CLS Holdings PLC

LSE:CLI

Earnings Call Analysis

Earnings Call Transcript 2018-Q2

[Fredrik Widlund, CEO & Director]

We're ready to start. So good morning, everyone, and welcome to CLS Holdings Half Year 2018 Results Presentation. I'm Fredrik Widlund, Chief Executive; and with me here is John Whiteley, our CFO; and Simon Wigzell, Head of Group Property. Today, we will talk about performance for the first 6 months, talk about markets and give an update on where we are against our strategic targets. As always, I would like to start by giving you a high-level overview.So if we go to Page 4. The first half of 2018 was a period when the company delivered solid earnings and made good progress on the acquisition and disposal side. Net rental income was GBP 55 million, up close to 9%. And this, together with valuation uplift, resulted in EPRA nearly up 3% and EPRA earnings per share up over 15% and in line with our expectations. Our portfolio is now close to GBP 1.9 billion, as you can see in the graph to the right, and well diversified over the 3 largest economies in Europe. We have been making progress on the vacancy acquired last year. And with a promising pipeline left the inquiries, we do expect this to keep improving during the rest of 2018. We have also continued to make acquisitions in the period and acquired 2 properties with either high-yield or good asset management opportunities. We also sold several smaller properties, mainly in the U.K., but more details about that later.On the 31st of July, we repaid the CLS retail bond and thereby lowering our cost of debt, 2.42%. Our fixed-rate debt percent has increased further and are now at the level that we have been targeting. Our contracted rent increased to GBP 106.1 million, up 15.8% in the last 12 month as a result of acquisitions and capturing rental growth.On the next slide, I would like to give some more details about the valuations and what is driving the uplift in each country. We saw valuation uplift across the board, and all 3 countries contributed positively. Starting with the U.K. We saw an overall uplift of 0.1%, but this number requires some further explanation to give the full picture. Overall, our portfolio in Greater London saw more robust valuations than the rest of the U.K. In London, the portfolio rose on a like-for-like basis by 0.5%, while the rest of the U.K. was down 2.2%, driven by the lower contract in rents from the 14 deals with the Secretary of State that took effect from April. These extensions would have taken our like-for-like contracted rent down 1.4% in the U.K., but because of other positive activity in the portfolio, our overall like-for-like contracted rent was only down 0.2%. Yields in the U.K. were overall flat.In Germany, we saw a very strong uplift of 4.6% in local currency, and that is the strongest valuation increase in 6 month that we have seen in Germany since we started investing here 10 years ago. This is an effect of a very buoyant domestic market on yields as well as rental growth in the market that is driving ERVs.The French portfolio was up 2.1% in local currency or 1% on a like-for-like basis, if we exclude our development at Ateliers Victoires. This was driven by lower vacancies in the portfolio but it's increasing our contracted rent. Yields in the portfolio are broadly flat, but we saw rent-free periods expire in 3 properties that took our net initial yield up 44 basis points to 5.1%.And now over to John for a deep dive into the financials.

[John H. Whiteley, CFO & Director]

Deep dive. Okay. Let's take the financials. Thank you, Fredrik. Good morning, everyone. This morning, I'll take you through the results for the first half this year and through our debt position.Let's start with some headlines. It's been a 6 months of asset growth underpinned by low-cost financing. EPRA net assets per share rose by 3% to 294.7p, and EPRA earnings per share rose by 15.1% to 6.1p. Profit before tax was a healthy GBP 64.9 million. The weighted average cost of debt rose by 14 basis points during the period to 2.65%, but it seems to have been brought down to 2.42%, and we'll see why in a moment.

[John H. Whiteley, CFO & Director]

[Audio Gap] The weighted average cost of debt rose by 14 basis points during the period to 2.65% but has since been brought down to 2.42% and we'll see why in a moment. This is now 280 basis points below the property portfolio's net initial yield. With a large differential between the net initial yield and cost of debt, our interest cover has remained very strong at 3.5x. And the final headline as of this morning, we've announced an interim dividend of 2.2p per share, being an increase of 7.3% on last year's. Our interim dividend approximates to 1/3 of the full year. So those are the headlines. Now let's take a look at stories behind, beginning with the 3% increase in NAV. EPRA NAV began the year at 286p. After we paid the final dividend for last year, the increase was driven by earnings of 6.1p and by the property valuation uplift of 7.4p per share. NAV finished the period at 294.7p, an increase of 3%. Excluding the dividend, the total accounting return for the 6 months was 4.5%. Moving now to the 6.1p of earnings per share. Last year's first half earnings were 5.3p. The uplift this year was all about the growth of our strong underlying business. The significant investment in property assets in the second half of last year and the first half of this produced higher rental income to the tune of 1.1p of earnings. Associated expenses and net finance costs increased by 0.3p and 0.2p, respectively; and tax and foreign exchange contributed a small amount. So overall, earnings grew by 15.1% over last year. The subject of our investments in property assets brings me to the next slide. We continue to reposition the group. Simon will address the disposals and acquisitions in more detail in a moment. Suffice to say that 5 properties were sold with a book value of less than GBP 25 million and two were required for almost GBP 70 million. After capital expenditure on developments and refurbishments of GBP 8.4 million, and the valuation uplift of GBP 32.5 million. Overall, our property portfolio grew by 4.6% to almost GBP 1.9 billion. So how did this growth affect our liquid resources? We began the year with GBP 206.7 million of liquid resources comprising about GBP 141 million of cash and GBP 65 million of corporate bonds. Cash from operations added GBP 36.8 million before net interest, tax and dividends. Property disposals contributed GBP 26.2 million and we spent GBP 76.9 million on property acquisitions and capital expenditure. And we drew down a net GBP 33.5 million of loans. At the end of June, we had reduced our corporate bond portfolio to GBP 46.5 million and had cash of GBP 137 million. At the end of July, we redeemed our GBP 65 million retail bond at a slight premium, reducing liquid resources to a pro forma GBP 115.1 million. So those are the results for the 6 months. And I'd now like to address our debt position, which is one-off low cost and low risk. First, low cost. Actually, our cost of debt rose for the first time in many years by, a not very high, watering 14 basis points in the 6 months to June due to the cost of new debt, an increase in LIBOR and a contractual step up in the margin of our largest debt at Spring Gardens. But the redemption of the retail bond I mentioned earlier, which had a coupon of 5.5%, reduced the cost of debt to 2.42% with effect from the end of July. That's more like it. As I mentioned at the start, our interest cover, therefore, remains strong. Most of the debt, which accounts in the 6 months to June was at fixed rates. So the proportion of our debt that was fixed at the 30th of June had risen to a shade over 80%, and having redeemed the retail bond it's now just under 80% and the fixed proportion has a weighted average duration of 4.2 years. Our balance sheet loan-to-value, that is debt -- sorry, net debt divided by property assets was 38.4% at the end of June. Given the way in which we finance the business, predominantly with nonrecourse bank debt, we target gearing to be below 40%. At the end of June, GBP 0.25 billion of our properties or just over 13% of the portfolio was unencumbered. So what have we done since the start of the year? Well, in the first 6 months, we took out around GBP 112 million of new debt at an average cost of 2.08%. Just over GBP 91 million of this was taken out at fixed rates with an average cost of 2.2% and for an average term of almost 6 years. We repaid GBP 73.5 million of debt on expiry. Then at the end of July, we redeemed the retail bond as a premium of GBP 3.4 million, which would have cost GBP 5.1 million of interest through to its expiry in December next year. The net effects of all these transactions was to increase the average unexpired lease term to 3.8 years, with a fixed portion at 78.7% of the total, having an average of 4.2 years to maturity and the floating debt having just a 2-year average maturity. Finally, I'd like to take this opportunity to share with you our thoughts on gearing and to provide some context to that by reference to the markets in which we operate. Half of our business is in Germany and France and we borrow in those countries in euros to give a natural hedge against part of the effect of exchange rate movements. Our borrowing is diversified across 3 countries, 25 lenders and 52 pieces of debt. Most of the borrowing is non-course to the rest of the group and is for a period of up to 7 years. We adopt a flexible approach over whether to fix interest rates by reference to our intentions for each asset and our view of the forward interest rate curve. As I mentioned earlier, we target gearing to be high enough to generate an appropriate return, but to stay below 40% and we spread the risk by having a diversified financing structure. On the top right-hand side of this slide, I've set out the diversity of our borrowings, showing by country, the gross debt at the end of July, the number of loans, the level of gearing and the cost of debt, which together aggregate to our group position on the 31st of July. From this, you can see that our gearing in the U.K. is below 30%, whilst in Europe, we are happier with a higher level of debt and an associated lower cost. And whilst you're taking implications of that, I'll pass you over to Simon to take you through the properties.

[Simon L. Wigzell, Head of Group Property]

Thank you, John. Just move to Slide 16, the map with the dots. As you know, our business strategy is to invest in well-located office properties with high potential for future growth. We've been successful in acquiring 2 investments in London with such potential. In March, we bought Harman House, a 129,000 square-foot office building adjacent to Uxbridge underground station for GBP 51.3 million, representing a yield of 6.9%. And the following month, we purchased a 25,000 square-foot office in Hammersmith for GBP 16.1 million, which we expect will generate approximately 6% net yield when all leases revert to market rents and after planned improvement works. We've continued to reposition the portfolio, selling assets which were either low yielding with limited potential or were too small to have any meaningful impact on the group. In the first 6 months, we sold 4 properties in the U.K., in Peterborough, St. Asaph, Datchet and Birmingham generating proceeds of GBP 20.1 million and one quasi office/industrial unit in outer Hamburg for GBP 6.1 million. And since the half year, we've subsequently exchanged contracts or completed sales on a further 3 properties: one in Paris, one in London and one in Chertsey for a total of GBP 20.6 million. So let's just look on the next slide, slightly further ahead. As part of our review to refocus our portfolio, we identified GBP 150 million of medium-term sales and we've made good progress having already completed or exchanged sales on approximately 1/3 in the first half of this year, which is illustrated in the pie chart on the top right. Those sales have, on average, been 6.7% above the December '17 valuation. The next sales to focus on include Quayside in Fulham and some regional U.K. assets and a small German asset. Looking at our acquisitions, we have maintained our disciplined approach when it comes to returns and due diligence. Uxbridge, which was acquired in March, is now fully let, and Hammersmith we've kick-started, redid discussions with our tenants as well as working out plans for an extension. In Germany, we were very close to acquiring 2 office portfolios with a combined value of EUR 180 million. However, we were outbid on one of them and the other, we were unwilling to compromise on the rigor of our due diligence. Whilst we were disappointed, maintaining a disciplined approach is of paramount importance to us. In the paragraph at the bottom right, you can see the first half of this year has been relatively busy, acquiring more than we did in 2015 and '16. [Foreign language], we continue to look. Now let's look at the resilient tenant base on the next slide. Our investment portfolio of 126 properties is well diversified with over 700 occupiers across 3, markets generating over GBP 106 million per annum of rental income. And approximately 28% of our rents are coming from government, 27.5% from major corporates and around 40% of rents and are subject to indexation. In the U.K., 42% of the rent roll is derived from central government departments. And over 90% of our properties are office use with the remainder, a mix of student, retail, and hotel accommodation. Across the group, we have very affordable average rents of just under GBP 16.60 per square foot, which as you can see is low in Germany, in the bottom right graph, but we are now seeing rental growth. In fact lettings in Germany were on average at 8.3% above December '17 ERVs. So secure and affordable rents. So let's look on the next slide at what we've been doing. Our in-house asset management team has continued to deliver. The first half of 2018 was a busy period of asset management seeing 85 deals, securing GBP 7.1 million of contracted rent, slightly ahead of the same period last year. But as you can see in the chart on the top right, a very strong performance from Germany, securing nearly 50% of all deals by value. And our German team closed some very successful lease extensions in the first half. With affordable rents, tenant retention remains good, with lease extensions accounting for 59% of all deals by value, 31% from new leases and 10% from rent reviews. Our WAULT is down only 2 months to 5.2 years during the 6-month period, but importantly, remaining at a level that creates asset management opportunities. The vacancy is summarized in the bottom right chart. It was temporarily up at 5.8% due to the German portfolio acquisition and REIT U.K. refurbishments completing, but now a 5.7%, it is starting to track down towards our target of below 5%. Let me move to the next slide. Many of you will have noticed that the nature of office occupation is going through a transformation, and I don't just mean flexible leases, which we've always provided, but it's softer issues. It is out with the power receptions and in with what I call hub receptions. And what does this mean, well particularly, they're younger employees, I include myself in that category. It's like the cavernous intimidating sterile reception.

[Unknown Executive]

[indiscernible]

[Simon L. Wigzell, Head of Group Property]

They want hubs, common spaces, activated perhaps by a concierge rather than a receptionist, with independent retailers brewing specialist coffee and drop-in informal work zones, personal lockers, cycle and shower facilities. Our employees, tenants, customers continue to seek more flexibility. Recent JLL Research identified that 54% of employees work from home at least once per month and 60% say access to external workspace has a positive impact. Social and networking events are also increasingly important. We continue to listen and respond to the needs of our customers. In the first 6 months, we carried out more occupiers surveys, 7 buildings in the U.K., including 2 recent acquisitions and 13 properties were completed very recently in France. Responses were encouragingly all above average but room to improve. So we are currently investing over GBP 2 million at Great West House in Brantford, creating a hub reception and independent-style café. Public realm improvements are being rolled out and more sustainability and technologies are being installed in our properties. Current developments. We're making good progress at Spring Mews. Vauxhall Phase 2 has completed, providing just over 9,000 square feet of office space and 9 student apartments ready for the university term start next month. The office has been designed to provide a more informal space with relaxed reception, a café-style work zone, which you can see in the image on the top left and a roof terrace. The office is currently valued at GBP 7 million, which equates to a profit on cost of 21%. Atelier Victoires in Central Paris is nearing completion providing 21,500 square feet of the office space, including a landscaped roof terrace overlooking the Paris skyline with views of the Eiffel Tower. And half-year valuation was EUR 29.8 million, which equates to a profit on cost of 39%. Terms are agreed for a pre-left of the whole building. And at Quayside in Fulham, the bottom left image. Agents are instructed on a full marketing campaign to sell this residential development opportunity are about to be launched. And finally, our last slide providing a bit more detail on some of the medium-term development opportunities. We're progressing designs and looking to secure planning consents on the following 3 sites in the next 12 to 18 months with potential construction starts in 2020. Maidenhead, we have an existing building of circa 10,000 square feet with an ERV of GBP 250,000 per annum. The June '18 valuation was GBP 2.8 million. And we believe there's an opportunity to create a 60,000 square-foot office with an ERV of circa GBP 2.3 million (sic) [ GBP 2.4 million ] per annum. At Vauxhall Walk adjacent to Spring Mews, the existing buildings have an ERV of GBP 90,000 per annum. The June valuation was GBP 1.7 million and there, we think, is an opportunity to create either an extension to our existing hotel or a new office of 15,000 square feet, with an ERV of circa GBP 750,000 per annum. And finally, at Vor dem Lauch in Stuttgart. The existing building is 93,500 square feet. The ERV is EUR 1.1 million per annum. The June valuation was EUR 13.6 million and the opportunity here is to increase this to circa 150,000 square feet with the potential ERV of EUR 3 million per annum. So combined, an opportunity to convert the existing income of GBP 1.35 million into circa GBP 5.7 million per annum during 2020 to 2022. Designs and build costs are being investigated, but importantly, and remember that we already own these assets and they currently generate some revenue. With that, I'll hand you back to Fredrik.

[Fredrik Widlund, CEO & Director]

Thank you, Simon. If you all flip to Page 24. On this slide, I would like to give you an update on our markets. So starting with the U.K. We are seeing a wait-and-see approach as investors and property owners awaits more clarity on Brexit, and this has led to a somewhat subdued market. In addition, the shorter term economic fundamentals seem to have taken a dip recently, even if unemployment and the longer term prospect remains stable. On the positive note, we did see a pickup in leasing activity in the latter part of H1 and market performance also seemed to indicate that investment activity and take up in the Greater London area is improving. In the U.K., we're also continuing to benefit from structural changes in the Southeast with residential conversions and secondary offices. So overall, in the U.K, we are continuing to reposition the portfolio for long-term income growth. In Germany, the fundamentals continue to look strong and despite some geopolitical noise around trade, this is still more fear than reality. Vacancy levels in the major German cities are all dropping and this is driving rental growth. ERVs in our entire portfolio were up 1.3% in the last 6 month and we expect this to accelerate going forward. We have found it more challenging to secure new acquisitions, but we will not compromise on our investment criteria whether it is targeting the right yields, we'll do a less thorough due diligence process. And as Simon says, we are looking. Overall, Germany remains one of our key markets for growth together with the Southeast of the U.K. The French market has seen increased investor confidence on the back of improving economic indicators. This is still a market dominated by local investors and our focus here is to maximize the value from our existing portfolio. As illustrated by vacancy that is now down to 3.5% in the French portfolio, whilst selectively looking for new acquisitions. Finally, on Page 25 to summarize the first half of 2018. The operational delivery was strong and we delivered another set of results with increases in both EPRA and net asset value and earnings per share. The changes in occupation markets are accelerating and we are responding well to the changing nature of offices by working even closer with our customers on new designs and customer surveys to meet their needs. We are continuing to reposition the portfolio towards higher growth and income-producing properties and our existing portfolio has some good opportunities for improvement, both from refurbishment and development, but also by reducing vacancy further. We have exposure in the 3 largest economies in Europe and are well positioned to continue to deliver earnings growth and subsequent long-term shareholder value. With that, I'd like to conclude today's presentation. Thank you all for attending, and open up for questions.

[David Thomas Brockton, Research Analyst]

David Brockton from Liberum. I've got few, actually, if I may. Firstly, on Germany, you've been active on a couple of assets there. I'm just wondering if you can talk whether you feel that market is overheating now in respect to the competition. Or whether you still think you'll be able to find suitably attractive assets in the current environment? That's the first, and maybe I'll do them individually.

[John H. Whiteley, CFO & Director]

Yes, I mean -- this is John. The German is seen as very attractive by a number of players. So we're not the only people investing in Germany and competition has increased. That's absolutely truth. I'm not really sure I expect much more yield compression in Germany. So future growth is more likely to come from -- and valuation increases from rental growth in the market. It's a big market. It's very deep and I still believe there are opportunities for us to continue to grow in Germany. But as I said before, we will not compromise. So if we don't find the right things, we will wait. But as you know, there's always another deal coming. So yes, competition has increased, but -- so that's where intensity in terms of finding new things.

[David Thomas Brockton, Research Analyst]

Okay. And the second one relates to France. You talk about sort of strengthening the investor sentiment yet I think the yields moved out a bit there, and I just wonder if you could help me understand, I guess, what were the pieces there?

[John H. Whiteley, CFO & Director]

Well, if you talk about Paris, let's go down to deals and rents in Central Paris. The CBD side it's moving yields down, rents up. It is still spread a bit further out, but we have our properties in the French capital, but it is likely to happen as it normally does when some tenants are pushed out of the more central areas.

[David Thomas Brockton, Research Analyst]

Okay, that's clear. And then the final question was just on the corporate bond portfolio. I see there's been a slight negative total return in the period, in particular, you've reduced the sort of scale a bit. Can just talk about your sort of thought process in terms of managing that going forward? Did you reduce the size of it in relation to what we've seen, I guess, in terms of U.S. rates and maybe just elaborate a bit more on it, please?

[Simon L. Wigzell, Head of Group Property]

We reduced the size of it because we knew we were going to use the cash to redeem the retail bond. We still think it is a sensible way of getting a decent income out of our liquid resources and it is at a level which is commensurate with the total liquid resources that we have. Where it will go from here, really depends on how much we will spend for disposal proceeds going forward.

[David Thomas Brockton, Research Analyst]

A few questions again from me. Just on the peripheral disposals you may post on the end of June. What are the yield on those?

[Fredrik Widlund, CEO & Director]

It will have been similar to the ones we've sold before. I mean, it's the same type of assets that we have identified. It's more a question if they fall in the second or the third quarter, but we've -- it will be the same level as the previous ones, but we don't have that number.

[David Thomas Brockton, Research Analyst]

On Germany, on the vacancy levels, metropolis, I think, had an 11% yield at the end of the year, vacancies in particular. Given the sort of strength of the market, is this -- I mean, how is -- how is letting progress going? There are some as good results on these extensions. The vacancy levels are sort of the same. I was wondering...

[John H. Whiteley, CFO & Director]

Yes, I think the condition of that portfolio report, I think had been very badly managed prior to our ownership and I think it has taken the team a lot of hard work to sort of get hold of it properly and understand what we've got there, and a lot of marketing campaigns take a long time to launch and prepare and I think it was evident that they were really needed given the state of it. So it's just -- it's taken a few months longer perhaps to get it in the position we want. But I think we're in very good shape now and we will see those vacancies falling down in that portfolio.

[Unknown Executive]

Maybe to add to that, just that the intention of the plan was always to take down the vacancy by the end of the year, and we haven't changed that intention or target and it will fall. And as I said earlier on as well, we have a very encouraging pipeline of letting inquiries. So we would expect that to have fallen by the end of this year.

[David Thomas Brockton, Research Analyst]

German vacancies, at the beginning of the year was 7.1% and it was 7.1% at the end of 6 months.

[Fredrik Widlund, CEO & Director]

Actually, the vacancies have come down, but we've sold a fully let asset. So it's a smaller -- but it's the same percentage of a slightly smaller offer.

[David Thomas Brockton, Research Analyst]

Slightly smaller? GBP 6 million, GBP 6 million. And a slightly technical question. I don't know if this is the right forum to ask it, but in terms of interest cost, there's a big exchange rate movement, which I couldn't quite get my head around. So on finance cost there's a GBP 4.4 million extra cost from foreign exchange, as I thought most of the currencies didn't...

[John H. Whiteley, CFO & Director]

That's the effect of translating that monetary asset into sterling at the balance sheet date.

[David Thomas Brockton, Research Analyst]

From?

[John H. Whiteley, CFO & Director]

From euros.

[David Thomas Brockton, Research Analyst]

Right.

[John H. Whiteley, CFO & Director]

Predominantly.

[David Thomas Brockton, Research Analyst]

Okay. I'll have to get my head around that, but thanks.

[Kieran Lee, Analyst]

Kieran Lee from Berenberg. If we look into the German market, there's been a lot of pressure and a lot of other sorts of German companies commenting about change of use office to residential and the heat in that market. Is there any scope for that amongst your German portfolio?

[Fredrik Widlund, CEO & Director]

Yes, I mean, the location of our German assets are similar to what we have in the Greater London area and we have seen exactly that happening, as you know, in the Southeast of the U.K. We've seen less of that in Germany so far, but it wouldn't surprise me at all if we start seeing acceleration of that even in the German market because there is a lack of residential properties in the big German cities.

[John H. Whiteley, CFO & Director]

Sorry, Robin, it just occurred to me. On that 4.4, about 3.8 was kroner because of the 10% holding in for tenor.

[Fredrik Widlund, CEO & Director]

Right. That's a big chunk of it. Okay, being no further questions, thank you all, again, for attending.

[John H. Whiteley, CFO & Director]

Thank you.