Dear ladies and gentlemen, welcome to the conference call of Instone Real Estate. At our customer's request, this conference will be recorded. As a reminder, all participants will be in a listen-only mode. Afterwards, there will be an opportunity to ask questions. If any participant have difficulties hearing the conference, please press star zero on your telephone for operator assistance. I would like now to hand over to Burkhard Sawazki, who will start the meeting today. Sir, please go ahead.
Thank you. Good morning, everyone. Welcome, and thank you for joining our Q1 earnings call. Our CEO, Kruno Crepulja, and our CFO, Foruhar Madjlessi, will walk you through our results presentation and give you more insight into our current business performance in current environment. As usual, this will be followed by Q&A session. I will now hand over to Kruno Crepulja.
Good morning, everyone. I'm glad you could join us for Q1 2022 earnings call. You have all seen our news from yesterday evening. We had a very decent start to the year, which was overall fully in line with our budget. We sustained very high margin, but we also had to acknowledge that some things have changed materially since Russia's invasion of Ukraine, and that short-term risks have increased considerably. After a temporary relaxation at the beginning of the year, we are currently facing material shortages we haven't seen for many decades. This goes hand in hand with a significant broad-based rise in costs for building materials. The inflationary pressure in the entire economy finally also led to a jump in interest rates, which might cause a rise in short-term uncertainty for private and institutional investors.
Against this backdrop, we, as a management team, believe that it is currently not possible to provide a reliable financial forecast for 2022, and therefore we decide to suspend our guidance until we get more clarity. Nevertheless, we also strongly believe that the overall fundamental case of our business model is still valid. The structural demand-supply imbalance, which will be reinforced as a result of current market situation, paves the way for positive midterm business outlook. However, let me start our presentation with a summary of the highlights of the current business performance on slide five. In the first quarter, demand was once again very robust and stayed at elevated levels. Nevertheless, we also saw that early indicators point to a potential slowdown to more normalized levels. This comprises, for instance, somewhat higher cancellation rates in our retail business.
In our institutional business, we are still benefiting from the scarcity of investment alternatives and high investment pressure, especially for new build properties. The supply side has evolved to a major risk factor over the recent months. As mentioned, it is very obvious that the material shortages have intensified since start of the war. The Ukraine and Russia are key supplier markets for important building materials such as wooden flooring or construction steel. Apart from geopolitical tensions, supply chains are still suffering from general frictions in global trade. For instance, due to the lockdown in China. The supply bottlenecks will likely have an increasingly adverse impact on construction progress and therefore on revenue recognition. We are currently in a market situation that subcontractors are very reluctant to agree on fixed prices due to the volatility for certain building materials. It's clearly a very challenging environment.
We are currently anticipating a rise in construction costs of some 15% year-on-year. We are benefiting from a higher share of fixed price contracts, a conservative budgeting, subsidies for an energy-efficient building, and a still positive trend for residential prices, which should help to largely compensate for the negative cost effects. Accordingly, we are currently still quite confident that margins will remain robust. Our gross margin targets of around 25% for this year and 25% and 20% for two projects across the cycle remains realistic. We are currently clearly seeing the higher short-term risk for the revenue recognition. Let's now take a brief look at our financial KPIs for the first quarter of 2022. Our adjusted revenues amounted to EUR 118.5 million, fully in line with our budget.
This figure is, as you can see, slightly below prior year's figures, which is attributable to higher institutional sales in Q1 last year. There's a very large seasonality in the institutional business and bulk of the revenues is typically realized in the second half of the year. Therefore, you cannot read too much into this. Our gross margin stayed at a very high level of nearly 30%, which is above our target margins. This is again a leading margin within our industry, and this is clearly a reflection of the robust demand situation and also our good cost control. Due to the weaker Q1 seasonality and the lower top line, our adjusted earnings after tax dropped to some EUR 9.3 million, but this is also fully in line with our budget.
As mentioned at the beginning, in our project-related business, we currently find it difficult to quantify the potential impact from the disruption from the war in Ukraine, especially on our revenues, and therefore we have decided to suspend our guidance until we gain more clarity. We believe, however, that overall fundamental picture with structural over-demand situation for residential properties hasn't changed, which should pave way for a positive medium term outlook. To provide some more insight into the current demand situation in recent months, we have provided you an update of our retail sales ratio on slide number six. This chart clearly demonstrates that the demand remained at elevated levels despite the geopolitical tensions and the surge in interest rates. Also, the positive pricing trend continued during the first month, and we expect an overall positive price trend also for the year as a whole.
Nevertheless, it is also fair to point out that early indicators such as inquiries of reservations point to normalization of the sales speed. I think that's primarily attributable to the fact that certain customer groups are suffering from a deterioration of affordability due to the rise in mortgage rates. The jump in mortgage rates by some 150 basis points since start of the year definitely contributed to an overall risk, rising uncertainty among private customers, which might lead to a slowdown of decision-making processes despite the structurally strong demand. Some investors currently seem to prefer a wait and see stance. On the following slide number seven, we again collected some economic data points emphasizing the current short-term pressure on our business, which has emerged over the last two-three months.
On the chart on left-hand side at the top, we are showing the price development of selected important building materials. The prices for oil-related bitumen or construction steel jumped, for instance, by some 30%-40% within a couple of weeks, making it extremely difficult for sub-subcontractors to offer fixed price contracts. There are construction companies that even no longer submit bids for orders. A survey conducted by the ifo Institute confirms that the shortage of building materials has reached a record level after a short-term relaxation at the beginning of the year. We have to acknowledge the new realities, and it becomes increasingly likely that the material shortage could have a material impact on construction progress and therefore on revenue recognition in the course of the year.
Despite the strong volatility in construction costs, we are currently staying confident that our margin will stay robust also in the entire fiscal year. A large share of fixed price contracts, subsidies for energy efficient buildings, the conservative budgeting approach, and the continued positive HPI growth should help to largely compensate the cost effects in the current fiscal year. As a reminder, a price increase of 1% compensates a rise in construction costs of 2.5%. We are committed to a value-based strategy, and we are not going to make compromises on our margins to speed up sales processes. We have set the clear priority for prices over volume. We find confirmation for the continued positive price trend in recent market surveys, and more importantly, also our own sales activities provide evidence for this. We provide a summary on slide eight.
Nevertheless, we cannot ignore that the strong rise in mortgage rates by some 150 basis points within a couple of months will have a negative impact on our business. For certain customer groups within our owner-occupier business, affordability definitely becomes an issue. We are also witnessing, as mentioned, some normalization of relevant early indicators such as number of reservations. The uncertainty for private investors has increased. It is fair to assume that decision-making processes will take longer, and we therefore anticipate some deceleration of the sales speed. The decision of the German financial regulator regarding increased equity requirements for mortgage banks would also have an additional negative impact on sales speed, and therefore timely revenue recognition.
For institutional business, we are still benefiting from the fact that important buyer groups such as pension funds are still suffering from a lack of defensive alternative investment opportunities. The compliance of our product with EU taxonomy, the ESG aspect is also supportive for our product. The recent data from the Bundesbank in March still shows an accommodative financing environment with high availability of mortgage loans, which saw a strong increase on a yearly basis. Moving to our portfolio section on slide number 10. Also during the first quarter, we have continued to further expand our portfolio. As of end of March, the gross development value of our portfolio climbed to around EUR 7.6 billion after addition of two further projects. This forms a strong basis for our planned medium-term step change in growth.
However, we are currently taking a somewhat more cautious stance on new acquisitions, as we can see an increasing likelihood that there might arise good opportunities in the second half of the year. Slide 11 provides a breakdown of our current project portfolio as of the Q1 reporting date. The portfolio is made up of 55 projects with some 16,600 residential units. Some 87% of the GDV is distributed to the most attractive metropolitan areas of Germany and the remaining part in very attractive B-cities. This chart does not include our G-JV projects, which comes on top. The proportionate GDV of our three joint venture projects amounts to some EUR 500 million. On the left-hand side at the bottom, you can see the usual breakdown of the current development status of our portfolio.
Of the nearly EUR 7.6 billion of GDV, which is shown here, around EUR 3.3 billion is already under construction or pre-construction, and thereof, 94% has already been sold. This is a sound basis for our revenues and earnings in the years to come. On the following slide number 12, we illustrate our track record of ramping up our business. The development of the first quarter shows us on track to reach a volume of around 6,000 units under construction. Quite an impressive increase from around 2,000 units in 2019. Since our IPO, we managed to build up a high quality project pipeline, which increased by more than 120% within a couple of years.
Despite short-term uncertainty, I think it's fair to say that we have already built up the capacities for executing an ambitious growth strategy in an overall attractive underlying market. With that, I would like to hand over to Foruhar Madjlessi for the financials.
Thank you, Kruno, and good morning everyone from my side. Before going into the Q1 details, I'd like to stress the following points. First, while we are withdrawing our 2022 guidance due to the rapidly changing operating environment and our current lack of visibility, we reiterate and confirm our midterm target with 2026 revenues of EUR 1.6 billion. Second, we have a substantial gap between the value of our portfolio and our share price for some time. To make this gap transparent, we have decided to commission a third party valuation report with a view to publish results between now and the date of our Q2 results. Third, management will act in the shareholders best interest in considering all potential avenues to close the valuation gap. With that, I'd like to provide you with a quick overview of our Q1 results.
We had a solid start to the year in line with our expectations. Revenues have come in EUR 10 million lower than the previous year's figure as Kruno has pointed out. Q1 last year benefited from early institutional deals. As you know, institutional sales are more geared towards the second half of the year. More importantly, we've once again recorded a strong margin of nearly 30%. As Kruno has said, while revenues are more difficult to predict in the current environment, we expect our margins to be more resilient than revenues. Consequently, margins are likely to remain more in line with our previous guidance. Our platform costs have slightly increased, primarily as a result of personnel costs, with FTEs up from 350 to 400 year-on-year. Over the page, moving on to our balance sheet. We continue to show moderate leverage.
Our loan to cost stands at just above 20%, while net debt to EBITDA amounts to 1.8 times. Remember also that our inventories enter the LTC equation at historic cost, not fair value, resulting in considerable upside to book values. Our financial strength will continue to be a differentiating factor and a competitive advantage. This may prove to become even more relevant as particularly attractive investment opportunities may arise in 6-12 months from now. Page 16 provides a snapshot on our cash flow and liquidity position. Our operating cash flow in Q1 reflects EUR 25 million of cash inflows generated from our existing portfolio prior to investments of close to EUR 40 million in our land bank. Important to note that prior to any discretionary land investments, we expect our portfolio to continue to generate positive cash flows for the full year.
In terms of liquidity, our current cash position, including term deposits, amounts to EUR 160 million. In addition, we have undrawn corporate lines of EUR 120 million. Total corporate liquidity is EUR 280 million. Finally, we have undrawn agreed project debt facilities in excess of EUR 200 million. Let's move to page 17. The Russian invasion in Ukraine has obviously further fueled the inflationary trends globally and in turn driven up interest rates. Let me share with you our current position and views on financing. The page provides an overview of our corporate debt maturity profile. The EUR 70 million three-year tranche of our 2019 promissory note will be due in August this year. We expect to refinance this in the next few months.
The cost of debt for the new instrument will likely exceed the interest cost of the existing financing. However, the overall impact will be negligible. My current estimate would be an increase of around 100 basis points. In terms of project financings, these are obviously more short-term in nature. We continue to see project financing terms essentially unchanged to our pre-war experience. Essentially all our project financings are variable and linked to EURIBOR with a 0% floor. With EURIBOR rates still negative, we don't expect for the time being any change of our effective project financing costs. Turning to page 18, you will find our prospective NAV. As of March 31st, the value embedded in our EUR 7.5 billion project pipeline amounts to almost EUR 2 billion or almost EUR 41 per share. A wide gap to the trading value of our stock.
With these remarks, I would like to open the call for Q&A.
Thank you.
We will now begin our questions and answer session. If you have a question for our speakers, please dial zero one on your telephone keypad now to enter the queue. Once your name has been announced, you can ask your question. If you find your question has been answered before it is your turn to speak, you can dial zero two to cancel your question. If you're using speaker equipment today, please lift the handset before making your selection. One moment please before the first question. We have a first question from Thomas Rothäusler from Deutsche Bank. Please go ahead.
Hi. Morning, everybody. A couple of questions. First one is on the guidance. I mean, you have decided to suspend the guidance, given low visibility. I mean, any idea by when we could expect an update here?
Thomas, I think we'll provide a guidance as soon as visibility improves. It's very hard to predict whether that will be, you know, closer to now or closer to our Q2 reporting date. I think by then we should certainly have a clearer picture. In the meantime, I think we have to work on the basis of scenarios, and I'm happy to share sort of how we look at things at the moment. Assuming that the key drivers of the current situation, which is material scarcity on our side and financing costs on our customer side, don't change materially from here or don't improve materially from here.
I think a scenario that one could think of is a reduction in construction speeds of about 20%, so 20% less progress than we had previously estimated. That would translate in about EUR 120 million of revenues lost. If you then add some uncertainty on the retail side, you know that our retail sales ratio has been clearly above the longer term average. If we lose, let's say, 30% of our clients due to affordability or due to a wait-and-see mode, that would imply roughly EUR 50 million of revenues lost in 2022.
Lastly, you know, while I think the traction with institutions right now is strong, in some cases surprisingly positive, there's always a risk that that could also be affected. You know, moving or extending negotiation timetables, and moving a deal or two into next year could lose another EUR 30 million-EUR 50 million in revenues. All in all, I think in such a scenario, give or take EUR 200 million of revenues could be lost. Whether we'd see a better scenario will be a question of us getting better visibility before we would be willing to communicate a more optimistic view.
EUR 200 million revenues lost would be currently your worst case scenario for this year?
I think that's probably fair to say, considering the current uncertainties. Assuming no additional unforeseen events, it's hard to see how a scenario could be worse than that.
Okay. The second one is actually on house price inflation and your assumptions. I mean, you expect 15% higher material costs. What is your assumption regarding house price inflation for this year?
Hi, Thomas. Our assumption is at a lower single digit number. Here I have to say that my personal view is in the more expensive inner city locations where the average price is above EUR 8 thousand or EUR 9 thousand, there's a very limited upside in pricing, what I see currently. Where the attractive suburban locations with lower average sales prices will still benefit further from HPI growth. On the other hand, you know, midterm, I think there's a further scarcity of housing due to lower production to increase social housing shares. Additionally, I think we will see less construction activities, less supply, and this could again influence prices positively. What Foruhar Madjlessi mentioned.
Now, on the short-term view, I have to say that I'm really optimistic looking more in mid-term, due to following trends. I think what we see on the ground is a cancellation or postponements of construction starts, not our own, but from other developers due to cost-price inflation. We see that the banks are getting more cautious whom to finance and increasing equity requirements. This leads to two things, less supply of flats, reduction of construction capacity, and for us, of course, opening additionally the possibility for value-add opportunities. There are, I would say, different, of course, trends here, but we are really staying optimistic regarding our mid-term view on our business.
Okay. The third question is on cancellations. I mean, you referred to more cancellations, I think, since April. Could you provide any numbers here in order to get an idea on the magnitude?
Just for the avoidance of any confusion, the term cancellation does of course not refer to cancellation of existing contracts.
Yeah.
It's a cancellation of reservations or early inquiries. But Kruno can provide the answer here.
What we have seen now in, let's say, I have to say that we have seen this, and I've never in my career seen such a shock in a few weeks. The interest rates they went up in a few weeks from, let's say, 1 point something to 2.5%. This has hit people who couldn't afford 2.5%. This was, Foruhar said, it's 10%-15% of our reservations have been canceled because the people who have made the reservation couldn't afford any more the financing. This is what has happened. As Foruhar said, I think it's a short-term shock.
The same for it when you look at, you know, steel price rising in four weeks to up to 50%, which is not a normal situation, I would say. This caused some shocks which we have to see and wait, get more clarity in the course of this year.
The final one is on the ramp-up of the affordable product line. This is still on track or do you think you might adjust that?
No, we are still here on track. But as Foruhar mentioned, we are currently clearly looking at a value add opportunities. I would say. From my perspective, we will see really good chances coming up due to the fact that not every developer has his costs under control as we have. Also the banks are clearly looking at, you know, whom to finance the construction. Therefore, I think that one or the other developer will get under pressure. For us, it's a perfect time period to do the investments. We focus clearly with a very strong balance sheet on value add opportunity.
Okay. Thank you.
There will come many, I would say, in the second half of this year.
Okay. Thank you.
Welcome.
We have a next question from Emily from Credit Suisse. Please go ahead.
Good morning, guys. I hope you're well. I've got three questions, please. The first one just on price inflation, just on cost more than price. You've obviously reiterated margin guidance for this year today. If we look out sort of beyond this year into next year, I appreciate you've got these sort of fixed price supplier contracts at the moment. As those start to roll off, if prices are where they are today at sort of a spot level into next year, do you automatically sort of face a sort of meaningful price cost headwind? Therefore, should we sort of, if we're thinking about next year at the moment, should we automatically start to think about downside to where gross margins are today? Secondly, just on starting new projects on a similar tone, really.
If sales rates sort of start to normalize, are there projects that you would expected to be starting sort of into the second half of this year where you just probably won't be 30% sold or your caution on the outlook on those means that sort of projects get meaningfully delayed and there's an ongoing sort of revenue impact into next year? Thirdly, just on the buyback, could you give us an update there and sort of what your continued plans are? Thank you.
Okay. I can respond, Emily, to the first and the final question. In terms of construction cost inflation, clearly, with significantly increasing costs continuing, there is increasing pressure also on our margins. That is unavoidable, but it will be a question also of the selling prices that we can achieve for our product. I think Kruno Crepulja has explained that, the way that we look at this is that there is, for, in particular, the, let's say, lower price situations, there is certainly some upside that will potentially be even accelerated as a result of a further drop in supply.
The dynamics here are maybe not that unfavorable, and affordability in the suburban areas is still, I'd say, acceptable at least. Whereas in the inner city locations, that is probably more difficult to compensate ongoing cost price inflation with house price increases. It's a mix. I mean, I think as we said before, we're totally committed to the 25% through the cycle margin. We'll have to see how the operating environment develops from here, but we can't completely rule out if we have another, you know, 15%-20% cost rise next year, that we won't be able to fully compensate that.
I'd also say very clearly that we can't see supply coming to the market without us being able to achieve very reasonable and attractive margins regardless. If that would not be sort of achievable, then things would have to break down across the economy. I'm quite optimistic here that the overall dynamics will help us protect our margin largely.
So-
On the third one, Emily, I'm sorry. Just to quickly respond to that. We will continue the share buyback is on autopilot. I think we're expecting to spend about EUR 20 million over the course of this year. Our ability to buy back stock is somewhat limited given the liquidity in the markets that legally we are allowed to operate in, which is really restricted to et cetera. But there's no change in the program from our perspective at this point.
Regarding your second question, looking forward, you know, next 12 to 18 months, I would say that what I expect is that we will see less construction activities because of construction projects being postponed or canceled. This will help us, of course, regarding finding sufficient capacities for construction works. Also from my perspective, will have some influence on costs of on prices also material prices. I think there are different, you know, trends which also help us. And on the other hand, we are absolutely confident regarding, you know, our sales activities. I think we have been above, let's say, from safety perspective in the last 12 months above the average.
If it comes down to the average, which we currently see, this should be sufficient to stay in line with our revenue targets for next year.
Okay. Thank you.
Welcome.
We have the next question from Thomas Neuhold from Kepler Cheuvreux. Please go ahead.
Good morning, gentlemen. Thank you very much for taking my questions. I also have three. The first one is on your acquisition strategy. If I understood you correctly, you think in the value add space in suburban areas, the selling prices are lower than city center. They're still relatively reasonable affordability, and that you will focus now more on the value add project or business. Do you continue to acquire, let's say land plots here, projects here or you're having everything on hold now and also wait to see how the interest rate situation evolves and settles?
Hi, Thomas. Let's say we look of course into the different directions and also not only being focused on suburban areas. I think it has to make, let's say from our perspective, in our residual cash calculation, an inner city location could be still attractive if it meets our, let's say, our margin target. I also think that, you know, the inner city locations will. We will still see higher sales activities. The question is the price dynamic here the same as in the suburban areas? My answer is, currently, we don't see the same HPI growth in the high price segments in comparison to suburban areas. This is our current view into the market.
Additionally, this could prospectively change because, you know, with less supply, with increase of social housing requirements overall, this could influence positively the price development in the inner city locations. Again, but currently, the HPI growth in these suburban areas is more dynamic. We focus on both, but clearly focusing on value add opportunities.
Understood. The next question is on the impact of this lower throughput times and production speed on your free cash flow situation. Will it mean that you will build up more inventories if the production speed is lower and also the selling process is lower?
I think that's inevitably the case. It's I think a very manageable reduction in our cash flow. We still expect a three-digit million EUR positive cash flow for this year prior to land investments. I don't think we could reach to our target. That's a more normal rate of EUR 200 million-EUR 250 million of cash flows generated from our existing portfolio. The slowdown will then and therefore have an impact. I'd also be very clear in saying that none of our financial ratios or others would be negatively affected in any relevant way. What Kruno said before will be a positive for us.
I think our ability to negotiate more favorable terms in land purchases means that we will also have to spend a bit less and can also potentially negotiate delayed payments, et cetera. What we've always done, but the share of these more attractive, financially attractive transactions should also increase.
My last question is on the institutional demand side. You mentioned it's been solid. Do you have already any discussions with institutional buyers about pricing? Is anybody saying already that rental yields need to go up because the financing costs of institutional investors also go up and/or that alternative investments or the rising bond yields might also become more attractive?
What we see here is currently, I would say, a mixed picture. There are still investors willing to offer our prices we ask for. There are other. There's another group waiting to see what is happening further in the market. It may be waiting for value add opportunities. I would assume that from my perspective we will find sufficient number of investors willing to pay our prices.
Foruhar also said that we can't completely exclude the risk that what has been planned in the last quarter as a sales activity could last longer because we won't accept price reduction here. Because you know that we always have the alternative to switch to owner-occupier business. This I can't completely exclude, but looking at the current activities after the shock, you can say, we still see a strong demand of institutional buyers who have to invest year by year. Pension funds, for example, who are pressed to invest.
On the other hand, Thomas, I think it's also fair to say that here the supply that developers who have not the cost control we have with the banks in the back saying, "We don't want to finance your construction." I think there will also be less product available for institutions.
That is a fair point. Okay. Thank you.
Welcome.
Thank you very much. We have no further questions for the moment. Ladies and gentlemen, I would like to remind you that if you wish to ask a question, please dial zero one on your telephone keypad. Thank you. Once again, ladies and gentlemen, if you wish to ask a question, please dial zero one on your telephone keypad. Thank you. We have no further questions for the moment.
Thank you. Thank you for your participation. If you have further questions, please feel free to contact the IR team also after this call. Thank you and goodbye.
Thank you.
Thank you. Ladies and gentlemen, thank you for your attendance. This call has been concluded. You may now disconnect.