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Edited Transcript of FABG.ST earnings conference call or presentation 5-Feb-18 2:30pm GMT

Q4 2017 Fabege AB Earnings Call

Solna Feb 5, 2018 (Thomson StreetEvents) -- Edited Transcript of Fabege AB earnings conference call or presentation Monday, February 5, 2018 at 2:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Åsa Bergström

Fabege AB (publ) - CFO, EVP and Board Secretary

* Christian Hermelin

Fabege AB (publ) - CEO and President

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Conference Call Participants

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* Julian Ashley Livingston-Booth

Goldman Sachs Group Inc., Research Division - Head of European Real Estate Equity Research

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Presentation

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Operator [1]

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Ladies and gentlemen welcome to the Fabege AB Q4 Report 2017. Today, I am pleased to present CEO, Christian Hermelin; and CFO, Åsa Bergström. (Operator Instructions)

Speakers, please begin.

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Christian Hermelin, Fabege AB (publ) - CEO and President [2]

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Welcome to Fabege's year-end report. Please turn to Page 2. Looking at earnings in 2017, we have benefited from a persistently healthy property market in Stockholm. We have also been quick to harness all the opportunities on the market, and a substantial portion of our strong earnings is down to our organization, delivering over and above expectations.

Almost all our key ratios saw improvement in 2017. Here, you can see some of the most important key figures, not least for our long-term earnings performance.

Please turn to Page 3. I also want to highlight our high revenue growth in 2017. As you can see in the purple bars, rental income has increased as a result of completed projects and rising rents. And when our costs are stable or even falling, our cash flow and, thus, our dividend-based earnings, will increase by the order of SEK 200 million.

Åsa will now tell us more about the 2017 performance.

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Åsa Bergström, Fabege AB (publ) - CFO, EVP and Board Secretary [3]

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Thank you, Christian. What a great year. Strong key ratios, rising rental income, improved earnings from property management and continued value increases, although not at quite the same pace as in 2016.

Rental income totaled SEK 2.3 billion, that is SEK 175 million higher than the previous years.

In an identical portfolio, income rose by almost 10%, 5.5% of which related to growth via completed projects ready for occupancy, while just over 4% related to growth primarily resulting from renegotiations and new lettings in the investment property portfolio at improved levels.

The surplus ratio was 74%. Our target for 2017 was to achieve 73%, but the level improved owing to mild and relatively snow-free fourth quarter.

Administrative expenses are slightly up on last year. We believe this level will persist for 2018 as well. Interest expenses are lower than last year in absolute terms.

Overall, we are borrowing more but at a lower average cost. The main explanation behind the lower average interest rate is that we have increased the proportion of capital market financing while old expensive interest rate swaps have expired during the year.

The average interest expense at the year-end was 2.2% compared with 2.64% the previous year.

Earnings in associated companies totaled minus SEK 105 million and relate to the capital contributions to Arenabolaget for the period. The ongoing deficit in Arenabolaget is in line with the budget, but the change in operator has resulted in a number of one-off costs, mainly in the second and third quarters.

Last year, we recorded a significant impairment of our commitment in Arenabolaget. Excluding earnings from associated companies, earnings from property management increased by 22% in 2017. In absolute terms, earnings from property management rose from SEK 471 million to SEK 992 million. The Selfoss 1 property in Kista was sold in the second quarter to co-owned Selfoss Invest. The sale had no accounting effect, and no further sales were made in the period.

The entire property portfolio was externally valued over the course of the year, and some properties were valued more than once. Normally, around 25% of the portfolio is externally valued at the end of each quarter. In the fourth quarter, just over 50% of the portfolio was externally valuated.

The growth in value continued with unrealized changes in value of SEK 6.1 billion, corresponding to growth in value of around 13%. Values in the project portfolio rose by SEK 1.6 billion, producing a return on invested capital during the period of 72%.

In the third quarter, we also adjusted the value of development rights on the property Stora Frösunda in Solna upwards by SEK 695 million.

Value in the investment property portfolio was driven mainly by increases in rents but also by somewhat lower yield requirements. The average yield in the portfolio is now 4.36% compared with 4.53% at the year-end 2016.

The value in the derivative portfolio continued to decrease in Q4, and the deficit value dropped by SEK 268 million in total over the year. And the deferred tax is estimated at 22% on current earnings.

Please turn to Page 5. We have decided to reinforce our financial profile by adjusting some of our financial targets. This means that the loan-to-value target is being reduced from a maximum of 55% to maximum of 50%. The interest coverage ratio target is being raised from 2.0 to 2.2. And we are introducing a new financial target, debt ratio, which is interest-bearing debt divided by EBITDA, and the long-term target for this key ratio is a maximum of 13.

Please turn to Page 6. The balance sheet has continued to strengthen in line with the favorable earnings trend. Visible equity is now SEK 169 per share, and the long-term net asset value, EPRA NAV, is SEK 201. Most of the financial target figures have strengthened during the year, and the debt ratio will improve considerably in 2018 as we will see high growth in the cash flow resulting from completed projects. On this slide, you can also see our results compared with the target figures.

Please turn to Page 7. The financing market, both the banking and capital markets, remain very positive. We are not experiencing any of the difficulties in accessing capital that are sometimes the topic of articles in the media. On the contrary, there is a considerable amount of interest from both banks and from the bond market, particularly in green bonds. We are also seeing indications of somewhat lower bank margins, and a STIBOR floor in bank financing is no longer guaranteed. We have continued to increase the proportion of green financing. Green loan agreements are now in place with all our Swedish banks and green bonds and also via our own MTN program and SFF. Half of our outstanding financing will soon be green. And in the most recent refinancing round, we have extended the fixed term maturity, which is now an average of 4 years.

We have also subscribed to several new long-term interest rate swaps. Earlier on in the year, a number of old and expensive swaps expired, which reduced the average interest cost. At the year-end, 54% of the loan portfolio was fixed. This summer and in early autumn, we will see 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. We intend to replace these with new long-term swaps, but this still means that we will have a lower average interest in the second half of the year.

Unutilized facilities at the end of the year totaled around SEK 2.7 billion. We are confident about both refinancing and access to capital for continued investments.

Thank you, and back to Christian.

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Christian Hermelin, Fabege AB (publ) - CEO and President [4]

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Thank you, Åsa. Slide 8, robust demand combined with low vacancies mean that we are continuing to see a strong upswing in rents in all our areas. Rental increases in our renegotiations are a good indicator of the strength of the rental market.

In 2017, we achieved an average rental increase of 26% in our renegotiations. The 2 largest renegotiations during the year were with Carnegie and Svea Ekonomi, who are in the top 2 properties. 2017 net lettings were a high priority for us as we wanted to add new projects to replace all the projects that will be completed in 2018. As record few customers have left us, meanwhile as new lettings were good, we have achieved a record high net lettings of SEK 244 million, which I am more than satisfied with. The good net lettings has also resulted in the decision to start 5 new projects during the year.

The 2 largest lettings, you can see in the bottom. And they were to Swedbank in Orgeln 7 located in Sundbyberg and to the Swedish National Agency for Education in the property, Fräsaren 12, located in Solna Business Park.

Please turn to Page 9. As a result of rising rents and completed projects, we are experiencing strong growth in revenue this year, as you can see from the purple bars. And as shown here, we will continue into 2018 and '19 as we have lots of projects that are being completed then -- and will start generating revenue.

The rental market remains strong in Stockholm, with few vacancies and continued rising rents. Given the prevailing economic forecast with a GDP growth of over 2% in 2018, I expect rents to continue to rise.

Please turn to Page 10. But if I'm wrong and market rents freeze at their current levels, our rental income will increase by our renegotiations. This slide shows what we achieved through renegotiations over the past 5 years period. Most of the leases that will be renegotiated in 2018 were originally signed back in 2015 or earlier. And market rents today are a good 20% higher than levels at the time our leases were signed.

Now let's take a look at the transaction market and yield requirements at Slide 11. Here, you can a see simplified picture of the background to our value increases. Our changes in value during the year are due to projects and rising rents, as expected. We assumed that the effect of falling yield requirements would vanish in 2017. However, this was not the case, as you can see in this graph. Instead, we are continuing to see -- continuing to experience the effect of declining yield requirements, which will persist into 2018 although it's beginning to slacken off.

In 2018, we anticipate a persistently strong change in value from our projects, along with sustained solid contribution from rising rents.

Let's now turn to our project portfolio, which is continuing to create value, at Slide 12. The occupancy rate in 2017 increased from 80% to 88% in our projects. Investments are continuing at a high rate. The total investment in new construction and redevelopment during the year was just above SEK 2.8 billion. And the large investment volume, combined with the high-profit margin in the project portfolio of 72%, generates high-value growth.

Slide 13. Here, you can see the 5 projects that have been approved by the board in 2017. And these projects, together with those already underway, mean we are confident that we will retain the same high level of investment in 2018.

And if we take a look at the earnings outlook for 2018, in Slide 14, we know that our cash flow from property management will increase significantly, primarily due to increased revenues from completed projects and concluded renegotiations.

We expect good value growth in the property management portfolio, primarily due to rising rents. We will also continue to see substantial value creation in our projects portfolio, with a high investment volume and a high-profit margin.

Overall, I'm looking forward to a strong result in 2018.

And that was all from Åsa and me. Thank you.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question comes from Julian Livingston-Booth of Goldman Sachs.

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Julian Ashley Livingston-Booth, Goldman Sachs Group Inc., Research Division - Head of European Real Estate Equity Research [2]

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Can you hear me?

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Åsa Bergström, Fabege AB (publ) - CFO, EVP and Board Secretary [3]

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Yes.

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Julian Ashley Livingston-Booth, Goldman Sachs Group Inc., Research Division - Head of European Real Estate Equity Research [4]

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First question's just on the new debt ratio. I guess, why 13x as a maximum? And why the focus on the longer term?

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Åsa Bergström, Fabege AB (publ) - CFO, EVP and Board Secretary [5]

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Because we are not at 13 today, we are at 15.5, and it will take a while for us before we can go to 13. So that's why we say it's a long-term goal.

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Julian Ashley Livingston-Booth, Goldman Sachs Group Inc., Research Division - Head of European Real Estate Equity Research [6]

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Okay. And the level 13, how did you sort of come to that number?

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Åsa Bergström, Fabege AB (publ) - CFO, EVP and Board Secretary [7]

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Fabege will never be best-in-class when it comes to debt ratios because of the large project portfolio. So we think it's a fair target that will be possible to achieve, but it will still take some effort to get there.

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Julian Ashley Livingston-Booth, Goldman Sachs Group Inc., Research Division - Head of European Real Estate Equity Research [8]

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Okay. I have a couple of others if that's okay. Just on the share of profits from associates, you made the point that a lot of the number we're carrying came in the second and third quarter. Should I assume therefore that the result in the fourth quarter is a good guide to the current underlying run rate? And following on from that, how should we expect that loss to develop going forward?

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Åsa Bergström, Fabege AB (publ) - CFO, EVP and Board Secretary [9]

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There will be a loss also in 2018. I think I have said previously that the run rate is somewhere between SEK 30 million and SEK 40 million deficit on a yearly basis for Fabege. So that's what we expect in 2018. And then we expect it to gradually improve as the tenant will be able to improve its business and pay more rent than today.

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Julian Ashley Livingston-Booth, Goldman Sachs Group Inc., Research Division - Head of European Real Estate Equity Research [10]

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Okay. And final one from me. Just you made the point that with the swaps expiring, you expect a lower interest cost in the second half of 2018. Are you able to say what assumptions you make about Swedish -- the level of Swedish interest rates when you make that statement?

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Åsa Bergström, Fabege AB (publ) - CFO, EVP and Board Secretary [11]

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Well, we know that the swaps that are expiring, they are signed at levels between 3.5% and 4%, most of them. And today, if we sign new 10-year swaps, the rate is around 1.40%, 1.45%. And so it will depend on if we replace them all or if we decide to replace part of them. But definitely, from the second half year, we will see an improvement in the average interest cost for Fabege.

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Operator [12]

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(Operator Instructions) And as we are waiting for them to be registered, I'll hand back to the room for the questions online.

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Christian Hermelin, Fabege AB (publ) - CEO and President [13]

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Okay. Then Åsa and me thank all the listeners from Fabege's report. Thank you.