share, representing just shy of 20% increase in a single year. Even when accounting for their downward projections and conservative estimates, the sell-side analysts still feel bullish on Unite.
Source: Genuine Impact
With over 60% of analysts rating this as a buy, and the rest being a hold, we see strong sentiment towards future growth and returns. With Unite’s development pipeline extending until 2023, this means over new 5,000 beds, a 6.5% increase in capacity as well as additional furnished buildings and assets on the balance sheet.
Why A Buy?
Unite is a bit of a mixed bag when it comes to fundamentals. Loaded with debt relative to their revenue, but strong with long term assets. They have a dividend in place which they are keen to keep expanding, but they are overpriced compared to their earnings.
With COVID-19 putting a cloud on their Liberty purchase recovery, and 2020/21 student numbers expected to be lower, there are bumpy roads ahead.
What we do have is a premium solution for housing which is focused on direct partnerships with both individuals and universities. Even now universities are having to cover the committed rent by students, which represents 21% of their beds currently. Expanding their capacity and guaranteed rents, while investing in innovation to drive down the costs of maintenance and support, means we can start to move that gross margin needle even more.
I’ve said in the past I’m bullish on TW, the same goes here. The assets they hold are the saving grace in my mind. The growing dividend is unlikely to be cut due to shareholder pressure, after eight years of growth are you going to stop now unless you have to?
Source: Unite FY 2019 Report
With the expectation of higher education growing, and governments stepping in to ensure affordable education as it’s a political focus, we can expect a steady stream of new university students to replace the old.
While students believe that university is the ultimate answer, we’ll always need firms like Unite. This is a rough year for them, and that makes them a distressed buy to me. Tough times ahead, but one they are well prepared for.
Let me know what you thought, have you been looking at Unite? Let me know if you think I missed anything or any parts of my analysis I can improve upon.
Thanks for reading and stay safe!