Earnings Call: Q2 2016

Jul 8, 2016

Summary

H1 profit after tax reached SEK 2.7 billion as property values rose 6.7% and property management profit grew by just over 10%. Strong leasing and a SEK 2.5 billion 2016 investment plan supported an outlook to exceed 2015 results.

Hello, and welcome to Fabege's presentation of our interim report for the second quarter. Please turn to page 2. We have a very strong property market in Stockholm at this time. Stockholm is growing and so is the number of office workers. While the supply of office space is limited, which means that today we see continued rising rents, continued declining yield requirements, and we saw higher business activity in the second quarter, which is normal. Taken together, these factors have contributed to a very strong performance in the first half of the year, which Åsa will now present in the greater details. Åsa will now continue with slide 3. Thank you, Christian. Profit after tax reached SEK 2.7 billion, based on growth in profit from property management, as well as substantial changes in value in the property portfolio. Rental income totaled just over SEK 1 billion. Increased rental levels and completed projects properties now contribute to growth. This was offset by the sale of Uarda 5 as of March 1. Growth in identical portfolio was approximately 7%. The surplus ratio ended up at 70%, which was not as high as last year. A more typically cold winter and slightly higher administrative costs due to more employees had a negative impact. The sale of Uarda 5, which had a higher than average surplus ratio, also affected the outcome. Our objective to reach 75% within 5 years remains unchanged, though. Central administration costs rose to SEK 36 million, mainly because we now made a provision for an increased allocation to Fabege's profit-sharing foundation in accordance with the decision of the AGM. Interest expenses decreased compared with the previous year due to lower average interest rates and a smaller loan portfolio. The average interest rate increased slightly since January 1 because we are now borrowing less and the cost of derivatives is thereby distributed over a smaller volume of loans. The average interest rate is now 2.8%. Profit or loss in associated companies was minus SEK 7 million. The second quarter included a net profit from the settlement of the old SFF structure of SEK 18 million plus. Otherwise, this item mainly relates to the deficit from Arenabolaget, the arena. Overall profit from property management increased by just over 10%. Realized value changes of SEK 162 million related to the sale of the property Uarda 5, the Vattenfall office in Arenastaden in February. Growth in value remained extremely strong during the second quarter. Overall, unrealized value changes amounted to SEK 2.7 billion, corresponding to value growth of 6.7%. During the first half year, more than 50% of the portfolio was externally valuated. Yield requirements continued to decline, and the average yield in the portfolio is now 4.75%. Increased rent levels in conjunction with the renegotiations and new lettings now have had a greater impact on the positive valuations. Our large project properties continued to increase in value. The projects that are completed or are nearing completion have now essentially been measured up to their final value. The yield on the project portfolio was 82% for the first half year. This high yield will not hold for the full year 2016, but we will end up much better than our target of at least 20%. The value of the derivative portfolio varies greatly with long-term interest rate developments. Falling long-term interest rates during the first half year contributed to the increase in the deficit value. Now over to slide 4, key figures. Here you can see the effects of the positive trend that we have had over the past two years. Equity has demonstrated strong growth, increasing by almost 50% in two years. At the same time, the long-term net asset value, the EPRA net asset value, has increased by SEK 44 to SEK 131 per share. Our loan-to-value ratio target is a maximum of 55%. With continued value-generating project investments and strong value growth in the management portfolio, we are now at 49%. Yet another indicator of our growing strength is the equity ratio, which is now up to 42%. Now we can turn to financing on slide 6. During the second quarter, we refinanced SEK 2.8 billion with maturities ranging between three and four years. After Q1, I said that we felt that margins had risen since late 2015. However, this trend has not continued. Instead, we now see stable margins, though at levels slightly higher than last autumn. Our new green MTN program was established in April, and in May, we completed the first issuance of SEK 600 million. It was a two-year loan with a margin of 130 basis points. Since bond financing does not have STIBOR floor and we can take advantage of the negative STIBOR, the financing was highly competitive in terms of price. Nordea has been added as a dealer in the MTN program, and we have also received a shadow rating, which like the predecessors from Handelsbanken and Swedbank, ended up at BBB-. At the end of the quarter, unutilized facilities amounted to approximately SEK 2.9 billion. Added to this is the ability to borrow more on the capital market through our own MTN program and via new SFF. They provide us with the security to be able to handle future project investments, as well as to take advantage of new business opportunities. During the first half year, we gradually continued to fix interest rates through new interest rate swaps. In all, we have now set fixed interest rate terms for approximately SEK 1.3 billion in 2016, including SEK 600 million after the mid-year. Brexit concerns have had a major impact on long-term rates, and we obtained the most recent 10-year at only 0.73%. These are levels that just a few months ago would have been extremely difficult to imagine. In August, SEK 2.6 billion in old, more expensive STIBOR swaps will reach maturity, which will have a positive effect on our average interest rate. Then over to slide 7, green financing. Last quarter, I said that the most exciting thing that happened was our new green MTN program. We are now experiencing a bit of a race between banks to offer green bank financing. We have pursued discussions about green financing with all our banks, and we are pleased to note that we have also succeeded in converting the first bank facility to a green facility through a supplementary agreement. SEB was the first bank out. We are now starting to see a price difference between green and non-green, which we believe is due to the quality of the assets and that we reach a new range of investors. We are convinced that this trend will continue and look forward to a greater proportion of green financing on competitive terms. Our goal is to certify the entire property portfolio, which will enable a greater share of green financing in the future. Ideally, everything should be green. Today, the proportion of green financing is 10%. Now back to Christian and slide number 8. Thank you, Åsa. If you turn to slide number 9, I will talk about the rental market. The rental market today is robust demand and high activity. In the second quarter, we have a big contribution to the net letting, and we ended up on strong SEK 83 million. Our target for the full year was SEK 80 million. The trend of rising rents continued as expected, causing average renegotiated rents to increase by 27% in the first half. Renegotiated rents usually increase by 15%-20% today. However, because of a few major contracts with large increase, the end result was 27%. Over to slide 10. Here we can see market rents for modern premises in our areas. Rents are rising across the board, and as usual, rent levels in the CBD are about twice as high as in the best suburban location. Given that rent is SEK 6,000 in CBD and SEK 3,000 in best suburb location, we believe Arenastaden, with its qualities, should fall in between the CBD and the best suburban location. Our goal is to reach that point within 5 years. Now I will continue on to slide 12. We made 2 acquisitions during the first half of the year, Trädgården 9 and Sådepalatset 1 in Solna. We acquired them because we see that both properties offer good long-term development potential. Now over to slide 13. The transaction market remains strong with record sales volumes in the Swedish property market during the first half of the year. This contributes to strong value growth, which entails a 6.7% increase in value per the past 6 months. About 50% of the change in values are related to declining yield requirements. Now we will continue on to slide 15. We have 2 projects that were completed in the first half and switched to management. Both will provide strong contribution to cash flow moving forward. The occupancy rate is at 93% and 100% respectively. If we move on to slide 16, we see our new project at the Globe Arena in Stockholm. We have owned this vacant land for many years. It has long been an established truth in the industry that no company would move to the south side of Stockholm. We are therefore extremely pleased that we succeeded in getting a reputable large company to move from the inner city to the south side of Stockholm. Move on to slide 17. We currently have more than 150,000 sq m in new construction, equivalent to approximately 50% of all office building construction in the Stockholm region. Our investment target is currently SEK 2 billion annually. Our forecast shows that we will invest about SEK 2.5 billion in 2016, well above our target and at low risk since the occupancy rate is 87%. We aim to start even more projects during this year. Finally, I would like to briefly comment on our earnings performance on slide 18. Not only is our overall earnings strong, we can also conclude that our business model is working very well since we can see that all three segments making significant contributions. It is impossible to predict the long-term implication of Brexit for us at this time. However, we can conclude that long-term interest rates have fallen significantly, which will probably strengthen the ongoing yield compression in our market. At the beginning of the year, I believe that our earnings performance would be strong, but I didn't think we would match our 2015 results. However, it is now highly likely that we will exceed last year's performance. That concludes our presentation, and operator, we are now ready for questions. Thank you. Ladies and gentlemen, if you do have a question for the speakers, please press 01 on your telephone keypad and you will enter a queue. After you are announced, please ask your question. Our first question comes from Robert Woudstra from Kempen & Co. Please go ahead, your line is now open. Good morning, this is Robert Kempe. First of all, thank you very much for hosting the presentation in English. Much appreciated. If I look at your market outlook, and you indicated yourself that it's difficult to assess what the impact is on Brexit. But in the same sentence or in the same paragraph, you actually mentioned that you are well-positioned to capitalize on opportunities ahead. Does this mean that you expect potentially forced sellers in the market, and that you can do the relatively better deals, or how should I read this? Hello, Robert. As we said, we do not know the full consequence and cannot even guess the full consequence today of the Brexit. But what we see today, we continue to see a very strong property market. As the market are looking today, we see declining yields and increasing rents and growing company in the Stockholm market. We have a lot of ongoing discussions and a lot of potential in Stockholm. Therefore, we are still positive to the future, but of course, things can change very quickly, but we cannot see it on the market today. Okay. Perhaps as a follow-on question then. You mentioned ongoing discussions. Is that typically on letting or potentially selling more properties? If it is the latter, do you think that underwriting assumptions with respect to rental growth will change for the potential buyers of properties that you potentially could sell? Mainly letting discussions. That is what we are focusing on today. I did not follow your follow-up questions. You asked me one more question, I heard. Yeah. Actually, at this point in time, is there any properties that you are currently or is in the market to be sold from your side? If so, the potential buyers of these properties, have they moved away from potentially buying properties from you after Brexit or not? We are not out on the market with any property for sale. We are always having a lot of interest at this time and have had late this year. The first reaction we had that some investors on the market was saying that they must see what the consequences is of Brexit. But after just some days or a week, we hear signals that this maybe will have a positive effect on the Stockholm market, because on the yield compression Actually, and that's also what your last sentence was in the presentation. You still expect more yield compression to come through in the second half of this year? Yes. We have a clear trend, but as we said earlier, we don't know what happened on the market, but today we see a clear trend, and I think if we see some impact of Brexit, it will only accelerate the yield compression as it looks because of the long-term interest rate has declined very much. Okay. That's all clear. Many thanks for this. Thank you. Our next question comes from the line of Erik Granström from Carnegie. Please go ahead. Your line is now open. Thank you. Good morning. Thank you for hosting this presentation. I had a couple of questions, and the first one relates to the net letting figure that you report here in Q2. Obviously a very, very good figure, which is comforting. I noticed that the termination figure, which I believe was negative 24, is the same as last year in Q2. I was just wondering if you could give us some indication of what was the effect of new leasing in terms of Pelaren and Uarda 6 during Q2, just so that we get a sense for how those lettings affected the net letting in Q2. The question was, how big impact on the net letting Pelaren and Uarda. Which Uarda property you ask for? Well, the one that you mentioned in the report, I believe it was 6. Is that correct? Yes. Uarda 6, Ambea. Yes. Elsa, do you have those figures in your head? I think Pelaren was SEK 39 million. The contract with Ambea was- Around 10. 10, a little bit less than 10, 9 point something. I think you have all those figures. I do not know if you have it in the report, but you have it. We have sent out releases on it. These two project lettings together sum to approximately SEK 50 million. Okay. Yeah. All right. That is what I was figuring, but I just wanted to make sure. Also, regarding the rental market in Stockholm, obviously it seems to be very strong, and it has continued to strengthen throughout Q2. Are you looking into renegotiating contracts that are currently not open for renegotiation simply to see what you can do with the current rent levels in your portfolio? Well, I would say that the normal contract on the Swedish property market is only a three-year contract. Over a period of three years, you will end up renegotiating more or less the whole portfolio, except for some of the buildings where we have longer contracts. We are not really starting. We have discussions with tenants, not only when it comes to renegotiations for a specific year, but we try to start as early as we can, but we are not pushing renegotiations because of the market situation right now. But we are taking advantage of the possibilities that we have. Okay, perfect. I have two more questions, and the next one would be regarding your statement in terms of the central cost. You said that you made provisions due to incentive programs in Q2 which then boosted the cost in Central a little bit. Should we look at that as a one-off effect, that that is a provision that you took now in Q2, and we shouldn't expect a similar figure for the coming quarters this year? Well, the provision that we made in Q2 relates to Q1 and Q2, so there will be an increased cost also in Q3 and Q4. Okay. All right. Perfect. That's just what I was looking for, basically, some clarification on that. Finally, it seems at least on my part, it seems that I was perhaps expecting financial costs to come down a little bit in the quarter compared to the last quarter, given that we have lower interest rates. Obviously the lending portfolio was slightly bigger. You also mentioned that you do have some older things that are terminating at the second half of this year. Should we expect that interest costs or your net interest financial items should drop in the coming quarters compared to what we saw now in Q2, that it was sort of a high point? Yeah, you will see it drop in the next quarter because of the maturing swaps in August. On the other hand, when we make new swaps today, we also have to pay the negative part of the STIBOR, and STIBOR is a little more than 50 basis points negative today. So making new swaps is an insurance for the future, but it's of course more expensive to fix the interest than it is to just stay on a variable interest rate. I think overall, the average interest cost will come down in Q3. Okay. Yeah, perfect. Thank you very much. Thank you. Our next question comes from the line of Peter Papadakos from Green Street Advisors. Please go ahead. Your line is now open. Good morning. Two questions, please. One for Christian, one for Åsa. Christian, in terms of the leasing spread that you are achieving, can you give us a sense of money that you have to put into the buildings or any types of fit-out costs or enhancements to the buildings? Are the releasing spreads of 15-20 that you say for the market pretty clean, or do they require some CapEx injections? Normally, you always have to invest something. We have total investment on a yearly basis between SEK 1.5 billion and SEK 2 billion. Out of that, approximately SEK 400 million will be invested in the property management portfolio. That goes for everything. That is both for adjusting premises for new tenants and energy efficiency projects, and all kind of different projects that we have to maintain the properties. Okay. Then just a final question for us. Previously, maybe I was wrong, I had considered that you were targeting maybe not growing your absolute value of debt, and maybe as values went up, your LTV would come down. Is that still a goal, or have you changed your mind a little bit also because of what's happening to interest rates? I wouldn't say that what happened to interest rates have changed our mind. We set the target during the autumn in 2015 to have a maximum LTV of 55%. We have also said after that with increasing values, we are quite happy to keep the LTV ratio at a lower level than that. So 49%, which we ended up with in the second quarter, is a comfortable level for us under these circumstances. Okay. As you launch new projects, is it still your goal to have pre-leasings in some instances? Yes. We want to have pre-leasing before we start new development projects. Okay, thank you. It can be a bit different. It depends on if we start a project for new production or if we start project in existing buildings that we are emptying for refurbishment and maybe the possibility to build more square meters on the existing building or existing land. Right. But for new production, definitely we want to have at least a major part pre-leased before start. Okay. Thank you both. Thank you. Our next question comes from the line of Jonas Andersson from Danske Bank. Please go ahead. Your line is now open. Yes, good morning. I have one question regarding the rental discounts on page 7 in your report. It seems like the rental discounts is up by SEK 100 million from SEK 102 in Q1 to SEK 230 in Q2. So, what is that referring to, and how long will these discounts stay? This is mainly because Telia moved in, and they have a discount for the first year according to the contract. The SEK 100 million is roughly the Telia discount, okay. Yeah. Okay. The second question is regarding the surplus ratio. You touched upon it. It's down to 71%, and that's a big drop from last year Q2. This is selling property and also some more staff. This is an impact we will see on the surplus margin also for Q3 and Q4 this year if we compare to last year. Is that true? Yes, you can say that the sale of Uarda 5 has a major impact. It's a difference 1 percentage approximately on the portfolio relating to Uarda 5. On the other hand, we have the properties which have been completed that will have a higher surplus ratio than the average in the portfolio. We should end up at least above 70% this year, but it will be improved over the next year. As we said also in the report, the target of 75 within 5 years still stands. That's something that we are working for. Okay, thank you. That was my last question. Thank you. As we appear to have no further questions, I return the conference to you speakers. We have one more question that came on email. You stated the average yield is now 4.75%. Could you tell us about the regional differences in our asset average valuation? Yes. In Solna, we have an average of 5% today, and in Inner City it is 4.4%, and in Hammarby Sjöstad it is 5.2%. Thank you. If there is no other additional questions, I just would like to thank all of you who have listened to our interim report, and I wish you a pleasant summer. Thank you. Thank you. This now concludes our conference call. Thank you all for attending. You may now disconnect your lines.