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Edited Transcript of CLI.L earnings conference call or presentation 14-Aug-19 8:00am GMT

Half Year 2019 CLS Holdings PLC Earnings Call

London Aug 15, 2019 (Thomson StreetEvents) -- Edited Transcript of CLS Holdings PLC earnings conference call or presentation Wednesday, August 14, 2019 at 8:00:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Andrew Kirkman

CLS Holdings plc - CFO & Director

* Fredrik Widlund

CLS Holdings plc - CEO & Director

* Simon L. Wigzell

CLS Holdings plc - Head of Group Property

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Conference Call Participants

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* Kieran Adrian Lee

Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst

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Presentation

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Fredrik Widlund, CLS Holdings plc - CEO & Director [1]

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Good morning, and welcome to CLS Holdings plc Half Year 2019 Results Presentation. I am Fredrik Widlund, Chief Executive; and to my right is our new CFO, Andrew Kirkman; and to my left is Simon Wigzell, Head of Group Property.

Today, we will present to you with the results for the first 6 months and give you an update on our markets and progress against our strategic goals.

Firstly, though, I would like to set the scene by giving you a high level overview of the first 6 months of the year. The company has continued to grow. And once again, our diversified portfolio in our 3 core markets have proven to be the key driver for sustainable results. Net rental income increased by 5.9% to GBP 53.8 million, up from GBP 50.8 million in the same period last year. This was primarily driven by acquisitions, but also from rental growth with ERVs growing 2% for the group in the 6-month period.

Our vacancy was slightly up at 4.2%, but well within our target of 5%, and with strong momentum, especially in Germany.

Valuations were overall up 1.9% in local currency, with strong performance in Germany and France, while the U.K. was roughly flat, but more details about that later.

We also had a very strong development for our stake in Catena that increased in value by 32% in the 6-month period. We have continued to see good opportunity for acquisitions and also successfully executed on the disposal program.

In the period, we acquired properties for close to GBP 140 million, while we sold for GBP 115 million.

The valuation increase and the net additions from acquisitions grew our portfolio to circa GBP 2.1 billion, which you can see in the graph on the right-hand side. All this means that our EPRA NAV was up 5%, and now stands at 325.3p per share. EPRA earnings per share was down slightly from 6.3p to 6p per share, with increased rental income being offset by lower interest from a smaller bond portfolio and higher tax.

The interim dividend, which will be paid on the 27th of September, will be up 6.8% per share and is in line with our progressive dividend policy.

In addition to Andrew joining as CFO, we've also made good progress in strengthening the Board, with Lennart Sten taking over as a Non-Executive Chairman and Denise Jagger joining as a new independent Non-Executive Director.

On the next slide, I would like to give you some more details about the valuations and what is driving the uplift in each country. So overall for the group, valuations were up 1.9%, with Germany and France showing very healthy increases, while the U.K. was roughly flat.

Starting with the U.K., where overall valuations dropped by 0.3% and yields softened by 13 bps. This is, however, a blend of different characteristics between Greater London and the rest of the U.K. In our London portfolio values were up 0.2% driven by increased ERVs of 1.2%, while yields softened by 3 bps. So in short, London is still experiencing rental growth, while yields are flat.

In the rest of the U.K., which only represents 7% of our U.K. portfolio, we experienced a drop of 6.5%, and that was driven by the shortening lease terms for many of our regional properties and yield softening, [yielding] rent-free burn off by 64 bps.

In Germany, we saw an increase of 4.5% in 6 months, that was driven by rental growth with ERVs increasing 4.3% and yields hardening 21 bps.

Nonprime quality assets in the larger German cities are very sought after as investments, and we do expect this trend to continue. The French portfolio was also up 4.5% with ERVs up 0.2% while yields hardened with 27 bps (sic) [37 bps], reflecting a strong investment market, especially in Lyon and in Paris.

In summary, as you can see in the graph to the right, we had a strong overall valuation uplift of GBP 36.9 million that was driven by Germany and France. I would now like to cover the acquisition and sales in the period.

So we had a very active period in the first 6 months. We acquired or exchanged on 7 properties at the total of GBP 139 million at the net initial yield of 5.5%. We closed on an acquisition in Lille in France for just over GBP 10 million that complements our 2 existing properties in the city.

In the U.K., we closed on acquisition of Prescot Street in Aldgate for GBP 54 million, at which we now intend to launch a substantial refurbishment program to capture the current market rents.

We also made 2 adjacent acquisitions in Crawley for GBP 16.5 million, which means that we now control one of the premier office locations opposite the station in Crawley.

And finally, we acquired a small property next to our existing Spring Mews development in Vauxhall and now intend to launch the final phase with a new office building, but more about that later in Simon's presentation about the developments.

In Germany, we acquired 2 properties, Puro in Munich and Connect in Cologne, for a total of GBP 56 million. Both these acquisitions are multi-let and represent excellent opportunities for us to add value in addition to capturing rental increases that we are seeing in these cities.

In the first 6 months, we also sold or exchanged to sell 7 properties for a total of GBP 115.1 million. This was in line with our disposal program and was either properties that had a small lot size and a higher alternative use value or was now single let on a long lease.

In Germany, we sold East Gate that had been transformed by the team after the previous tenant left in 2017. And in France, we sold [Ateliers Victoires] that was now fully completed and fully let.

Both properties sold at yields of 4.3% and 3%, respectively, and substantially above 2018 year-end valuation.

We also exchanged to sell a property in Dusseldorf to a residential developer. And in July, we exchanged on the sale of Quayside in Fulham which was also a residential development opportunity. In addition, we have also exited a couple of smaller properties in the rest of the U.K.

So in total, the average sales prices achieved was about 20% above December year-end valuations. And this activity reflects our focus on maximizing value, but also to crystallize profits that can be redeployed in other opportunities that will (inaudible) the company long-term and the earning capacity.

I would now like to introduce you to Andrew, who will take you through the financials in a bit more detail.

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Andrew Kirkman, CLS Holdings plc - CFO & Director [2]

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Thank you, Fredrik, and good morning, everyone. I'd first like to say how delighted I am to be here as the new CFO. CLS is a fantastic business with a clear strategy and an industry-leading track record. Furthermore, as shown over the next few slides, the business is in great shape.

Slide 6 sets out the financial highlights, which demonstrate we've made further progress in the first 6 months of 2019. As already discussed, EPRA net asset value grew particularly strongly, up 5% to 325.3p per share. EPRA earnings per share were stable at 6p per share. Total accounting return, which is the rise in EPRA NAV adding back the 2018 final dividend paid in the first half of 4.7p per share, was 6.5%. Our weighted average cost of debt at the 30th of June was 2.49%, a slight rise from the year-end, as most of our financing activity in the first half was in sterling for U.K. properties to maintain our natural hedge strategy by financing in local currencies.

Interest cover remained strong at 3.6x. Finally, reflecting the progress in the first 6 months, we've announced an increase in our interim dividend of 6.8% to 2.35p per share.

Overall, a very good set of results. I'll now discuss some of these numbers in more detail and the drivers behind them. The waterfall chart on Slide 7 sets out the main component movements in EPRA NAV, with growth largely driven by fair value uplifts and earnings.

As already highlighted, property values increased by 1.9%, which equates to 9.1p per share. And the Catena share price rose by 32% in the period, equating to a rise of 5.1p per share for our stake.

EPRA earnings were stable and more than cover dividends. Of note, we sold our stake in First Camp on the 7th of March, and the loss until sale is included within discontinued operations. This loss was more than offset by the rise in the value of our bond portfolio.

Moving now to EPRA earnings per share on Slide 8. We made positive progress in rental income from new acquisitions and the strong rental markets. This is -- this increase in rental income more than covered the increase in expenses. The main driver of the slight fall in EPRA earnings per share was the reduction in interest income as a result of the sale of roughly half of our bond portfolio in July 2018, taking it from over GBP 60 million to circa GBP 30 million. There was a full period of reduced interest income, whilst given varying purchase dates acquisitions only contributed for part of the period.

Slide 9 shows that our property portfolio grew to over GBP 2 billion for the first time. The principal drivers of this growth were the 6 acquisitions completed in the first half for GBP 117.1 million in all 3 of our country markets. And the valuation uplift of GBP 39.7 million or 1.9%, with strong growth in Germany and France, demonstrated the merits of our diversified approach.

Slide 10 shows that we maintained a healthy cushion of liquid resources across the period. To continue driving the growth of the business, nearly GBP 125 million was invested in new property acquisitions and CapEx. This was funded almost exactly by the drawdown of loans, [some] Amortization and fees, and to a small extent by the sale of properties. Liquidities were over GBP 10 million ahead as the cash from operations more than covered interest, tax and dividends.

As highlighted, in July we exchanged on the disposal of 5 properties for circa GBP 110 million. The proceeds we're expected to receive in the second half will give further capital to be deployed in the business.

As set out on Slide 11, it was a very busy first half, with 5 refinancings for new loans. The 2 notable transactions in the first half were the GBP 65 million financing of New Printing House Square, which is let to the U.K. government and which following the repayment of the previous debt had been unencumbered. The other key transaction was the financing of our largest acquisitions in the U.K. in the period, being Prescot Street in Aldgate and Portland house in Crawley.

These were added to an existing loan and allowed us to extend the debt maturity of that loan by 3 years from 2021 to 2024. Taking account of these transactions and the refinance at Westminster Tower, over 85% of our financing in the first half was in the U.K. Whilst our cost of debt actually fell in each of our 3 countries, this greater portion of financing in the U.K., where rates are above those in Germany and France, resulted in our average cost of debt rising slightly from 2.43% at the end of 2018 to 2.49% at the half year.

In the second half, we expect further financing activity and refinancings, which should also extend the maturity of some facilities.

My final slide summarizes our debt position, showing that we are well positioned, with very low cost of debt, strong interest cover, over 3/4 of our debt is fixed, our balance sheet has sufficient headroom with gearing below 40%, and we have strong banking relationships with loans from 28 different lenders.

And with that, I'll hand you over to Simon to talk you through our property portfolio.

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Simon L. Wigzell, CLS Holdings plc - Head of Group Property [3]

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Thank you, Andrew, and welcome on board. It's good to have another safe pair of hands at the tiller. Right, look at property. So just to highlight, we have a very resilient and diversified tenant base with over 700 occupiers across 3 markets generating just over GBP 116 million of rent per annum, well in excess of the group's cost of debt. Approximately 27% of our rents are coming from government and 25% from major corporates. 35% of our contracted rent comes from 15 tenants, which you can see in the bottom left hand of the slide. You may remember last time we flagged Honda as a potential risk, but we were confident that they wouldn't exercise their break option. And I'm pleased to report they didn't, and we're now actively discussing building enhancements with them.

And across the group, we have a very affordable rent, you can see that in the top right there: the U.K., approximately GBP 23.40; Germany, just over GBP 11.50 per square foot; and in France, just over GBP 19.40 per square foot. 90% of our properties are pure office use, with the remainder spread across high income-generating student and hotel accommodation in Vauxhall and 2% food retailing, providing important amenities for our office occupiers.

So this geographic spread, affordable rent and strong tenant mix makes our portfolio very resilient.

Let's move on to the next slide and explain what we've been doing. So our in-house asset management team continued to add value. We signed new leases and regears on approximately 0.5 million square feet. And including rent reviews, we closed 78 transactions, securing just under GBP 7 million of contracted rent. And on average, negotiated deals were an encouraging 4.3% above December ERVs.

New lease activity accounted for 41% of the transactions, higher than in the same period last year, and that's as we continue to let up new vacancy created from developments and recent German acquisitions.

Our weighted average on expired lease term is just under 5 years. It reduced slightly due to acquisitions we made. Importantly though, it remains at a level that creates asset management opportunities.

Top right there, so who did all the work? You can see that the larger portfolios are the U.K. and Germany secured the majority of the leasing deals, with the U.K. fractionally ahead.

Looking at the vacancy in more detail on the bottom right, we had a slight uptick in vacancy in France, but settling back to a more comfortable vacancy. Remember, too low and we can't actively grow the cash flow.

U.K. was stable at 4.1%, and Germany was up at 4.7% due to timing of some lease expiries in the first half of the year. I'm comfortable, though, with the German vacancy closer to 5%. Why? Because it presents more opportunities to push the rents on in the German market.

Lettings and renewals in Germany were on average 5.25% above December ERV.

So in summary, it's a high level of deal activity in all 3 countries, with a good level of vacancy to allow us to push the rents on, particularly in Germany, and I'm confident that at the year-end we'll be at or below our group target of a 5% vacancy.

So some -- next slide, some examples, we're adding value. In Germany, we completed a lease regear with Kaufland in Adlershofer Tor, which is Greater Berlin, and that secured EUR 1.3 million of rent on a lease to 2035. This has then been the catalyst to invest further in the building with plans to improve the office entrances and work up designs for additional floors on the building.

In France, we have a number of older properties which have fairly dated facades and lack air conditioning, and we're currently working on 3 facade projects, 2 in Lyon and one in Lille. These are interesting because it will improve the thermal insulation of the building, and it's an opportunity with air conditioning to capture higher rents in the buildings.

And finally, in New Malden, Greater London, we have regeared the lease with BAE, who occupy the entire building. They will downsize into the lower half of this 14-story office and commit to a further 10 years from next summer. And in the interim, while BAE are paying us full rent on the whole building, we are allowed to go in early and start refurbishing the reception and introducing shower blocks and the office space on the upper levels. We have GBP 10 million of CapEx budgeted for this, which will transform this 1960s office tower, which is just 2 stops from Wimbledon.

On the next slide, development. Whilst it is only a small part of our business model, it can play an important role in creating value. We're particularly good at identifying the optimum use and design for a site, securing attractive planning consents and delivering high-quality properties.

Our Central Paris development Ateliers Victoires has been a huge success, making a significant contribution to the group. The former building was valued at GBP 9.9 million in December '15, and we spent GBP 9.8 million on a design, constructing and a letting journey which transformed us into a new single-let HQ for a French PR firm. And we have now realized that value by selling the property for GBP 37.6 million, which equates to a net initial yield of just 3%. So "Vive la France."

We've made good progress on all 3 of our development opportunities. Vauxhall Walk, we have pushed the envelope and what was last reported as an 18,000 square foot opportunity is now a 29,000 square foot office opportunity. This was achieved from acquiring, as you heard from Fredrik, the last industrial unit on the site, which allowed us to provide a more comprehensive master plan. Planning was submitted a couple of weeks ago, with potential delivery for 2021.

In Maidenhead, a detailed planning application was submitted in June, and that is for a 78,000 square foot office, and the delivery targeting date for that is 2022. These 2 U.K. assets would enable us to grow existing ERVs of GBP 380,000 a year to GBP 4.6 million per annum of contracted rent.

And lastly, in Germany, Stuttgart, planning will be submitted in the next 4 weeks for a new 6-story office, providing 140,000 square feet of high-quality London spec office space. So for the first time German occupiers can look forward to making use of showers, co-working space and relax on a garden terrace sipping a beer from the top of their office.

Combined, all 3 developments require approximately GBP 90 million of capital, which when let will secure an additional GBP 5.8 million of rent.

Moving to my last slide. Faced with challenges of ever-growing urban populations and macro trends such as climate change, the case for improving sustainability and resilience of our assets has never been stronger, and our commitment and ambition is to be leading the way. Our sustainability charter, top left there, is underpinned by what we call the 4 pillars, the 4 Ps: planet, property, people and profit. And they encapsulate a sustainability focus vital to our future. And each pillar is aligned to relevant UN sustainability goals. We've just finalized and submitted our 2 key environmental, social and corporate governance questionnaires for 2019, and that's GRESB and CDP, and expect improved ratings to be published towards the end of this -- year, sorry.

Last month, we were awarded our first BREEAM excellent for our new office development at Tinworth Street in Vauxhall. 96% of the energy we purchase now in the group is from renewable resourced contracts, and management team have reduced our operational carbon by 3.4% to date, making a good start towards our group target to reduce carbon by 25% by 2025.

And I'm pleased with the results, but even more pleased with the improved collaboration and sustainable behavior I'm seeing on a day-to-day basis across our business and the increasing level of interest from our tenants.

And with that, I'll hand you back to Fredrik.

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Fredrik Widlund, CLS Holdings plc - CEO & Director [4]

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Thank you, Simon. So on Page 21, I would like to give you a snapshot of our markets. So starting with the U.K., and although I think we all probably suffer a bit from Brexit fatigue, it is having a real impact, and like everyone else, we are seeing a wait-and-see approach both from tenants and from investors.

Commercial property sales volumes are significantly down in the first 6 months, and many people are sitting on the sidelines. The economy is still doing relatively well. And even if growth is slowing, London is holding up well with good inquiries on the letting side.

There has been slower take-up from new tenants, but existing occupiers are also not exercising breaks and we are long-term positive on London and the Southeast.

The current situation has also created opportunities for acquisitions that we are exploring.

In Germany, the economy has slowed down, and the important export sector is impacted by lower global growth, but also by more structural changes in the automotive industry. Even here, unemployment is at record lows and the consumer and service sectors are doing well. Property fundamentals are still strong with very low vacancy levels and limited new office supply. This means continued rental growth, and we see good value in our sector in the larger cities and we'll continue to invest in the right properties.

In France, the economy is gradually improving and the political reform agenda and deregulations have slowed down, especially after last year's protest, but they do remain ongoing. The investment market in Paris and Lyon remains very buoyant, and we have seen relatively few value-add opportunities for us to invest in.

Nevertheless, we continue to selectively look for new opportunities, like the acquisition we did in Lille, but more focus is on maximizing value from the existing assets that we have in France.

Finally, I would like to summarize the first 6 month and leave you with some thoughts on the longer-term potential of the company. The strategy is working and the diversification of the portfolio, with 125 different properties in the 3 largest economies in Europe, over 700 tenants and multiple financing providers, is delivering long-term income and asset growth. We have been increasing rental income and is well positioned to capture further rental growth in our markets. Our excess net yield, illustrated on the right-hand side over a longer period, is over 250 basis points, and this is driving cash flow.

Net rental income grew 5.9% in the first 6 months of 2019, and EPRA NAV was up 5% to 325.3p per share. We are actively acquiring properties, like Office Connect in Cologne that you can see on the right-hand side, that offers opportunities for our country teams to improve, and we're exiting others where we see no further opportunities.

Both the acquisition and disposal strategies are well defined and ingrained into the business.

We've also have good opportunities in our existing portfolio to add value by pursuing selective refurbishment and developments that will deliver long-term value, as you heard from Simon's slides. The balance sheet is strong, gearing less than 40%, and we have substantial liquid resource to finance further growth, driving shareholder value and growth in dividend. Our interim dividend is up 6.8% to 2.35p per share for the first 6 months.

Notwithstanding the uncertainty we are experiencing in the U.K., the type of properties and locations are proving resilient and our portfolios in Germany and France have further potential for growth and to keep delivery. And with that, I would like to conclude today's presentation. Thank you all for attending. I'd like to open the floor for questions.

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Questions and Answers

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Unidentified Analyst, [1]

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It's [Tom Musson] from Liberum. Just 2 short ones, hopefully. Firstly, on net rental income of 6%, I noticed there wasn't a like-for-like figure, do you have a like-for-like figure for that? And secondly, on LTV, is your stake in Catena included in the LTV number or not?

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Fredrik Widlund, CLS Holdings plc - CEO & Director [2]

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Well, I can do the first one, I'll hand over to Andrew for the LTV question. But -- so net rental growth grew 5.9% in total. Of that, you had acquisitions and you had like-for-like growth. The like-for-like growth was 2.6%. So acquisitions contributed 3.3%, adding up to the 5.9%. That's a pretty good number. Last year, our like-for-like was just over 1%. So we've seen good rental growth in the first 6 months.

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Andrew Kirkman, CLS Holdings plc - CFO & Director [3]

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Quickly on the second one, no, we haven't included the Catena in our calculation of net debt to get to our 39.3% yield.

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Fredrik Widlund, CLS Holdings plc - CEO & Director [4]

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If you would do that, you would fall down to close to 30%.

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Kieran Adrian Lee, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [5]

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Kieran Lee from Berenberg. Just a couple from me. The first was in France, where I just noticed that some of the recent leases had been agreed at small discounts to ERV. Just to sort of get a sense, is this a function of occupier weakness, oversupply, or is it anything asset related?

And then secondly is just on sort of future geographic allocation of acquisitions and disposals. So with the U.K. weakening, is that -- do you see that as an opportunity? Or would you look to sort of prioritize investment in Germany and France as you have been doing recently?

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Fredrik Widlund, CLS Holdings plc - CEO & Director [6]

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If I take the second part while Simon thinks a bit about France, I think it's fair to say that Germany still offers a lot of opportunities for us to acquire properties. I mean the net yield between what you could acquire for and the financing cost is still very attractive. And the fundamentals in terms of limited supply of new offices is driving rental growth. So Germany is still one of the key focuses for us to continue to grow. And it's a very large and deep market, so there's plenty to look at.

Sales volume was down in Germany in the first 6 months, but it's probably more driven by a lack of stock available than anything else. It is a very popular market. And we're not the only people that are expanding in Germany. But we will continue to do that.

I think there will be opportunities for us to acquire in the U.K. People have different views on the long-term future of the country. And I mean we're still positive and think that London is still going to be here and still going to be an attractive place to invest in. So that hasn't changed in terms of our strategy for where we deploy money.

France has proven a bit more difficult to find opportunities. I mean, as you know, it's quite a domestic market, and the majority is French institutions buying. And while we are looking and we have been bidding, we have not been successful to acquire. So I think it's likely that Greater London and the big cities in Germany is still where our focus will be.

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Simon L. Wigzell, CLS Holdings plc - Head of Group Property [7]

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Yes. Just taking the first question, I mean, it's a difficult one. We have -- properties are so different, locations have different aspects. But I think -- I mean the main key thing is that the team are very focused on letting up the space. It's better to extend a lease with an existing tenant and avoid going through the marketing process of new lettings and agencies, et cetera. So that's very much what they focus on. I don't see it as a trend of rents dropping. It's pretty stable, to be honest, and I think not of a concern.

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Fredrik Widlund, CLS Holdings plc - CEO & Director [8]

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I should mention also, it is driven by one fairly large lease extension. And if you exclude that one, the ERVs were above -- or the signed leases were above ERV.

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Unidentified Analyst, [9]

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(inaudible) questions. You mentioned Brexit (inaudible) what preparations you've been engaging over the last 2 or 3 years and how you think things might pan out?

Secondly, on the Catena shareholding, can you perhaps give us a flavor of what the future for that might be? Is it staying? Does it go? If it was to be sold, would you be minded to reinvest that capital or fund dividends or some other form of capital return?

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Fredrik Widlund, CLS Holdings plc - CEO & Director [10]

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Let's start with the Brexit question. Like any larger company, we have done a fair amount of research and review of our portfolio. So immediately after the Brexit vote, we did start by going through all our tenants, all 700 -- half of that is roughly in the U.K. -- to understand if we had exposure, they were likely to leave or exercise breaks. And that's when the Honda HQ in Bracknell came up. And then obviously I'm very pleased that they have not exercised their break option there.

A large proportion of our tenants in the U.K. are government; they're not likely to go anywhere. So we have a very resilient portfolio in terms of a tenant perspective. When it comes to financing our investments, we don't tend to finance in London and then send the cash to Europe. As you know, we use local banks and local funding in each of the countries to avoid having a situation where we might have a squeeze on that. We've also extended some of the loan maturities. If you've followed us for a few years, we have actively extended that to make sure that we don't have a large exposure in a single year, and specifically not in 2019 or in 2021, which would be the 2-year transition period for Brexit.

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Simon L. Wigzell, CLS Holdings plc - Head of Group Property [11]

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Just a bit more on the tenant side, I think it's important to remember that where our buildings are there is not -- fundamentally, there is not an oversupply of office space. Quite the opposite. And we still see office space in our markets going to -- now more to private rented sector to residential, and that is still happening and we think that will continue, because fundamentally there is a housing shortage, particularly in London and the suburbs.

And as Fredrik said, it's -- percentage is 41% of U.K. rent is government and a large chunk of that is also indexed.

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Fredrik Widlund, CLS Holdings plc - CEO & Director [12]

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Catena. Catena is a great company. I mean they're active in a space which is doing very well at the moment, driven by fundamental growth in the logistics sector. Like all our investments, we do look at it on a very regular basis in terms of when is the time to move on. But as we have seen, it's been a very good investment, and we're very happy shareholders with that one. If that will change in the future is nothing I can really comment on at this stage, but we do review it on a regular basis, as I said. And yes, there's still growth in that sector, and yes, happy shareholders.

Any other questions?

All right, in that case I think we'll wrap up, and we'll be around here for a few more minutes if anyone wants to talk more. Thank you all for attending.