Earnings Call: Q3 2019

Oct 21, 2019

Summary

Rental income and property-management profit increased, while unrealized gains lifted property values. Management cited a strong Stockholm market and expected yields to fall further.

Ladies and gentlemen, welcome to the Fabege AB Q3 report 2019. Today I am pleased to present CEO Stefan Dahlbo and CFO Åsa Bergström. For the first part of the call, all participants will be in listen-only mode, and afterwards there will be a question and answer session. Speakers, please begin. Welcome to Fabege's presentation of the third quarter of 2019. As most of you know, it's my first presentation as CEO of Fabege. I have now been here for about 7 weeks. It has been hectic. It has been educational. It has been most interesting and fun. I must say, I'm very impressed by the organization. I know there was a lot of knowledge, a lot of entrepreneurship, a lot of passion, but I'm still very impressed. It's even better than I thought or expected it to be. The last 10 years, we can say, has been fantastic for the property sector and especially maybe for the market in Stockholm. As you can see at slide 2, we all know that the yields have continued to trend downwards. We have seen rents increasing. We had a good economic cycle. We have been investing during this period a lot in different projects. It has been very prevalent times for Fabege as it continuously grew. Today, as we see on slide 3, we have a total property value of almost SEK 72 billion. 40% of this value are in the inner city of Stockholm. 10 years ago, Arenastaden was very small part of our holdings. Today, it's about 30%, SEK 21 billion. As for our business stock, this is roughly 15% through Solna, and the inner city of Stockholm is about SEK 40 billion each. That's great, and we will come back to that future potential in all those and the other areas where we're active. Slide 4, and generally speaking, we saw continued good earnings, a good trend during the third quarter. I will ask Åsa to take you through the quarter's results in more detail. I will. Thank you, Stefan. The situation remains positive with increased rental income, improved profits from property management, and property value changes. Rental income amounted to almost SEK 2.1 billion, an increase of more than SEK 270 million compared to the previous year. Rents as we measure in an identical portfolio income increased by 14% in total. Completed projects made a big contribution to the increase, but higher rental rates in agreements and index adjustments also contributed positively. However, the sale of Pelaren 1 in Q2, which was completed on 1st of July, meant that the rental income in the third quarter fell slightly. The outcome of the property tax assessment was also better than we were expecting at the beginning of this year. This means that both income and expenses were lower, and this had a positive effect on the cost ratio in the third quarter, and the cost ratio for the entire period came in at 75% in total. Interest expenses are slightly lower than last year in absolute terms. Over the year, we have borrowing more overall but at a lower average cost. The result in the associated companies amounted to -SEK 72 million and mainly related to the capital contributions to the Arenastaden project during this period. During the third quarter, we made no capital contributions. In total, we therefore recorded profit after the management of SEK 1.1 billion, which was a solid increase of 27% compared to last year. Before the end of the quarter, just over 40% of the portfolio was externally evaluated. The yield requirements fell further but with only 1 basis point during the quarter to 4.33. Overall, unrealized changes in value amounted to SEK 2.9 billion, equivalent to a value growth of nearly 60%. The values in the project portfolio rose to SEK 1.1 billion. This amount includes an impairment loss in relation to its asset development price. In terms of return on invested capital on the project portfolio amounted to 104%. The values in the investment property portfolio in the third quarter were mainly driven by rent increases while the yield requirements only fell slightly. During the third quarter, we increased our long-term interest term further through new swap agreements. Together with continued falling long-term interest rates, this meant the book value in the derivative portfolio increased further and to -SEK 780 million in total during this entire period. The tax expense amounted to -SEK 775 million and mainly just related to deferred tax. This amount includes the inclusion of deferred tax related to the sale of Pelaren of SEK 118 million. We have made a new complete tax calculation of all of our legal entities in accordance with the new rules that limit interest rate deduction. The change did not have any effect on tax paid, but we will use carry-forward losses at the party rate, which is also reflected in the tax calculation for the period. Please turn to page 6. In line with the strong earnings trend, our balance sheet has continued to strengthen. The core equity now amounts to SEK 114 per share and the long-term net asset value, the EPRA NAV, is SEK 138 per share. The debt ratio, in other words, interest-bearing loans in relation to EBITDA, strengthened and amounted at the end of the quarter to exactly 13, which is in line actually with our long-term target. All our financial key ratios are more or less unchanged or have strengthened. Please turn to next page. Last week, we received an upgrade of credit rating of Baa2 with a stable outlook from Moody's. Fabege has, as you know, been active on the capital market for many years via commercial paper program and bonds. For us, it is important to make investors aware of our high quality and our long-term approach to financing. We are very happy to have received this acknowledgement of the company's financial stability via this upgrade from Moody's. Now please turn to page financing. During the first half year of 2019, we were very active with refinancing of long-term credit facilities, bond issues, and the launch of our new green framework. This activity has continued with the extension of one bank facility, a further bond issue, and the gradual change to green certificates as they have traded during the third quarter. Through the refinancings remained, capital tied up has further increased to 6.2 years, and our green financing now amounts to 86% in total of our outstanding loans. We have also taken advantage of the opportunity to extend the fixed interest term. During autumn period, primarily in August, it was possible to fix the long-term interest rate at extremely low levels. We have entered into long 10-year fixed interest terms at around 20 basis points, and we have been able to balance this with short maturities at a negative interest rate. Finally, unutilized credit facilities amounted to SEK 5.4 billion by the end of the quarter. We believe that we have every opportunity to spend a little more money in the form of new investments. Now back to Stefan. Thank you, Åsa. If we look at slide 9 and the numbers there, we see that the rental market in Stockholm remains strong. Our rents have increased this year by 8% in renegotiations. It has gone a little bit since previous quarters. We had a major renegotiation with some lower rates. The reason behind that was it was a big contract and that could be very small and minor adaptations to the premises. So it was still a very good transaction despite the lower increase. The net letting for the year is minus SEK 92 million. We can divide that into three parts. First, as you know, we lose the Swedish Tax Agency at the start of the year, and that had a negative impact on the net letting of a little bit more than SEK 100 million. The second part is the day-to-day letting. It has been performing well. The first three quarters, we are up about 15 million SEK, and during the third quarter, we were down about 5. Being down 5 in a single quarter is nothing that worries me, but I still see how the renegotiations ends up in positive gains for us. The third part is about our project lettings. As we know, such major deals always take a long time to complete. This is something that we must always keep in mind. We are right now having advanced discussions with several potential customers. I am optimistic that we will make the deals and complete them, but I think it is too optimistic to expect any major new credit lettings before year-end. For me, it doesn't really matter what quarter it happens in. The most important thing is that it happens. Slide 10. Here you see how our average yield requirements have developed in the last 5 years. Yield requirements have fallen equally in all of our key areas. In the prevailing interest rate at the moment, I think those groups continue with lower yield requirements in all our markets. In slide 11, we can see how our changes in value came from the period January to September 2019. As you can see, the yield had the greatest impact, even though it was largely the same, but the yield will have a larger impact in the future. In the third quarter, the rents helped us most. Slide 12. Let's look at our progress before you. Today, we have about 57,000 sq m in the portfolio. This is low for Fabege. One-third will also be completed over the next three quarters. Of course, we have to profile the portfolio with more projects. The first new project is Gustav III in Arenastaden, which you can see on the next slide. In September, we turned the first sod in the Gustav III project. This will be next door to ICA's new head office in Arenastaden. Sustainability is and will be an important and integrated part of everything we do. I am impressed about what I have seen, how we work in, and it has worked in the past and with all the challenges that are going on. But can't you also tell us a little bit about the work we have done and will be doing? Yes. In the property sector, sustainability historically involved a lot of focus on environmental and energy issues. In Fabege, we are creating our city district. We want people to enjoy, live, work, and visit these districts. Therefore, we believe that social sustainability will become a more important factor in the future. The life between the buildings is becoming a key issue, and it is something that we will take into consideration when we are developing our city districts in the future. After the summer, we have received some really good sustainability awards. We were taking part in the GRESB ranking and received in total 94 points, which made Fabege the number one of listed companies in the office sector in Europe. We also received the Sweden Green Building Award of 2019 for our new built project in Norden III, which is ICA's head office in Arenastaden. In total now, 83% of the tenant area in our portfolio is environmentally certified according to the BREEAM system. We have also received 82% of green financing. The next step will be a more focus on social sustainability. Thank you, Rosa. As I said, I am impressed with the work I have seen. I also think that as a real estate company and as a developer, we can make impact in all the areas we are operating. Slide 15. A little bit more about our four different urban development projects. Arenastaden is only halfway. It has been an incredible success story for Fabege. It is easy to forget that we are only halfway in the development of the area. Now we are going to work on creating more housing in order to ensure an even better mix between offices and houses. In Haga Norra, we are working right now with phase 1, and this is to complete Elia's new facilities. The plan is that it should be ready during Q1 2021. In Solna Business Park, as you can see on slide 18, there is a huge potential. The entire area is about to begin a major development journey. Today, the area is a very good office location, and we have several large and good customers, but we now are going to develop the area into an even more attractive city district. This will happen in several stages, and the first step is to obtain a better mix between housing and offices. In the longer term, Solna Business Park can also connect Solna by international way. I think this area has a big potential. On slide 19, you see a photo of our Flemingsberg today. This is the area where we focus on developing new office buildings, hotels, and even residential buildings in the future. It will be a completely different area in the next 10 years. Today, it is a city district with universities, hospitals, housing, and very beautiful natural areas around the corner, which usually go to the park. The opportunities here in Flemingsberg is actually maybe even better than they were in Dalvägen industrial area 10 years ago. Dalvägen industrial area is today known as Arenastaden. During 2020, we will be able to present more concrete details and plans for Flemingsberg. We are currently right now conducting a dialogue with potential customers and partners about how to develop the area. We also have a very close and good cooperation with the local authorities, and we have the same vision and of course that make it much easier for the process. On slide 20, we have what we aiming for with Flemingsberg. 50,000 living there, 50,000 working there, 50,000 visitors. Already today, we have a lot of people working there. We have 70,000 students, for example, visiting. There is a lot of residents already. With this mission, we conclude the presentation. Are there some questions? Please. Thank you. Ladies and gentlemen, if you do have a question for the speakers, please press 01 on your telephone keypad now. First question is from Andres Toome from Street Advisors. Please go ahead, your line is open. Hi, good morning from my side. First question to Stefan. Has there been or are you planning a strategic review, and do you envisage potential changes in the current direction of the company? Good morning. No big plans. I think, first of all, the focus on Stockholm will continue. Stockholm has great potential, and it's also very important for us to have focus, so we have the knowledge, and we have the attractiveness of where we have the focus in Stockholm. Commercial office is also the focus. It will continue to be the focus. The short answer on your query is no. Okay. Thank you very much. The second one, could you add some color on what's driving this decelerating like-for-like growth? Is it mainly because of the renegotiations that you talked about earlier, or is there something else contributing? You mean the like-for-like growth in comparison to previous years? Like-for-like rental growth versus what we saw in H1. Yeah. Okay. The like-for-like growth in total is around 14%. And of that, around, I would say three quarters is explained by projects being terminated towards the end of last year, and that are now generating income in 2019. And the rest is the increased rental levels in renegotiations. Right. But the growth rate has come down compared to H1. What is behind that? The growth rate has come down from? In Q2, you reported 20%, if I remember correctly, like-for-like. If you look at separate quarters, one large explanation for the income to come down in Q3 in comparison to Q2 was that we sold one property, Pelaren 1 in Globen. Another explanation is that when we calculated the increase in property tax, we calculated a bit too much, which means that we have now made a correction to both the income and the cost of the property tax in Q3. This correction reflects all the three quarters this year. So that is the explanation behind that. Okay, thanks. The last one from me, what are you observing in the rental market currently? Specifically, there's fears that the market is slowing down. Are you seeing that, or are you seeing something different? No, we're not seeing that. We still have a lot of good discussions. Still, the re-negotiations we're doing is of course, I would say, better terms than before. It's still in Stockholm, all our areas are very good markets. All right. Thank you very much. That's all from my side. Next question is from Cesar Svedlund from Nordea. Please go ahead, your line is now open. Yes. Good morning. Cesar Svedlund, Nordea. Could you just please clarify, in your report, you are talking about investments in new projects declining in more or less in the same sentence as you talk about your weak net lettings. Could you maybe shed some light to clarify on the impact on investments, potential recurrence, and if this is in connection with the slowdown or slight weak net lettings we are seeing right now? The net lettings we report on, as we explained before, could be divided in three parts. I am happy to say lifting is still positive. As I said, even if the third quarter was a little bit, the 5 million minus. The projects is running with the speed we expected them to do. No changes. We have a plan process for some. It will, as we said before, mean that it will not be started except for targeting in Solna. We are rather at the end of next year, beginning of 2021, before any other big targets. Nothing has been changed for our plans. Right. On the yield requirements, it is down only one basis point, and we have seen some of your peers actually pulling down their yield requirements slightly more. In the quarter, would you expect yield to be bottoming out on these levels, or do you see any pending transactions to support further uplift in values? I feel quite optimistic with that. We see a lot of capital coming into Stockholm market and the real estate market in Sweden as a whole. I think we can expect the yields, as it looks today, to come down further. Would you expect it to be around 10 basis points, or what is your thought? Maybe even more. Okay. That is my question. Thank you. Just as a reminder, if there are any further questions, please press 01 on your telephone keypad. There are currently no further questions raised. I will hand it back to the speakers for any closing comments. Go ahead. Thank you very much for joining us today. You are all, as you know, always welcome to give us a call or mail us or anything. Thanks for today. Bye. That concludes today's conference call. Thank you all for attending. You may now disconnect your lines.