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Edited Transcript of KLED.ST earnings conference call or presentation 10-Jul-19 9:00am GMT

Q2 2019 Kungsleden AB Earnings Call

Stockholm Jul 12, 2019 (Thomson StreetEvents) -- Edited Transcript of Kungsleden AB earnings conference call or presentation Wednesday, July 10, 2019 at 9:00:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Biljana Pehrsson

Kungsleden AB (publ) - CEO

* Magnus Jacobson

Kungsleden AB (publ) - CFO & Deputy CEO

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Conference Call Participants

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* Niclas Hoglund

Nordea Markets, Research Division - Senior Analyst of Construction & Real Estate and Sector Coordinator

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Presentation

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Operator [1]

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Hello, and welcome to the Kungsleden Q2 Report for 2019. Today, I am pleased to present Biljana Pehrsson and Magnus Jacobson. (Operator Instructions) Please begin.

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Biljana Pehrsson, Kungsleden AB (publ) - CEO [2]

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Thank you, and welcome, everyone, who is listening to the call today. We are very happy to present first half year's results.

I will start off the agenda on Page 2 with the interim period in summary. Thereafter, I will hand over to Kungsleden CFO, Magnus Jacobson, to present the financial performance and key figures. After that, I will continue with giving our view on the markets and outlook going forward. And thereafter, we will open up for questions.

So if you please turn to Page 3. We have another strong first half year of 2019. The profits from property management are up by 15% compared to same period last year. The uplift in the profits from property management comes from like-for-like growth in rental revenues by slightly above [4%] and like-for-like growth of NOI of 9%, combined we continued lowering our financial costs.

Rental markets continued to perform good. And as you can see, we have good leasing results for the first half year, SEK 93 million in new lettings, SEK 10 million in net lettings and new lettings. We also continue to renegotiate our existing leases. For the first 6 months of this year, we managed to renegotiate SEK 144 million, and on average, managed to increase the rent by 7%.

So the positive net lettings from last year -- this year, combined with the renegotiations we have made over the past 1.5 years, is resulting both in increasing rent per square meter, but also a decrease in vacancy. And for the very first time, our vacancy rate is now 6.6% in the investment properties, which we are very happy about. As you know, we have had a target to decrease our vacancy to 7% or lower, and finally, we are there.

If you then please turn to Page 4. We have had other important milestones during the second quarter. And one of that is, of course, us being upgraded to investment grade with a stable outlook by Moody's. It has been a journey since autumn 2017, and we are very pleased about the recognition we have received by the rating institution, Moody's, saying that we have a good quality in our asset base, we have a financial stability, and all that together has resulted in an upgrade to investment grade. This will mean that we will continue to see a lower financial cost over time. Our estimation is that the financial costs should come down with another 30, 40 basis points over time, thanks to the investment grade.

Another milestone during second quarter was the decision to establish our own facility management operation placing customer service in focus. We have had and have for many years set our target to improve our customer satisfaction. And we strongly believe, by strengthening our organization, both on property management side, leasing management side, and now the final step of the facility management side, we will be able to further improve our customer satisfaction and build even stronger relationships with our customers and tenants.

If you turn to Page 5, you will see how the property portfolio looks by end of second quarter. And we believe -- strongly believe that we have right properties in right locations where there is a demand for space. All in all, SEK 36 billion of property value, 87% of that is located in our strongest rental market and that is Stockholm, Gothenburg, Malmö and Västerås, Västerås being the fifth largest city in Sweden. And as you know, this is where the economical growth is taking place. All of our biggest cities are attracting people, are attracting companies, and there is a demand for commercial space, especially offices.

If we look to the categories, offices now represents 75% of the property value, while industrial warehouse and logistics represent [15%]. And this is approximately how we will look like going forward. Probably, the industrial warehouse logistic part will grow while the retail will further decrease onwards. And having good properties in right locations on demand, on Page 6, that is the fundamental thing in having good leasing results.

And the first half year, we managed to sign new leases corresponding to a value of SEK 93 million. And then important to note is that we didn't have any large new lease agreements and we have still not managed to sign leases in our development projects that we have such as [Eden], such as [Stettin]. So those are still in pipeline, and hopefully, we will manage to sign them second half of this year. But despite the fact, we still have strong new leasing results and that leasing amounted SEK 10 million.

If we turn to Page 7. I'm very happy about our very positive renegotiating results. The first half year of this year, as you can see, we have renegotiated existing leases corresponding to a value of SEK 144 million. It's a record high number of leases and value that we have renegotiated in 6 months' time. And on average, we have managed to increase the rent by 7%, which corresponds to SEK 10 million in rent uplift.

I believe that we will continue to see strong renegotiating results onwards this year. And also important to notice, it was close to 60 leases that were renegotiated. And almost half of those have actually added new space to the existing lease agreements, which is also positive and also contributing to the fact that we are lowering our vacancy rate in the portfolio.

If you then please turn to Page 8. All in all, this is, of course, resulting in improved net operating income and improved average rent per square meter. In 1 year's time, we have managed to increase the average rent by 11% and it stands now close to SEK 1,400 per square meter. At the same time, we are working very actively on decreasing our cost side. We also have better quality in our properties, which means that we don't have to have a lot of maintenance in our properties. And that, together, high rents, lower costs, is driving the surplus ratio. As you can see, excluding the IFRS 16 effects, the surplus ratio has improved from 64.8% first half year last year to 67.3% this year, which is very good and in line with our target that we have set out. As you know, we are targeting to have a surplus ratio of 70% or more over time.

If you then please turn to Page 9. We are also happy about having a value uplift of 2.4%, the first 6 months of this year, SEK 848 million. And of those, SEK 577 million were as a result of positive development of the net operating income. From last of December to 30th of June, the valuation yield contraction was merely 7 basis points. So the main driver behind our value uplift are improved rent and improved net operating income.

If you then turn to Page 10, you will see our list on ongoing development projects. And what is new in this list is that we have a new development project that we started off in the second quarter, and that is Finnslätten building 357, 21,000 square meters, old ABB space, that will now be divided into separate premises for companies. And we have already now leased out 41% of the space and those will be now under construction. And the estimated investment of SEK 250 million is like a framework. So as we sign the leases, we will start the construction and not before that.

Another change in the list is B26, our development project office in Västerås, where we have managed to sign new leases and the occupancy rate has increased from 52% to 68%. All in all, the investment -- development projects that are under construction have an estimated investment volume of SEK 1.5 billion, of which SEK 700 million have already been completed. And once these development projects are finalized and the tenants have moved in, they will contribute by just about SEK 200 million of rental value.

If you then please turn to Page 11. Another milestone in second quarter was, of course, the grand opening of Blique by Nobis. The hotel, restaurant, bar, rooftop bar in Blästern, 12,000 square meters, 249 rooms, et cetera. The start has been very good of the hotel. They have had many nights that have been fully occupied. And the rooftop bar, the Arc, has been nominated as one of the 10 best rooftop bars in the world by Forbes, which we are very, very happy about. So if you haven't been here, please go there next time in Stockholm.

If we look at our tenant base on Page 12, our largest customers. The 10 largest tenants and customers looks the same from previous period and they represent 74% of our total rental value and have an average lease duration of close to 5 years. However, post ABB selling off the power grid business in Västerås to Hitachi, we will actually see ABB shrinking as a share of total rental value and Hitachi will actually be the second largest tenant on our tenant list. So that is something that will take place during the second half of this year. Interesting also to notice that 28% of the rental value of the top 10 largest tenants are public tenants. And if we look at the total tenant list, 15% are represented by public tenants, somehow financed by state or municipalities.

On Page 13, all in all, we have 1,500 unique tenants and it's really a well-diversified tenant base we have. We have everything from ABB, the large global company, down to start-ups and everything in between. We are not -- we do not have any sector representing more than other. It's a very broad base of companies and different sectors represented.

What's also interesting is that we have 50 headquarters in our portfolio, and we have actually not included companies -- global companies such as ABB and their headquarters in Västerås. The 50 headquarters in our portfolio are truly the main headquarters for the company, either they are Swedish or Nordic or whatever. And that's really a good quality, of course, to our rental revenues and future rentals income.

And with that, I will hand over to Magnus.

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Magnus Jacobson, Kungsleden AB (publ) - CFO & Deputy CEO [3]

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Okay. Thank you. Biljana guided you through the most important figures and achievements the first half year. And we can see that our strategies increased the quality in the property portfolio and customer base is paying off: higher rents, lower vacancies and increased property values.

If you look at the slide, rolling 12 months are steadily improving, and that is Slide 15. And the profit from property management increased by SEK 74 million or 15% compared to last year. This is explained by lower costs and better financial net. Rental income is slightly higher compared to last year. We divested the properties in Eskilstuna, Enköping, Helsingborg, and replaced it with quality properties in Gothenburg, Tändstickan, and [Malmö], which has a greater value potential. The latter has given us a total return of more than 12% the first year of ownership.

Like-for-like rental revenue growth was 4.3% due to high rents. Renegotiation has a rate of 7%, as you heard before, and indexation. And the vacancy has come down to 6.6% and we see a continuous strong letting pipeline.

Property costs decreased by SEK 53 million and IFRS excluded due to better weather conditions for property owner. Maintenance costs was also down, explained by better cost control. And as you heard, we are ramping up the organization with our own property caretakers to be even more cost-efficient and customer-focused. NOI like-for-like was up 9% and surplus ratio reinvestment properties 67% compared to 65% last year.

And on the next slide, 16, you can see that the rolling 12-month surplus ratio, we are a step closer to 70%, as Biljana mentioned, was our goal to reach. And the net profit for the period was SEK 954 million, lower than last year due to larger negative value changes in derivatives.

Page 17, funding mix. Bonds are amounting to up over SEK 6 billion, 37% of the total funding of SEK 17.4 billion. [Consistent] work to enhance the asset quality customer base, well-defined [yogastic] position and combined with a robust balance sheet has led our -- to raise to investment grade. And we are satisfied that Moody's finally took that decision. We have already seen bond spreads tightening and have discussed them with the investors, which indicates a 40 basis point compression on the 5 years' maturity.

On the banking side, we believe that they already have ticked off most of the new Kungsleden, and in recent discussions, we have not seen adjustments of the margin due to the FSA memorandum about bank's high-risk weight for property companies. On the other hand, if margins in general increase, we believe that our investment grade will mitigate upward pressures.

We have also prepared our financial situation by loan capital and interest maturity and diversified funding. We have a high ICR and backup facilities, which are questions that bother FSA a lot.

Finally, in the second quarter, we issued SEK 500 million 4-year bond to 1.75% and used it to pay back bonds which matures now in July. That means that we don't have any bank debt or bonds during -- maturing during 2019 and '20. LTV is unchanged, 46.6%. And if the ratio is adjusted by paid rents but not registered in [bank in your line], the ratio is down to 46.3%.

Slide 18. In our funding, bank and mortgage financing and in bond issuance, the green footprint is always an issue. Better margins are motivating us to increase the proportion. And until today, the green funding is now over 1/4 of the total funding. We have continued the work to certify our property portfolio, and the plan is to have 30% certified this year, and the share of the green properties would represent half of the property value in 2020. So except the better margins on the green funding, the ESG work in general leads to better attitude from the company's stakeholders [as the new strategy], attract more tenants, which means lower vacancies on high rents, benefit the valuation of properties and lower the property costs.

Average debt maturity on Page 19. In order to build a robust financial situation, we've continuously reduced the risk of liquidity, capital and interest. In Q1, we renewed the RCF of SEK 2 billion and the maturity to 2023 to a low cost and a good margin level if used. Our refinancing activities have led to a retained long average debt maturity north of 5 years and the interest maturities 3.2 years at the end of Q2.

ICR and average interest rate, Slide 20. Due to a better EBITDA and a lower financial cost, ICR reached 4.6x. And after refinancing activities and the relatively long maturity, we have been able to keep the average interest rate level at 1.8%.

Key financial ratios, Slide 21. EPRA NNNAV increased by 11%, close to SEK 83 due to good performance in the operation and the positive property value change of 2.4%. And I would like to add that in that calculation, we have deducted the dividend, we have decided on the general meeting.

And to summarize the financial situation, we have consistently worked with risk reduction and established a robust balance sheet. We have a diversified and have an even maturity structure. We have secured low interest levels. And we have got the [received] investment grade.

Biljana, over to the futures.

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Biljana Pehrsson, Kungsleden AB (publ) - CEO [4]

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Thank you. If you then please turn to Page 23. As I mentioned in the beginning, we continue to see good office rental market in our 4 core markets. This is a chart from Newsec, where you see that for 2019 and 2020, the rent is expected to continue to grow despite the fact that there is some new supply which will enter the market next year and we will see some slight upwards vacancy movement, but still, from very low level as of today and still having room for rental growth.

And if we look at the transactional market on 24, there is a high activity in Sweden. There is good willingness to invest in commercial real estate and especially offices. We see further yield compression onwards for good properties in good location. The transaction volume in second quarter this year was more than 30% higher than corresponding period in 2018. And the total volume for 2019 is expected to beat the previous years, which is encouraging.

If we look at our own activities onwards, we are, of course, focusing in -- if we turn to Page 25. We are focusing on leasing out the development projects that we have, both on the construction and also the work that we have in pipeline in order to start the construction. Rotterdam district is progressing well. We are now targeting rent of about SEK 3,000 per square meter. There is an interest in the market for this office building, and we believe that we will see some new leases signed in the second half of this year.

If you turn to Page 26. B26 is another office development project in Västerås where we have managed to sign new leases, amongst others, with PricewaterhouseCoopers. And the occupancy rate has increased from 52% to 68%. The rent that we are achieving in this office building is really setting a market -- new market rent levels in Västerås. We have rents from SEK 2,500 per square meter up to SEK 2,800 per square meter, which is very encouraging, and will also have a good impact on our existing office portfolio in Västerås City cluster. As you know, this is one of our largest clusters in offices in Västerås, 140,000 square meters office space in our portfolio, and so there is a lot of room for renegotiations in the other buildings onwards.

If we then turn to Page 27. A lot of good development is taking place in Västerås. And a year ago, Kungsleden, together with ABB, our largest tenant, we started off work on developing a future vision for Finnslätten in Västerås. As you know, that is one of our 12 clusters. We own 240,000 square meters in this cluster. It's offices, it's logistic areas and it's production area. We have now set out our vision. And we want to create an international destination for research, education, innovation and production with focus on power and automation.

And as you perhaps know, ABB Robotics, which is the production facility for whole Europe, is located in this -- in Finnslätten. Northvolt's new test factory is under construction in Finnslätten, and they are on the way to recruit 400 engineers in Västerås for that facility. Amazon web service [halls] are opened in Finnslätten this year, 40,000 square meters off of that in Finnslätten. So an area where a lot of good things will happen. And we see a large interest from both existing companies, but also new companies who want to establish themselves in this very vibrant area.

And on Page 28, you will see Kungsleden and ABB started out this work or vision of Finnslätten in Västerås, but we are joined by Västerås municipality, Mälardalen University, Bombardier, Northvolt and ABB High School. So it's a broad collaboration between companies, world-leading companies in different fields of robot and automation and power. And we will also be joined here by Hitachi, of course.

And as a starting point, on Page 29, Project 357, an old ABB office building, that will be converted to up to 7, 8 different premises. We have signed lease agreements with Scandinavian Gene Synthesis, SGS DNA, and they will be the starting point of this redevelopment. We have also signed lease with ABB and Northvolt, 21,000 square meters, a total investment up to SEK 250 million to be deployed as the leases are signed. All the premises will have separate entrances from the street.

On Page 30, another project that we have in pipeline, meaning once we have leased out at least 50% of the GLA, we will enter a construction phase. And our target is actually to have signed a lease agreement corresponding to 50% of the GLA within 2 to 3 months' time. And if we manage to do so then a new office building in Hyllie, Malmö will enter a construction phase in autumn this year.

Another project in pipeline is on Page 31, Stettin/Tegeluddsvägen. This is a redevelopment of an existing office building, in total 26,000 square meters. Here, we actually managed to sign a lease agreement with a restaurant and co-working operator, Eatery, of 600 square meters. And we continue to market these premises. And hopefully, we will also be able to start off this redevelopment in second half of this year.

All in all, on Page 32, as you know, when we launched our investment program back in 2017, our target was to have investments of around SEK 1 billion per year the coming 3 years and onwards. And all of these investments, when it comes to development projects, when it comes to test improvements and other value-creating investments, we have an IRR target of in excess of 9% and -- or yield on cost in excess of 6%. And on top of that, tenant improvements have a payback time less half -- than half of the leasing contract duration.

However, as you can see, already in 2018, we had more developments than expected and the total investment amount to SEK 1.3 billion. This year, we believe the SEK 1.3 billion will be invested even a chance -- a bit more of that. And if all the -- all what we see today, future potential development pipeline, will come to happen, we do have another SEK 8 billion of potential investment with very good return targets in the future. So this will enable us to continue to grow our profits from property management per year onwards in somewhere between 6% to 10%, and that is in line with our growth strategy. On top of the growth from profits from property management, we will also grow our net asset value.

And with that, I will stop and open up for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question is from the line of Niclas Hoglund of Nordea.

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Niclas Hoglund, Nordea Markets, Research Division - Senior Analyst of Construction & Real Estate and Sector Coordinator [2]

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Niclas Hoglund from Nordea here. So I was a little bit late into the call. You might have talked about it, but I didn't hear you sort of commenting on sort of the new leases that you have signed now in the third quarter and announced, well, early this week and late last week. You comment a little bit about them on the sort of -- [in board] this morning, but could you please tell the international audience on your thoughts?

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Biljana Pehrsson, Kungsleden AB (publ) - CEO [3]

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Yes. You're completely right. So we have actually -- as you may remember, last year in the third quarter, we had a big termination from ABB in Västerås, and that is the property that we now have leased out to 4 different tenants. All in all, 20,000 square meters. And the rental value is SEK 17 million per year, and that is approximately 25%, 30% higher than the rent that ABB paid. So every time we receive a termination from ABB, it hurts a bit. But then again, the potential is big because all of the leases with ABB have on average a lower rent than the market level, so we have a nice upside potential in these vacancies. So we're very happy about -- and this property is not part of Finnslätten, it's actually on the west side of the city. And still, even there, there is actually a good demand for office premises and warehouse [paddle center] as well. So that's -- those are the -- all the leased area onwards.

And then we have also signed a new lease agreement in Stettin in one of the developments in pipeline, 600 square meters. So we have still to go there in order to sign 50% of the GLA, but it looks promising. And I also mentioned that we continue to have a strong pipeline. And I was hoping that we will actually lease out and sign more leases, new leases in our development project in pipeline, but it looks like we will have to wait another 2 or 3 months to do so and -- in order to get those developments under construction. So it looks very promising.

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Niclas Hoglund, Nordea Markets, Research Division - Senior Analyst of Construction & Real Estate and Sector Coordinator [4]

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And if I may continue a little bit more. We also talked this morning about the project portfolio sort of pipeline. You were talking about Finnslätten here in the presentation as well. But this morning you also sort of talked about the total investment, although in a couple of years' time, to be up to SEK 2 billion to SEK 3 billion. Could you sort of shed some more light on that, please?

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Biljana Pehrsson, Kungsleden AB (publ) - CEO [5]

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Yes. As I mentioned, we have both existing companies for tenants and new ones that have showed interest for Finnslätten. And there is a momentum now in the markets and we are -- in parallel with these discussions for new premises for these existing and future companies into Finnslätten, we are driving the zoning plan together with Västerås municipality and the collaboration is fantastic. Everything is moving very quickly and smoothly. And the potential is everything is to happen. What we have in the pipe right now is an investment of up to SEK 3 billion over, of course, a number of years, but still, a fantastic potential for the future. And we strongly, strongly believe in Västerås and in this location.

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Niclas Hoglund, Nordea Markets, Research Division - Senior Analyst of Construction & Real Estate and Sector Coordinator [6]

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Yes. And then my final question. From this morning, we got a little bit of a cliffhanger from you that we should be getting more information on the sort of surplus margin and the strong surplus margin reaching close enough to the target. I'm not sure that we got that much inflow from Magnus on that. But maybe you can shed some more light. Do you -- well, the target seems to be a little bit conservative now given the higher occupancy ratio and the improving mix. Do you agree on that?

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Biljana Pehrsson, Kungsleden AB (publ) - CEO [7]

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Well, we set out the target of reaching a surplus ratio of 70% but we were down on 64%. But I agree, the development has been better and has happened faster than we thought. And as Magnus showed on Page 16, on rolling 12-month basis, we are close to 69%. So of course, if everything develops the same way onwards, we will definitely be above 70%.

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Niclas Hoglund, Nordea Markets, Research Division - Senior Analyst of Construction & Real Estate and Sector Coordinator [8]

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But isn't it fair to say that these are lower occupancy or higher occupancy now we see it into the third quarter given these leases? Or in the second half at least, should actually have a slight positive effect on the surplus level?

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Biljana Pehrsson, Kungsleden AB (publ) - CEO [9]

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Definitely, definitely. Yes. Definitely. So -- and all the development projects when they are actually finalized, they also have a very high surplus ratio. I mean Blästern is 100% occupied, triple net rents. So really, we see a good potential for the future when it comes to the surplus ratio.

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Magnus Jacobson, Kungsleden AB (publ) - CFO & Deputy CEO [10]

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We also see that the maintenance cost is going down because we have better properties in the portfolio. So we are showing the direction of the surplus ratio is going the right way and probably going to reach our goal.

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Niclas Hoglund, Nordea Markets, Research Division - Senior Analyst of Construction & Real Estate and Sector Coordinator [11]

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And maybe one final question, if I may. Now you have reached the investment-grade rating, you are below 50% in LTV. But do you feel comfortable that you will be able to sort of do these investments and the pipelines without, I mean selling down other part of the portfolio and sort of -- and do you have the capital at hand to sort of achieve this investment target at the moment? Or should we sort of expect you to sort of do -- need to sell some properties in order to finance that growth or raise equity?

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Biljana Pehrsson, Kungsleden AB (publ) - CEO [12]

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I think that the investment problem that we have before us, so SEK 1.3 billion annually, that we have room to finance with our -- the profits we'll make in Kungsleden. And as we grow the portfolio, as the development projects are being finalized, we are further improving our rental revenues, the NOI and profits from property management. So definitely, the SEK 1.3 billion today, we -- there is room for further growing our investment pipeline onward as we grow our profit, of course.

So we don't see any need for selling off properties or doing anything else. However, I mean the optimization of the portfolio will always continue. I don't foresee any big movement onward, but still, it's the -- part of our job to -- if we have properties that are perhaps developing positively but we see better potential elsewhere, we will definitely continue to make that shift. And that will always continue, so to say.

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Operator [13]

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(Operator Instructions) As there are no further questions, could I please pass it back to you for any closing comments?

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Biljana Pehrsson, Kungsleden AB (publ) - CEO [14]

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Okay. Thank you for your time, and have a nice day. Bye. Thank you.

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Magnus Jacobson, Kungsleden AB (publ) - CFO & Deputy CEO [15]

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Bye.

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Operator [16]

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This now concludes today's session. Thank you all very much for attending. You may now disconnect.