Earnings Call: Q1 2018

Apr 24, 2018

Summary

Q1 delivered higher rental and property-management earnings, substantial project profits and strong value growth, lifting EPRA NAV to SEK 220 per share. Lower leverage and improved financing terms supported the outlook, while proposed tax changes remained a consideration.

Hello, and welcome to the Fabege AB Q1 Report 2018. 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. I will now hand you over to Christian. Please begin. Welcome to Fabege's presentation of the first quarter report of 2018. After the upward development in our property market in recent years, many people are wondering whether this trend will continue. Our strong earning figures for the first quarter clearly shows that we still have a very robust property market in Stockholm, and almost all our key indicators have improved. I am very pleased with the fact that we continue to have extraordinary profitability in our project business with a profit contribution of more than SEK 1 billion, while we are also reducing the financial risk. Our loan-to-value ratio, for example, is now 41%. Overall, our consistently strong result for the quarter have created excellent value growth. Our long-term net asset value, EPRA NAV, which usually governs our share price performance, increased from SEK 201 to SEK 220 per share during the quarter. It really can be this good when the market is in a great shape, and my colleagues also do a fantastic job. Now I will hand over to Åsa who will go through the results in more detail. Please turn page. Yes. All key ratios have continued to improve alongside the strong earnings performance. The positive trend is continuing with rising rental income, improved earnings from property management, persistent value growth, and strengthened key ratios. Rental income amounted to SEK 614 million, an increase of 12% compared to the previous year. In an identical portfolio, income increased by just over 13%, around half of which referred to project occupancy and half to growth via renegotiations and net lettings at higher levels. The surplus ratio was 72%. We achieved our target for Q1 despite the winter weather conditions during the quarter. Higher heating costs were offset by lower costs for other items. Our target for the full year 2018 is 74%. The administrative costs remain at a consistent level. Interest expenses are lower than last year in absolute terms. Overall, we are borrowing more, but at a lower average cost. The average interest expense at the end of the quarter was 2.27%. Earnings in associated companies totaled minus SEK 21 million and relate to the capital contributions to Arenabolaget during the period. We believe the costs are a little front-loaded and that the forecast of up to SEK 40 million annually still stands. We therefore reported earnings from property management of a total of SEK 274 million, which is an increase of more than 25% compared with the previous year. The realized changes in value in Q1 amounted to SEK 83 million and relates to an additional consideration paid out regarding a transaction that was concluded in 2010. During the first quarter, we signed an agreement on the sale of Uarda 6 in Arenastaden. At the beginning of April, we also signed an agreement on the sale of Resedan 3 on Odengatan in Stockholm. Both transactions were concluded at low yield levels, and compared with the year-end valuations, this generated a total profit of SEK 132 million. Since due to new IFRS rules, the properties must remain on the balance sheet up until the transfer of ownership, the profit was recognized as an unrealized change in value. The unrealized change in value was attributable to the property transactions also appeared in our segment reporting. Just over 35% of the portfolio was externally valued in Q1. Transactions on the market, particularly our own sales, indicate a persistent decline in yield requirement. The changes in value amounted to SEK 2.7 billion, corresponding to roughly 4.6% value growth. Values in the project portfolio rose by SEK 1.1 billion, producing a return on invested capital during the period of 178%. Q1 saw an upward revision of the value of Pyramiden 4 in connection with the project's completion. Value in the investment property portfolio was driven almost equally by rent increases and lower yield requirements. The average yield in the portfolio is now 4.24% compared with 4.36% at the year-end. Deferred tax is estimated at 22% on current earnings. The Uarda 6 transaction involved a reversal of deferred tax of SEK 105 million. Please turn to next page. In February, we received an investment-grade rating from Moody's. We have had a number of positive reactions to the rating and can already see that it has had a substantial positive price effect on our bonds and that we are reaching a broader investor base. That leads us to financing on the next page. We are seeing considerable interest in lending to Fabege from both banks and the capital markets. We have continued to increase the proportion of green financing. Green financing is now available to us in all Swedish banks and on the capital markets, both via SFF and through our own MTN program. We have continued to work on boosting our financial profile via longer fixed-term maturities and new fixed interest terms to gradually replace the old swaps that are due to expire during the year. In the most recent refinancing round, we extended the fixed-term maturity, which is now an average of 4.2 years. The fixed-term maturity was extended in part in order to cut back slightly on the outstanding commercial paper and replace them with bonds. However, we will continue to use our commercial paper program as a source of financing and as a complement to other financing. Capital market financing has offered better terms than banks over the past year. We are now seeing a general improvement in margins, and we also have several examples of bank financing without zero floor. One example of a refinancing discussion that we are currently having is with one of our banks who is now offering a 10-year facility on attractive terms. This summer and in early autumn, we will see the expiry of several more old interest rate swaps at significantly higher levels than what we are currently able to subscribe to. A total of SEK 4.5 billion will expire in 2018. This still means that we will have lower average interest in the second half of the year. Unutilized facilities at the end of the quarter totaled SEK 3.1 billion. We are confident about both refinancing and access to capital for continued investments. Now please over to page 6. To finish, just a few words about the new tax proposal. The proposal on new corporate taxation was presented in March. It feels like the Ministry of Finance has listened to much of the criticism that came out of the consultation period, and the proposal is now more consistent with the EU directive. It is an improvement from our perspective. To summarize, it means that the tax rate will be reduced in two stages from 22% down to 20.6% by 2021. It will also mean interest deductions will be limited to 30% of EBITDA. For companies and groups that have carry forward losses, the deduction will be recalculated at a lower amount. However, it is positive that it is not entirely offset but can still benefit from interest deductions when offsetting against carry forward losses. For Fabege, it means that we will use up carry forward losses at a faster pace. Based on the 2018 budget, the proposal would mean an increase in deferred tax expense of roughly SEK 50 million. Tax paid will still be close to zero. All in all, it is extremely complicated even for the tax experts. From what I understand, there is a majority in favor of the proposal, and we expect it to enter into force from January 2019. Now back to Christian. Thank you, Åsa, and please turn page. In our rental market, the good demand in combination with the low vacancy rate mean that the strong increase in rents is continuing and continues to spread from the CBD. In our opinion, the biggest increase at the moment are in the rest of the city center and the top suburbs. During the quarter, we achieved an average rental increase of 20% in our renegotiations. Net lettings was relatively weak for being us, and we expect the usual increase in activity during the second quarter. Please turn page. The purple bars illustrate our strong rental growth during the past year. Here we also see that the revenues growth has now temporarily halted due to the two sales we have made this year. Rental growth will continue as normal later in 2018 and in 2019 as a result of renegotiations and the fact that numerous projects have been completed and are beginning to generate revenue. The result at the end of this two-year period will probably be significantly better as a result of contributions from forthcoming renegotiations and leases of project vacancies. Please turn page. Now let's take a look at the transaction market and yield requirement. We have divested two properties this year. We sold Uarda 6 in Arenastaden for SEK 1.2 billion, which is almost double the capital invested. Another good example of our value creation model. We continued to manage the property and take care of the customers. The second property was a rather solitary one in our portfolio in Vasastan, a mixed low-yield property. We have previously said that our ambition was to sell residential building rights and found new projects. As it's currently a bad time to sell residential building rights, we conducted these two sales instead. Both the properties were sold for about 20% more than their estimated value at the start of this year. These and various other transactions in the market have given support to the adjustment of values by valuators, which has contributed to the significant change in values during this quarter. Despite these valuation increases, we are probably further than normal away from the market's willingness to pay because of both the continued rise in rents and somewhat more unexpected compression of yield requirements regarding quality. Please turn page. We have externally evaluated 38% of the portfolio. By far, the largest part of the change in value amounting to SEK 1.7 billion comes from the property portfolio, where the valuators lowered the yield requirement. The valuators have also adjusted the yield requirement for some investment properties, which means that we have relatively equal contribution from rising rents and decreasing yield requirement, as you can see in the graph. Please turn page. Let's now turn to our project portfolio, which is continuing to create value. The investments are continuing at a high rate, and the leasing rate is a good 86% in our projects. Despite the fully leased SEB property now being removed as it is taken into operation and a new empty conversion property is being added. Please turn page. Here you can see the conversion project we decided to start during the quarter. We own a large neighboring property that we also plan to renovate later, and several existing customers from there will probably move over to it once it has been modernized. With a strong demand in our rental market, we expect to increase the leasing rate in our project portfolio and also start more projects this year. Please turn page. I showed this picture in the last quarter regarding the 2018 financial prospects. We said that our management result would increase mainly due to rising rental income from completed projects and already completed renegotiation. The increase in the management result was 27% in the first quarter. We also said that we could get a major contribution from our project portfolio with a high investment volume and a high profit margin. The profit margin amounted to no less than 178%, and even more importantly, the contribution to result from projects was just over SEK 1.2 billion. We also thought that we would have good value growth in the investment portfolio, mainly due to rising rents. We achieved a 20% increase in rents in our renegotiations. Overall, we saw the prospect of a strong result in 2018 with a pre-tax result just over SEK 3 billion and a long-term EPRA NAV that grew from SEK 201 to SEK 220. We had to admit that we have in fact exceeded our expectations quite considerably. Thank you. Åsa and I are ready for questions. Thank you. Ladies and gentlemen, if you do have a question, please press 01 on your telephone keypad now and you will enter the queue. After you are announced, please ask your question. Ladies and gentlemen, once again, if you do have a question for the speakers, please press 01 on your telephone keypad now. Okay, if we don't have any questions, that was all from Åsa and me, and we thank all listeners. Thank you.