Earnings Call: Q1 2021

May 20, 2021

Dear ladies and gentlemen, welcome to the Instone Q1 twenty twenty one Results Conference Call. At a customer's request, this conference will be recorded. May I now hand you over to Burkhard Zawaski, Head of Business Development and Communication, who will start the meeting today. Thank you. Good morning, everyone, and thank you for joining our Instone Q1 earnings call. Our management team is represented by our CEO, Chrono Sepulja and our CFO, Foua Vaclesey. They will walk you through our presentation and provide you an update on our business performance and our outlook. This is, as usual, followed by a Q and A session. With that, I would like to hand over to Chrono Fepulla. Good morning, everyone. I'm glad you could join us for Q1 twenty twenty one earnings call. Our management team and I are very pleased that we had a good start to the year despite the pandemic related economic slowdown. Although Q1 is traditionally a rather quiet quarter, the overall business performance shows us well on track to reach our fiscal year twenty twenty one growth targets. Now let's start our presentation with the highlights on Page five. Our business model is back on its growth trajectory across all parts of the value chain. Most importantly, the demand for our product remains very strong from both customer groups, private as well as institutional investors. Investors. Especially worth mentioning is that we have already signed the first two deals with institutional investors at Wattenberg in the Southern Part of Germany and the larger joint venture project in Berlin at a comparatively early stage of the year and at very decent margins. The upward trend for German resi prices continues to provide major tailwind to our business model. To support envisaged step changing growth, we are working very actively on acquisitions and the expansion of our project portfolio. Currently, we are in exclusive negotiations for several projects, including also larger size opportunities with a GDV of some EUR 1,300,000,000.0. Deals with a volume of around EUR $240,000,000 have already been approved year to date. On the construction side, our projects under construction are running according to plan. A negative factor which cannot be ignored is the recent inflationary development in commodity markets, which will result in rising material costs. However, large parts of construction works for this year will not be affected as costs for such projects have already been fixed. Nevertheless, this development will limit additional margin upside, but we can clearly reiterate our financial targets. At our financial KPIs for the first quarter. Our adjusted revenues amounted to €128,100,000 This reflects a strong growth of plus 28.5% year on year. In the coming quarters, you can expect further growth acceleration in absolute and also in relative terms. Our gross margin stayed at a very high level of 31.6%, also compared to other peers This clearly reflects the very strong demand situation for our product and it is also attributable to a favorable sales mix. In Q1, we benefited from a high sales contribution from particularly high margin projects. Projects. And finally, with the further expansion of our operating margin, our adjusted earnings after tax saw a strong increase of some 85% year on year to EUR16.1 million. Coming to our outlook. Despite some headwinds from rising commodity prices, we can fully confirm our financial targets for this year. Hence, we are expecting adjusted revenues in the ballpark of EUR820 million to EUR900 million and adjusted earnings after tax in the range of EUR 90,000,000 to 95,000,000. The EAT is also the basis for future dividends. We intend to keep dividend policy unchanged with a payout ratio of 30% of EAT. On Slide six, you can find the chart with our retail sales ratio, which is calculated on a weekly basis. This chart is again a good indicator for dynamics. After the recovery from the first lockdown period in spring last year, the demand remained stable at a high level above the long term mean. We are not only benefiting from volume effects, but are also able to exploit the favorable pricing environment. As another positive demand indicator, we currently also have a strong backlog of reservations and authorization appointments, providing high visibility for strong sales development also in the weeks ahead. On the following Slide seven, we again collected some data points regarding the development of the overall market environment. Although results of the different surveys comprised a rather wide range, the overall direction is very clear. The upward trend for German residential properties in metropolitan areas also continues in the first month of twenty twenty one. Against the background of this positive momentum witnessed over the last month, we also view a close to mid single digit HBI growth, I. E, a further yield compression as a realistic scenario for 2021. On the financing side, we have recently seen a slight rise in mortgage rates from their all time lows. Nevertheless, this has not changed the overall picture. It is obvious that the still ultra low interest costs with average mortgage rates of still below 1% for ten years and the good availability of debt for residential investors remain very supportive demand factors. Also, the main demand drivers for institutional investors remain fully intact. A lack of defensive asset classes also due to structural headwinds in other real estate segments and the attractive spread to bond market yields also in the historical context are pushing demand. We can confirm that we are receiving strong indications of interest from institutional investors also for the remainder of the year. The margins on the deals we have negotiated and on the two institutional deals we have signed year to date absolutely in line with the retail channel. This clearly provides additional optionalities. In general, the institutional business offers some structural advantages such as a superior cash flow profile and an overall lower complexity in the marketing process, etcetera. Let's move to Slide eight. One major new development for our business over the last few months as well as for many other industries was a strong rise in commodity prices. As a result, within a short period of time, we have seen a jump in costs for certain construction materials such as construction timber, steel, copper or for facade insulation. Apart from mounting material price inflation, the availability of certain materials, I. E, the risk of potential delays is a risk factor we also have to keep an eye on. We expect that CPI growth in 2021 will exceed our initial assumption of 3.5%, possibly by one to two percentage points, driven by higher material costs. The higher material costs are partly offset by more moderate growth in labor costs. Due to decreasing demand for commercial development projects, our negotiation power vis a vis the construction companies has improved over the last month. Moreover, the majority of our construction costs have already been fixed. Generally, we as Instone, I think that is really fair to assume are comparatively well positioned in the market with the rising supply constraints. Our established network with long lasting supplier relationships and our leading market position are paying off. Last but not least, the fact that we are mainly focusing on single awarding of traits, unlike most of our peers, is clearly helpful in this respect. This offers a higher degree of control over our suppliers and ultimately our construction costs. All in all, the above budget CPI growth in 2021 is mitigated by, first, a certain amount of cost buffers secondly, the HPI growth we have seen in Q1 as well as thirdly, the significant share of 2021 construction costs we have already contractually fixed. So for the avoidance of any doubt, despite the recent price developments and the current supply chain risks that we do monitor and actively manage, we remain absolutely confident to achieve our 2021 guidance. Moving to our portfolio section on Slide 10. We have committed for step change in growth with a midterm annual revenue target of 1,600,000,000.0 to $1,700,000,000 The launch of our value home product is supposed to be a key driver for this. Instone will therefore continue to expand its project portfolio in the coming two years. We are going to invest it to land in the ballpark of 300,000,000 to up to €400,000,000 each in 2021 and in 2022. And we are making good progress on this. Currently, we are in exclusive negotiations for several deals, including also large size opportunities with a total GDV of around €1,300,000,000 This also comprises a decent share of value home projects. Hence, we are hoping that we can provide further positive news in the coming months. Important to note that we have already approved three projects year to date in the metropolitan areas of Stuttgart, Erlang, Nuremberg and Reimjin, with a GDV of around $240,000,000 Slide 11 illustrates a breakdown of our current project portfolio as of the Q1 reporting date. There are no major changes compared to the previous quarter. The portfolio is made up of 51 projects with more than 13,500 residential units. Almost 90% of the GDV is in the most attractive metropolitan areas of Germany and the remaining part in very attractive B cities. On the right hand side, you can see the usual breakdown of the current development status of our portfolio. Of the nearly $6,100,000,000 of GDV, around $2,600,000,000 is already under construction or peak preconstruction, and thereof $2,400,000,000 or more than 90% has already been sold. This secures a high level of visibility for expected sales and earning growth in the years to come. With that, I would like to hand over to Farooqa for the financials. Thank you, Kuno, and good morning to everyone from my side. Let's go right into our Q1 financial results. Page 13 shows our Q1 P and L. We are satisfied with our Q1 results as they do reflect a good start to the year. Our €128,000,000 in revenues are markedly higher versus the comparable 2020 periods and in line with our expectations. The revenue figure corresponds to €119,000,000 of concluded sales contracts, up 70% versus Q1 twenty twenty. As you know, the first half of the year tends to contribute a lower share to full year revenues and earnings compared to the second half, completed. You should expect a similar pattern this year with sales and revenues tilted towards the back end of this year. Our very strong 31.6% gross margin continues to benefit from favorable mix projects with particularly high margins. These mix benefits are expected to fade out as the year progresses. In addition, a number of lower margin social housing projects will temporarily weigh on our margin when they occur. For Q2, we would expect the gross margin substantially lower, more likely in the low to mid-20s. Kuno has already explained the sensitivity of our gross margin to material cost increases for the current year and the mitigating effects based on one, our high share of already secured fixed price contracts second, reduced capacity utilization in the construction industry associated with the need for our contractors to absorb a portion of the price increases in order to win new business and third, the opposing trend of HPI that will benefit our 2021 revenues and margin to the extent associated with yet unsold units. In summary, I would like to reiterate our expectation for an unchanged 2021 gross margin of 26% to 27%. Q1 platform costs have increased in line with expectations as we continue to invest into future growth. As previously communicated, our expected platform costs for the full year are around €80,000,000 Our attractive 20.8% Q1 EBIT margin benefits from €2,500,000 income from joint ventures. The figure reflects our 50% share in a Berlin based joint venture that has successfully completed an institutional sale of five buildings with a total of five thirty seven units. Finally, you will notice a relevant reduction of interest costs. This is due to a combination of our 2020 corporate refinancing at favorable rates as well as the reduction in gross debt outstanding versus the prior year period. Also, the twenty twenty Q1 figures include approximately $700 non recurring profit linked payments to our Wiesbaden joint venture partner deemed as interest under IFRS. Page 14 provides an overview of sales and revenues associated with retail and institutional clients. Focusing on the pie in the middle of the page, you can see the split on a pro form a basis, I. E. Including the sales contracts associated with our unconsolidated Berlin joint venture. On that basis, approximately 60% of our Q1 sales have been institutional versus approximately 40% retail. As the strength in institutional demand for residential real estate continues and in line with our previous communication, we do expect our institutional sales to exceed 60% for the full year 2021. With respect to revenues for the three months to March 31, approximately 40% are related to projects sold to institutions. For the full year, the institutional share can be expected to exceed 60% in line with the volume of new sales contracts. On to Page 15, we provide a snapshot of our balance leverage. As project financings have been repaid and incremental cash flow has accrued, our net debt figure is down by about 150,000,000 versus December 2020. As a result, our loan to cost figure amounts to 11% versus 26% at year end. Once again, the figure is based on historic costs of our inventories, not fair value. The corresponding net debt to EBITDA figure stands at 1.1 times. The balance sheet will relever substantially over the next few quarters as we execute our growth plan and invest into new projects. As we have communicated a number of times, our mid term revenue target of 1,600,000,000.0 to 1,700,000,000.0 is completely funded. In particular, no further equity will be required in order to hit the target. Over the page, with our operating cash flow at €150,000,000 we have had a particularly strong quarter. It is worth mentioning that milestone payments from our project Vestwell have contributed significantly to the strong flow figure. The aggregate Vestville related prepayments are reflected in our balance sheet as part of the other current liabilities. Nevertheless, the full year 2021 operating cash flow will be negative as we will invest in excess of €300,000,000 in new land and in line with our ambitious growth target. As you can see in the table on the right hand side, our undrawn corporate debt facilities and cash position adds up to more than 400,000,000 In addition, we have undrawn product financing lines with $90,000,000 undrawn capacity to cover future construction costs. Page 17 provides an update of our prospective NAV calculation. The figure reflects the NAV we would generate if our entire pipeline would be developed to hold in a rundown scenario without adding any new projects to our pipeline. On a per share basis, our perspective NAV stands at €33.5 As you can see on Page 19, our outlook for 2011 remains unchanged. While the commodity price developments will be monitored and managed closely, our high level of fixed price construction contracts for '21 and the favorable HPI development will help mitigate any detrimental commodity price developments. Consequently, we remain fully on track to achieving our full year targets for 2021. With that, I would like to open the Sorry, operator, would you mind allowing our audience to ask questions? Of course. Thank you. Now we will begin a question and answer The first question is by Thomas Rotheusser of Jefferies. Your line is open now, sir. Hi, morning everybody. I have a question on the acquisition pipeline. You referred to €1,300,000,000 of GDV. I mean, you give us some color on pricing? What you expect? What you see in the market and also competitive situation? And by when can we expect you to announce the next deals? Hello, Thomas. So regarding the competitive environment, after a shock freeze caused by the pandemic, the competition is back also driven by the strong demand for resi projects. The main change is that we see a less competitive environment for huge projects due to financing issues of highly levered actors which have been very aggressive before the pandemic started. So this is a competitive environment. Looking at price levels, what we currently see is and this is also linked to strong demand in the HBI growth we are already facing resi sales, the land price are starting to rise again approximately at a level of 2x HPI, which is current HPI growth we would assume at near to mid single digit size. And looking at our €1,300,000,000 of portfolio, which is under exclusivity, of course, the number is significantly bigger for all the projects we are currently checking in the acquisition. We are doing our job regarding due diligence and negotiation and I would expect the next four to six weeks to have the next deal announced. So can we expect this to be larger deals? I mean, larger land plots as you refer to better competitive situation for you there? So it's hard to say. Let's say, we have different project types in the portfolio. There are larger sites, let's say, in the portfolio and we'll see how far we get with the due diligence now in the next weeks. It could be a larger project, but it could also be a mid sized project depending on the finalization of the due diligence process. Okay. Maybe a last question on the topic we've discussed with reporting, actually, which was, you know, slower building permission process. Any change there or any relief in the meantime or as as things get even worse or and maybe maybe some thoughts on this. So I think it's it's it's working as we have reflected it in our plan. So overall, I would say it's still a mixed picture. There are authorities working faster, others slower. And I would say the speed is similar to what we have reflected the last time. We're making good progress. Overall, I would say, we achieved the building permit for all the Westwood parts, which was important. Think you can see this also in the cash flow position, in the positive cash flow position. This is mainly driven by Westville. We got the payments for the building permit. And we feel very confident with our this year guidance and also for the outlook for the next year. Okay. Thank you. You're welcome. The next question is by Pascal Ball of Stifel. I have several questions. First one is on the cost inflation. You gave on Page eight of your presentation, you gave a scenario analysis. However, can you explain that a little closer? I don't get really the point here. Secondly, you mentioned a materially lower gross margin in Q2. However, you also remain confident on your 26% to 27% target for the full year. So does this imply that you assume a higher or a better product mix in the second half of the year? And then finally, your net debt to EBITDA number came significantly down to 1.1x. What do you expect this number to be at the end of the year? Pascal, I'll take over the first one. Maybe Corrado will answer the two following questions. So regarding the material cost inflation, so what we are showing is overall, our assumption for cost price inflation we are using is 3.5%, including labor and material cost inflation. Now what we have faced in the last weeks is that material costs overall went up 7% to 9%. And this leads to CPI growth of approximately 5% to 6%. We have this other effect, would say, and I mentioned it's the labor cost inflation is a bit lower. And what is slowing down a bit, the 7% capacities of company construction companies weakened through corona. So these are the positive effects. Overall, we see a 5% to 6% cost price inflation currently. And as mentioned, this is only, let's say, influencing, of course, our margin, let's say, partly because it only influences the projects where we don't have any contracts signed already and the projects which have been already sold where we can't react on pricing. And this is very limited and therefore it's completely compensated by the HPI growth we've seen in the first quarter. And hopefully, with that, I have given you more insight and more transparency. But let's assume that next year for the following projects, the CPI assumption will be 5% or 5.5% instead of 3.5%. What would that do to your gross margin if we assume that the HPI pricing is more or less or less flat? So, if let's say, if the if the if we would face further, let's assume 5%, so an increase of 1.5% cost price inflation, which couldn't be compensated by HBI, then this would have approximately, let's say, overall 40% to 50% would be the impact on gross margin. So assuming 1.5% increase would lead then to 0.75% lower gross margin approximately. But as mentioned, it really influence only the projects where we have to fix the contracts. And it would influence the margin if we don't see any HPI growth above the 1.5%. Sure. Makes sense. Thank you. So, Pascal, on the other two questions, in terms of the gross margin, this is really just a health warning that Q2 margin will be lower, but shouldn't be a concern. We'll if you think about it will be a one off effect and then Q3 and Q4 will be more in line with our full year target figure. So the average will be 26% to 27% for the full year. And that's subject to these trades happening in Q2, which is never a certainty, but it is from today's perspective the likely outcome. In terms of the leverage figure, as we discussed, we are at 1.1 times. I would expect us to approach three times by year end as we still expect to invest, let's say, north of €300,000,000 of incremental monies into new projects. Thank you. All right. The next question is by Thomas Neuhold of Kepler Cheuvreux. Good morning, gentlemen. Thank you very much for taking my questions. I have three and maybe we take them one by one. The first one is a follow-up question on the cost inflation topic. Do you think the cost inflation is transitory? Or do you feel it's rather permanent? And I was wondering if you have adopted your cost inflation assumptions in your models when you look at new projects? Or are you still using the 3.5%? Yeah. Thomas. Good question. So from my perspective, have to say that this is based on what we see in the market and what hear from our suppliers and also what we see from analyst side. I expect for the raw materials where it's more a production driven issue currently that these prices will that we have reached peak. That's what the suppliers and analysts feedback is currently. And it will normalize during let's say the next six to twelve months. This is insulation steel etcetera. For copper, I would expect the prices let's say the inflation for copper price staying at a high level due to very strong demand not only from our industry, but from all industries. So this is my personal view. And currently we our calculation assumption that cost price inflation is compensated by HPI remains the same. So currently we see stronger HPI growth in 1.5% and our assumption is that both positions are compensating each other. And the second part of my question, what are you modeling in now if evaluate projects? Are you still using 3.5 or are you using high inflation? Thomas, we haven't changed our models. Clearly, it would also be I think inconsistent to assume that the price increase not just the price level, but the price increase would continue at that speed. Okay. Fair point. Good. Second question is on the regulatory environment. Can you please elaborate what the impact on your business could be from the mobilization of land for construction, Poland, obviously, cassettes and the federal funding regulation for energy efficient buildings, the risk in the Federico and Federico Pigeboide. The I can maybe start with subsidies. So the new buffer regulations is not really a major change for us. It is replacing the need to take out a loan via the KFW bank by the possibility to which would then be sort of repaid only in part. This can now be replaced with a direct subsidy for the same amount. We are entitled in a number of our projects to receiving these benefits. It's a negotiation question then whether we keep them for ourselves or we build them into the sales price and that the buyer either the retail buyer or the institutional buyer reap the benefits of the subsidies. That is not really a major change. In terms of Poland mobilization, I think there's a lot of restrictions in the law that don't apply to us specifically, but make the availability of new condo sales more difficult for other players. So, I don't want to say that regulation is helpful for us, but it's probably more detrimental to the competition. And it's more likely I think to drive prices further up than harm our business. Okay. And my last question is on the upcoming elections. Can you maybe share your views on what the potential chances and risks for your business could be from the likely participation of the Green Party in the next government? No. There are two main topics. And of course I think it's on the agenda of all the parties. It's climatic change and it's affordable housing and of course the greens will push more the or additionally more the climatic change part. So from our perspective, I think we are well prepared to this having the right answers with Value Home focusing on affordable housing, increasing the part in our business for affordable housing. And secondly, for the quarter developments being, I would say, a huge company in this business area, putting in renewable energy, being flexible in the question of product development, etcetera. I think we are well prepared for this. I would assume that overall the regulation will further increase, But I see more chances than risk for our company in this field. Great. Thanks a lot. You're welcome. Next question is by Emily Bedolff of Credit Suisse. Good morning, guys. I hope you're well. Thanks for taking my questions. I have two, please. The first one, I just wanted to come back on land buying margins. Are you as as we look at it today, obviously, you've been active in the in the last quarter, but do you think that you're buying land on the same margins that you were through the second half of last year? When you're buying land at the moment, are you continuing to make the same sort of near term assumptions on house price inflation and CPI that you were six months ago? Or are you trying to capture that sort of higher level of build cost inflation within the land price? Is there anything we sort of need to think about there in terms of sort of long term margins? And then secondly, you obviously said that this sort of project delays aren't getting any sort of better or worse than they were last time we heard from you, and that sort of gives you confidence in next year's revenue. Are we at a point when sort of the guidance for next year can become sort of more specific than just north of €1,000,000,000 Are we sort of closer to getting, yes, sort of slightly narrower range there? Thanks very much, guys. On the guidance point, I think in line with how dealt with that in the past, I think we will become more specific only with full year numbers next year. That's our plan currently, but we have no I mean, if we were to expect a material change to the revenue figure out there, would clearly be providing feedback and input here. And secondly, in terms of the margin, we have said that we're expecting 25% in line with our long term margin. And any sort of deviation from that, I think we'll specify more precisely with as I said, with in line with historic practice with full year numbers, but it will be around that level or at that level. Regarding your question on margins in acquisition projects, I would say that we are still facing the same margin assumptions. So it's the 25% for the core business, 20% for value home. We have had after the pandemic the one or the other projects we already reflected this, let's say, with an upside potential we catch caused by the pandemic. But currently, I would say the land price development and the competition situation is leading to margins we have also seen before the pandemic started. Looking at our calculation assumption, let's say, if you look at the current market environment, we see HPI growth at the level of near to 5%, cost price inflation at the level of 5% to 6%. This would mean that the cost price inflation numbers are overcompensated by HBI when you compare this with our assumption 1.5% HBI and 3.5% CPI, which is still in place. So, are still very conservative here due to the fact that I think that the construction costs, the material costs will normalize in the coming six to twelve months. So we don't see any necessity to change this here. Great. Thanks guys. You're welcome. The next question is by Philipp Kayser of Babok Research. Yes. Hello, everyone. Thanks for taking my question. Just two short questions left from my side. Maybe first, then add on to the building permit side. So they shouldn't trigger any risk this year, but so what is about next year? So when the normalization on the building permit side has to start that there will be no further delays also in 2022? And the second one is on the acquisition pipeline. So just could you indicate what volume is earmarked for Value Home from the €1,300,000,000 of project in the acquisition pipeline? So starting with the last one, approximately 500,000,000 is dedicated to Valjon. And regarding regarding the the building permit processes, so if this let's say the permission speed is as is today and we've seen it in the last one, two, three quarters, then we don't see any risk for our guidance for next year. I would say we're exactly where we expected to be. We've built in that sort of slowdown for the current year into our numbers for 2021. But with the vaccination improvements, we have to from today's perspective expect that we will be back to normal by the end of the year. Perfect. Thanks a lot. There are no further questions. So I hand back to Mr. Savatsky for closing remarks. Yes. So thanks again for your participation. If you have further questions, please do not hesitate to contact the IR team also after this call. Thank you. Good bye. Ladies and gentlemen, thank you for your attendance. This call has been concluded. You may disconnect.