Earnings Call: Q3 2018

Oct 18, 2018

Summary

Property management profit rose 25% YoY to SEK 895m, while unrealized property gains reached SEK 6.1bn. Strong lettings and project returns supported growth, with EPRA NAV at SEK 120 per share.

Ladies and gentlemen, welcome to the Fabege AB Q3 Report 2018 call. Today, I am pleased to present CEO Christian Hermelin. For the first part of this call, all participants will be in listen-only mode, and afterwards there will be a question and answer session. Christian, please begin. Thank you. Welcome to Fabege's interim report for the third quarter. Slide 2. The results for 2018 are still very strong. For example, if we look at the three key ratios that are most important for our long-term profitability, net lettings continue to increase during the third quarter. This year's good net letting have little impact on the result for the year, but have a major impact on the coming year's result. We see that our project operations are delivering strong value growth, and the return on invested capital in our projects was 97% on average during the year. If we look at the third important key ratio for our long-term profitability, we can see that rental increases in renegotiations are also continuing at a high level with an average increase of 30% during the year. This is a good measure of value of the strong rental market. This should also be seen in light of the fact that we give our existing customers a discount on the market rent in our renegotiations. Our long-term net asset value, EPRA NAV, has risen to SEK 120 per share, mainly due to value growth from projects and rising rents. Yield requirements were largely unchanged this quarter, mainly because there was very few transactions in our markets during the past quarter. This is in contrast to the situation during the spring when there were many transactions, which gave a larger review of the valuation in our property portfolio. Please turn to page 3. Happily, I can also confirm that we are continuing to improve the efficiency of our property management operations through a record-high surplus ratio of 75% after the third quarter. Combined with the rising income and falling average interest rate, this also contributing to the strong profit from property management, which increased by 25% in comparison with a year ago. Now I will hand over to Åsa, who will go through the result in more details. Thank you, Christian. The positive performance has continued in 2018 with increasing rental income, improved profit from property management, and continued value growth and strong key ratios. Rental income amounted to just over SEK 1.9 billion. In an identical portfolio, income increased by just over 10%. Two-fifths of this relate to project occupancy and three-fifths related to rental growth from renegotiations and new lettings at higher levels. The surplus ratio ended up at 75% after a favorable quarter. The goal for the full year is 74%. Now, of course, we have a winter quarter in front of us. Administration costs have increased to a slightly higher level than before. The number of employees is growing, but they also help contribute to our increased earnings. Interest expenses were slightly lower than last year in absolute terms. Overall, we are borrowing more, but at a lower average cost. Profit or loss in associated companies amounted to minus SEK 63 million. Of this, minus SEK 4 million relates to a residual amount from the divestment of associated company Tunet a couple of years ago. The remaining part relates to capital contributions to Arenabolaget during the period. In November, however, there will be a positive one-time effect, which means that we expect much lower capital contributions during the fourth quarter. We therefore reported profit from property management of SEK 895 million, which is an increase of 25% in comparison with the previous year. Realized value changes amounted to SEK 83 million and mainly related to payment of additional consideration in connection with the transaction that was completed in 2010. Before the Q2 report, more than 50% of the portfolio was externally valuated. About 20% of the portfolio was externally valued before the third quarter. The yield requirement was largely unchanged during the quarter, with a small decrease to 4.17%. Overall, unrealized value changes amounted to SEK 6.1 billion, equivalent to a value growth of 10%. Values in the project portfolio rose by SEK 1.9 billion, generating a return on invested capital during the period of 97%. In June, we adjusted some of the investment forecast upwards. Meanwhile, higher rental rates and lower yield requirements had a positive impact on the estimated final values. Values in the investment portfolio during the first half of 2018 were driven approximately two-thirds by rent increases and one-third by lower yield requirements. During the third quarter, the values were mainly driven by higher rental rates. Unrealized changes in value included SEK 132 million related to property transactions during the year. In our segment reporting, this item is separated and reported in the transaction segment. The deficit value of derivatives portfolio decreased in the third quarter. Meanwhile, we realized a deficit value of SEK 111 million by early redemption of interest rate swaps and by entering into new swaps with longer maturities. In total, this meant a net decrease in the deficit value of SEK 141 million during the period. In light of the new corporate taxation rules that will enter into effect from January 1, 2019, the tax liability and invested use of loss carry-forwards has been calculated according to the future effective tax rates. This means a one-off positive effect of around SEK 455 million. The property transaction also accounted for a positive effect of SEK 139 million in total during the period. Otherwise, the deferred tax expense for the year is calculated at 22% of current earnings in accordance with the current regulations. Please turn to next page. In line with the strong earnings trend, the balance sheet has continued to strengthen. Reported equity now amounts to SEK 101 per share, and the long-term net asset value, EPRA NAV, is SEK 120 per share. We have now also supplemented the report with a few additional EPRA key ratios. All our most important financial key ratios strengthened during the year. This includes the equity asset ratio, the loan-to-value ratio, interest coverage ratio, and debt ratio. This, of course, is due to an increase in cash flow and to the value growth. The slide also shows our results compared with the financial targets. Now over to financing on the next page. We continue to see a strong interest in lending to Fabege from both banks and the capital market. Capital market financing has offered better terms than banks during the past year and in recent years. Several banks, however, are now offering financing without STIBOR floors, which clearly strengthens their ability to compete. In the most recent refinancing round, we extended the fixed-term maturity, which is now just under five years. The goal is to always have available long-term facilities in order to refinance maturities during the coming 12 months. We refinanced a bank loan in a new 10-year credit facility, among other things. After the summer, we also issued bonds for SEK 1.6 billion in total as part of our green MTN programme based on maturities of three, five, and seven years. Extending the fixed-term maturity has involved cutting back slightly on the outstanding commercial paper and replacing these instruments with bonds. We are now happy being on a level with outstanding commercial papers of around SEK 3 billion. We have continued 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 the turn of the quarter, 59% of our financing was green. We have also continued to work on strengthening our financial profile through longer fixed interest terms. During the year, we have gradually replaced the old swaps that have expired with new longer-term interest rate swaps. In June, our old expensive callable interest rate swaps finally expired. Further swap maturities and early redemption of old interest rate swaps, combined with taking out new swaps with longer maturities, means that we are now reporting an average fixed interest term of 3.4 years and an average interest expense of 1.5% at the turn of the quarter. Unutilized facilities at the turn of the quarter totaled SEK 4 billion. We feel confident about refinancing and about access for capital for continued investments. Now back to Christian. Thank you, Åsa. Slide 7. We have a lot to be proud of. This certainly includes the fact that we have 50% of all new office development in the Stockholm region. Our success is not only based on constructing office buildings, but also on the fact that we try to create attractive city districts. Our methods for this includes Page 8, that we want to create lively city districts through a good mix of residents, workers, and visitors. This creates the right conditions for a comprehensive and varied range of service, and also for contentment and security. These are highly valued qualities and are necessary for development of long-term sustainable city district. That is our goal. Slide 9. As our ambition is to create even better city districts and to also have a very high project volumes going forward, it feels great that we now have several city district projects in different phases that can contribute to this. We have Arenastaden, of course, which is actually only halfway in terms of office production. We also have Solna Business Park, which is facing a major transformation. Then we have our new urban development project in Flemingsberg, which is just starting. Page 10. When we started the development of Arenastaden, we said that the city district should contain 25,000 to 30,000 workers. We have already reached this target. However, we have secured new development rights, and we have also expanded the area. Therefore, we estimate there is still about 250,000 sq m of additional office development rights left to develop. Page 11. Our project opportunities are now on our website where you can see our project plans. If we go to one of them in Arenastaden, for example, you can find a project that we call Park One, and you turn to page 12, so you can see it. That one is located besides ICA's new headquarter in the entrance to the area. If we turn to page 13, we also have a big new development project along Dalvägen, which you can see here. These properties are located close to the new Metro station, which you can see on the smaller picture on the left. If you turn to page 14, the transformation of Solna Business Park means a transformation from being a nice office district to becoming a lively city district. Slide 15. By adding housing, visitors, and a broad range of services, we want to create a city district with people day and night where we will take advantage of the good public transportation situations in Solna Business Park. Slide 16. Finally, here are some slides about our latest city district in Flemingsberg. Page 17. The reason we are investing in the city district on the southern side of the city is because a better regional balance is needed. Half of the population in Greater Stockholm lives south of the city, but most people work on the northern side. This has meant that the average Stockholmer commutes for a longer period of time than he or she is on vacation. The total population of Stockholm area is also growing quickly, and the infrastructure is lagging behind. Therefore, we think that it is extra smart to create attractive city districts where the workforce lives while making use of spare capacity in existing infrastructure, which you can see on page 18. If we turn to page 19, we can see the reason why we have invested in Flemingsberg. The fact that is behind that is that we see the same conditions in Flemingsberg as we saw in Arenastaden, and that is in order. Number one, large volume of low-developed land. Secondly, an active municipality. Third, a location linked by rail. If you turn to page 20, you can see that forward-thinking politicians have created the right conditions for an excellent communication hub in Flemingsberg. Today, it is possible to travel to Central Station in 10 minutes and to continue on the same line to both Arenastaden and Arlanda. The biggest challenge for many companies in the region is to attract labor today. For larger companies that want to be attractive employers, we think it will be a winning concept to have an office both on the south side and on the north side, and easy to travel between those offices without changing connections. Please turn to page 21. To create a really attractive place, you have to reach a critical mass. There is space in Flemingsberg who is enough. Our ambition is to create a city district with 50,000 workers, 50,000 residents, and 50,000 visitors on a daily basis. Slide 22. I will now finish the presentation by looking back two years in time to the quarter report for 2016, when I started to show this picture and I said exactly these words: "There is currently a high level of uncertainty in the market, and as always, it has been increasing ahead of the reporting period. The fact that people are beginning to worry is fairly understandable given that rising value is bringing increased risk. We are hearing that the economy has peaked and that we are heading towards a slowdown. We are also often hearing that rents have reached their zenith and that interest rates are set to start rising." Those were the exact words I used two years ago when I presented the Q3 report 2016, and it is fascinating to see that they are just as relevant today. I also, at that presentation, said, "However, what we are seeing in our business is persistently strong demand with this noticeable rise in rents." We can also say that this is just as true today. What can we learn from this? Well, that forecasts are just guesses about the future, and that it's sensible to always be prepared to handle a future which is very different from the current main forecast. Most importantly, of course, is not to be able to handle a situation that is more negative than expected, but also to take advantage of it to move forward our positions. With the strong key metrics Fabege has today, we are ready to meet the change in business cycle. If we don't see a downturn in the economy, which we don't know, we will continue to benefit from the favorable conditions. Thanks, and now we're 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'll enter a queue. After you're announced, you can ask your question. There'll 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. Okay, then Åsa and me thanks all the listeners for listening for us. Thank you.