Earnings Call: Q4 2018

Feb 5, 2019

Summary

2018 profit from property management rose 25%, while EPRA NAV increased nearly 25% to SEK 125/share. 2019 outlook pointed to 17% rental income growth and continued strong property-management earnings, with higher property taxes weighing on the surplus ratio.

Ladies and gentlemen, welcome to the Fabege AB Q4 Report 2018 call. Today, I am pleased to present CEO Christian Hermelin and CFO Åsa Bergström. For the first part of this call, all participants will be in a listen-only mode, and afterwards, there will be a question and answer session. Speakers, please begin. Thank you. It is Christian speaking. Welcome everybody to Fabege's year-end report for 2018. Turn page. 2018 was another year where we delivered according to plan or even better in many ways. Here you can see three most important key ratios for our long-term profitability. We have high ambitions for these three key ratios, and we have exceeded the goals by a big margin. Overall, this meant that our long-term net asset value, EPRA NAV, improved by almost 25% during the year. Net asset value increased to 125 SEK per share. Our profit from property management increased by just over 25% in 2018. This was due to strong net lettings and rent increase in the renegotiations in recent years. The strong profit during the year was due to our long-term target. Turn page. Here you can see our surplus ratio. This is a good measure of the effectiveness of our property management operations. We have set tough goals for our surplus ratio. Without them, I do not think we have reached this strong improvement. Turn page. In line with the rising values, our goals have been to reduce our borrowing and our risk. Even here we can see a clear change in line with our target. Turn page. Also, we reduced our risk and financial leverage. We have increased our profit as you can see here. The drop in profit we had 2012 is explained by our tax cases of just over 2 billion SEK that year. Turn page. Here you can see how our net asset value has developed during the years we have reported according to EPRA NAV. This graph is important. If you turn page, you can also see the development of our share price. If we compare these two, which you can see on the next slide, you can see how well the share price is following our net asset value trend. Our net asset value has increased much more than the sector average in the past five years. The difference is more than 30%. Turn page. Why are we performing better? One reason is Stockholm with its growth and rental trend. Another reason is that obviously it takes very good care of our customers, and we also are very good in finding new customers. The main reason is our value-creating project operations. In the past five years, our project operation has delivered net asset value growth of about 5% per year. Now over to Åsa. Thank you, Christian. Please turn to page Condensed Income Statement. 2018 was a really good year with increased rental income, improved net operating income, better profit from property management, and continued value growth. An excellent result at all levels and strong key ratios. Rental income amounted to SEK 2.5 billion, an increase of more than SEK 200 million compared to the previous year. In an identical portfolio, income increased by just over 10% through project occupations and through rental growth from renegotiations and new lettings at higher levels. The surplus ratio came in at 74%, which is in line with our full-year target. Administrative costs increased compared to the previous year to a level that we also expect to continue going forward. Interest expenses are slightly lower than last year in absolute terms. Overall, we are borrowing more but at lower average cost. The result in associated companies amounted to minus SEK 64 million. As expected, a positive non-recurring effect in Arenabolaget meant that we did not make any capital contributions during the fourth quarter. We therefore reported profit from property management of SEK 1.2 billion, which is an increase of 25% compared with the previous year. Realized changes in value amounted to SEK 153 million. They were partly related to paid additional consideration for a transaction carried out in 2010 and partly to a dissolution of a reserve created in connection with a property development. Before year-end, around 50% of the portfolio was externally valued. The yield requirement fell slightly during the fourth quarter from 4.17% to 4.13%. Overall, unrealized changes in value amounted to SEK 7.7 billion, equivalent to a value growth of 13%. Values in the project portfolio rose by SEK 2.3 billion, generating a return on invested capital during the year of 98%. Values in the investment property portfolio during the first half of 2018 were driven by rent increases as well as lower yield requirements. During the third quarter, the values were mainly driven by higher rental rates. During the fourth quarter, we again saw a combination of higher rental rates and lower yield requirements. Unrealized changes in value included SEK 132 million related to property transactions during the year. In our segment reporting, this item is separated and is reported in the transaction segment. During the second half of 2018, we realized the deficit value in the derivative portfolio of SEK 143 million through premature termination of interest rate derivatives. Net changes in value of derivatives during the year amounted to plus SEK 16 million. The tax expense amounted to SEK 1.4 billion and was mainly related just to deferred tax. The amount includes a positive effect from property transactions of SEK 164 million, and a positive effect of SEK 455 million due to the revaluation of the tax liability to the new tax rate. Now please turn to page Key Ratios. In line with the strong earnings trend, our balance sheet has continued to strengthen. Reported equity now amounts to SEK 106 per share, and the long-term net asset value, the EPRA NAV, amounts to SEK 125 per share. All of our most important financial key ratios strengthened during the year. This includes the equity asset ratio, the loan-to-value ratio, the interest coverage ratio, and the debt ratio. This, of course, is due to an increase in cash flow and value growth. Please turn to page Financing. After a long period of very competitive prices in the capital market, recently it has been dominated by turbulence, caution, and increased margins. Today, the banks appear more stable and competitive. Shortly before Christmas, we signed a new just-over-nine-year financing agreement for SEK 1.6 billion with Brunswick Real Estate. We are happy about this new green loan and about gaining access to a new source of financing. We have strived to extend bank facilities with the aim of minimizing maturities during the next 12 months. We have almost achieved this, and on the bond side, we have no maturities until after the summer. Capital maturity now stands at five years, and the fixed interest term has increased to 3.6 years. This has meant a slightly higher average interest rate during the quarter. Compared to the previous year, the average interest rate has fallen significantly, mainly because many of the old and more costly swap contracts expired during the year. We are continuing our efforts towards 100% green financing. This proportion is increasing in line with the ability of our financiers to provide green financing and the certification of our property portfolio. At year-end, 60% of our financing was green. At year-end, unutilized credit facilities totaled SEK 4.5 billion. This feels reassuring in view of future refinancings, as well as access to capital for continued investment. Please turn page. Before I hand back to Christian, I just want to comment on some different factors which will have an impact on our results and key metrics in 2019. Rental income will continue to increase both as a result of project occupation and due to renegotiations at higher levels. In the report, we show the rental trends for the coming four quarters based on how our lease portfolio looked by the end of the year. In other words, no further assumptions, but just based on already signed agreements. The surplus ratio will decrease on account of new property taxation, which will imply a significant increase in property tax. This will be largely passed on to tenants, but it will have a negative effect on the calculation of the surplus ratio. We expect the surplus ratio of 73% for 2019, and we have postponed our objective to reach 75% by 2022. Another change is that the leasehold cost will be separated from net operating income and reported among financial expenses. We will recognize a leasing liability and an equivalent right-of-use asset for just over SEK 900 million. Finally, based on the cash flow for 2019, we do not expect the interest deduction limitations to have a large effect in 2019. We have a total scope for deduction that exceeds the interest expenses. However, this requires an effective balancing within the group of net interest income and expenses. Now back to Christian. Thank you, Åsa, and turn page. Net letting for the year of SEK 159 million is one of the strongest ever. Net letting in the fourth quarter was just SEK 7 million. I want to be clear, we do not see this as a signal about the state of the market. A big termination of SEK 27 million affected the result during the quarter. Without the termination from the company, LRF, which is moving across the road to its own property, net letting would have been strong during the quarter. Turn page. The rental increase from renegotiations was 29%, and this is a better signal about the state of the market. We see that rents are rising today in all our areas. The strongest percentage increase now is almost outside the CBD. Turn page. Here you can see where our changes in value comes from 2017 compared to 2018. The difference is not so big. Ahead of 2018, we did not expect such a big effect from falling yield requirements, but the falling yield requirements in the world around us have also affected our yield levels. In 2019, based on the current market forecast, we will continue to see strong contribution from our projects and rising rents. The biggest surprise in 2019 can be continued fall in yield requirements. There have been few transactions in our market, and the values do not prove the current market values. We estimate that the willingness to pay today is much higher than the values, especially for quality objects. In other words, we think that if there are transactions in our markets, we can expect relatively large revaluations. Turn page. To project. I have said before that a lot of our success is generated from our attractive portfolio of development rights and their low cost. To keep topping up our portfolio with new and complementary development rights is a long-term priority. Many people have asked us where our next Arenastaden will be developed. We have said that such a place has to be unattractive today to fit our business model, meaning it needs to be a place where market values have not increased too much. One year ago, hardly anyone believed there would be a new office district on the south side. I expected many skeptics when we presented our vision for Flemingsberg on the south side. We mostly heard things afterwards, like brilliant and obvious. It's a bit surprising nobody thought of that before. With Flemingsberg, we are now topping up our project portfolio with more attractive development rights at a low cost. This is a good basis for us to continue delivering higher net asset value growth than the sector average. Turn page to slide Arenastaden. We are also topping up our development rights in the northern side of the city. Here you can see four of our development areas in Arenastaden. Both number 1 and 2 are recently gained legal force, and we expect area 3 to gain legal force within the next 6 months. Please turn to page Solna Business Park. In Solna Business Park, we also top up our portfolio with attractive development rights in the next few years. Right now, we are creating an overall design for the district. We're doing the same in Flemingsberg, and in both areas, we're using a Danish architect office named BIG. We want to create something special. It seems very natural to work with such an exciting and innovative company as BIG. Turn page to future. Fabege will get a new CEO shortly. One should not stay in charge for too long period. 10 to 12 years is considered to be a maximum, and I am now into my 13th year as a CEO. Today, Fabege is a strong team with a clear business model and long-term goals, and I am just a small part of this strong team. There is nothing dramatic about changing a small part of a team, and some new blood is always good. Looking ahead, Fabege still has a big advantage due to a strong base Stockholm long-term growth. It is perhaps the best basis for good property investment over time. Of course, our project portfolio and fantastic organization also contribute to this strong base. Turn page. Let us look at the facts ahead of 2019. We can see that our income will increase by a total of 17%. This is how it looks today based on all the entered into and terminated leases. It will probably get a bit better late in the year, mainly due to renegotiation and new lettings. We see also stable operating costs and largely unchanged interest rates with the current interest rate trend. This should also mean strong growth in profit from property management even in 2019. As regard changes of value, like I said before, I also expect a big contribution in 2019. That was Åsa's and mine presentation. We are ready for questions. Thank you. Ladies and gentlemen, if you have a question for the speakers, please press 01 on your telephone keypad and you will enter a queue. After you are announced, you can ask a question. There will just be a brief pause while any questions are being registered. Just as a reminder, if you do wish to ask a question, please press 01 on your telephone keypad now. As there are no questions, I will hand it back to the speakers. Then Åsa and me are thanking you for listening to us. Thank you. This now concludes our conference call. Thank you all for attending. You may now disconnect your lines.