Picton Property Income Ltd

LSE:PCTN

Earnings Call Analysis

Earnings Call Transcript 2023-Q2

[Operator]

Good afternoon, and welcome to the Pitcoin Property Income Limited Half Year Results Investor Presentation. [Operator Instructions] And I'd now like to hand over to Michael morris, CEO. Good afternoon, sir.

[Michael Morris, executive]

Thank you. So thank you, everyone, for dialing in. This is a short update following the release of our half year results this morning. And I'm going to just explain a little bit about Pitcoin, more generally about the market, what's been happening in the last 6 months, that's really relevant to kind of our underlying performance, which I'll talk about next. Then I'll talk about financial performance and indeed performance at a property level, give some thoughts on an outlook and there's an opportunity as has just been said for Q&A at the end.

So just turning the slides. For those that don't know picture and on to the next page, sorry and the next one. Those that don't know Pitcoin, we're a diversified U.K. REIT. We own a GBP 850 million commercial property portfolio diversified across the U.K. We've got net assets of just over GBP 600-plus million and a market cap of just under GBP 500 million. Borrowings, I'll talk about later, but very conservative in the way we use debt. And for us, owning real estate is about delivering a service for our occupiers and also in terms of our investors and other stakeholders delivering for them as well. And these slides will be on our website and there's more details about our strategy, et cetera, included in the appendices.

On the next slide is just a summary of our portfolio. So 58% in industrial warehouse logistics, 1/3 nearly in the office sector and 10% in retail measure. We're currently running at about 90% occupancy. So that's something that will drive income growth going forward. And again, this point about nearly 50 assets, nearly 400 occupiers. So a very diverse underlying cash flow from this multiple of occupiers. I think our largest occupier is less than 4% by value of our rent roll that underpins the business.

The next slide, just briefly talks to sustainability. And there's a very big piece here on ESG, very important to us. But I think sustainability for real estate is really important occupiers are increasingly asking about the sustainability credentials of buildings I think it's even more relevant in the last year as we've seen rising energy costs, people want to be inefficient buildings. And we set out a very clear pathway at the start of the year that we're starting now to implement on the portfolio to decarbonize it and improve energy efficiency. And 2 things I just mentioned about that, certainly, in this last 6-month period, our own investment committee has been signing off transactions in terms of putting solar installations on buildings, particularly on warehouse buildings with large routes. So where we are refurbishing buildings ahead of leasing. That's something we're looking at.

And literally, within the last few days, i.e., earlier this month, we appointed a head of Building [indiscernible] not only to look at sustainability, but more widely some of the refurbishment upgrading projects we've got going on in the portfolio. So I'm not going to say any more on that, but this is a key part of what we're doing now in terms of future proofing our assets. And again, on our website is our 2022 sustainability report if anyone wants to read about that in more detail.

So the next few slides now about the market. And just in terms of some headlines overall, I mean, I think we all know the sort of turmoil that's been happening, political turmoil at Westminster, we've seen rising gilt yields, swap rates. Base rates have gone up considerably since the start of the summer, and that has affected the property market. And the chart on that page just shows you in July, August and September, the market as a whole recorded downward valuations, downward pricing. And this is actually [indiscernible] valuations were 30th of September, and that was 6 or 7 days after the mini budget.

So the full impact and I think is felt in these numbers and this is, as I said, the marked change in views on risk-free rates and financing costs. and it's not strictly a one sector thing. All sectors are seeing and subject to this rising yield movement. And I think what I've put as a bottom point here is that in between sort of June and September, yield movements were maybe 25 to 50 basis points, but we do think that there's more to come. This isn't just a small blip. There is a price correction that's happening. That's one of the reasons why Pitcoin shares and indeed the wider real estate sector is trading on quite marked discounts to net asset value. And we've put some thought in the maybe another 25 to 75 basis points coming in the next few months as that sort of chaos of September works its way through the system.

If we look at each sector in turn. So on the next page, we've got the industrial sector and really interestingly, I think, positive rental growth from the industrial sector every month this year. Demand is good. Supply is limited the way instruction costs development finance are going, that's relatively tight supply, we think, and rental value growth in that sector year-to-date, just under 9%, I mean, that's, to my mind, inflation, keeping up with inflation levels of rental growth. But the counterargument to that is what happened on the capital side. You can see that in the bottom chart, is that actually values in this sector have declined more this year, erode more at the start of the year, but as this correction has come in, they've declined more than the other 2 sectors. And that principally reflects that the yields were lower in the first place. So it's a lower starting point and that yield movement has a bigger impact.

So there's a pricing correction going on, but the underlying fundamentals in terms of occupational demand, supply remain healthy. If we turn the page and look at offices, same scale. So you can see a far more lackluster rental growth story. In part still driven through the kind of hangover of sort of post COVID or during COVID working patterns. I genuinely think things like a train strike, tube strikes, et cetera, don't help with getting people back into the office. We are seeing good demand for the best space, the space that's got good sustainability credentials. So that goes back to my point at the beginning about it's important to office space that meets that and what occupiers want and also flexible space. And for those that know Pitcoin better, we introduced something called swift space earlier in the year that's aimed at meeting some of that demand.

Office values haven't corrected to the same extent as industrial in part coming off a higher base yield in the first place and seeing perhaps less growth at the start of the year. And if we turn to retail, it's a not dissimilar story. Really values in our mind of broadly stabilizing. There is a huge correction. These charts don't show, but a huge correction in pricing in the retail sector during the course of COVID, we think that broadly run its course. Occupational demand is there for the right units, the right towns, but it is patchy. So I think you have to proceed with caution and limited growth, but limited growth in the retail sector is arguably the best it's been for the last few years. So I think that sets of stability on the occupational side is certainly something that one can be positive about.

And again, there was a bit of a recovery coming through at the start of the year. The fee in that post-pandemic, there was more normality coming back. But the sort of sting in the tail has been these rising yields and that's just crept into valuation movements July, August, September. So that's the market that we've been operating in. If I look at our specific results for the 6-month period, so the headline is a decrease in our net assets of just over 3% to 117p per share. Our EPRA earnings, which is the kind of income profit, ignoring valuation gains or losses was at GBP 10.7 million, and that compares to GBP 10.9 million last year, so relatively stable. But the valuation movement on the portfolio led to a loss of GBP 10 million over the period. Our total return was minus [ 1.7% ]. Our dividend cover was at 112%. So earnings fully kept up and covered the distributions and the distributions for this period were 6% higher than a year ago.

And if we turn the page and just look at the income statement, coming next page. This just shows the higher rental income over the period, slightly higher property costs, financing costs, and this, I suppose, is some of the inflationary pressures that we're seeing on the cost base coming through. We refinanced some debt at the start of the year, moving a floating rate across to fix longer-term debt, and I'll talk about that in a minute, so reasonably well insulated, I would say, the P&L is from rising costs.

On the balance sheet on Page 16, that shows our income profit flowing through the valuation movement and the dividends paid of GBP 9.5 million versus our income profit of GBP 10.7 million. So again, relatively straightforward, relatively simple to understand on Page 17 -- oh sorry, the next page, just our capital structure. I think it's really important to reemphasize this. Firstly, Pitcoin's got relatively low gearing at 24%. 95% of the borrowings that we have drawn are fixed rate, so aren't subject to rising interest rates with the changing base rate environment that we're in. And not only are they fixed, but the maturity profile of that debt is just under 9 years. So we are very well insulated from rising financing costs. And I wouldn't underestimate how significant that is. In fact, the fair value of our drawn debt is GBP 191 million versus the GBP 225 million that is actually drawn. So you can see there the market value of the current debt structure that we have in the business.

So if we just turn to the portfolio and what's been happening at a property level, so noddling the valuation movement, which I'll talk about and explain it in a little bit, actually, there's been some good activity in the portfolio in the last 6 months. The passing rent increased by 3%. The rental value of the portfolio increased by 5%, predominantly driven by our industrial assets. The lease renewals the rent reviews, the lettings that we agreed were all above or in line ahead of our GRVs. And actually, going back to the point I made earlier, a number of those lettings have been more flexible lettings across our smaller suites. So meeting that more flexible demand that in the marketplace.

And then we've invested just over GBP 2 million into the portfolio to upgrade assets. So that ties in with just generally upgrading them or lease expiring to get the best wins to attract the best occupiers, but at the same time, putting in energy efficiency measures in terms of lighting heating, et cetera. And on the right there, our total property return, so this is ungeared, was minus 0.2%. MSCI, which is the real estate benchmark, the quarterly benchmark for that period was minus 1.3%. So some comfort that relative outperformance is coming through still. Property valuation occupancy are on the next couple of slides.

So let me talk you through those. So on page -- on this page, rather, the top chart shows the valuation movements in our portfolio over the first 3 months of the financial year, so March to June. And actually, we saw rising values in all sectors, driven actually by retail, but industrial, still at that point was doing well. offices less so. But there was growth in all sectors. And when we reported to the market in June, we did state at that time that we could see some downward pressure on values, particularly on very low-yielding industrial assets. And that was actually already we started to correct pricing on some of those assets as we could see the market changing.

But the 3 months to September were [ markedly ] different, and that covers this period of changing government budgets, not budgets, et cetera, et cetera. So in that period, industrial values declined the most overall our portfolio declined 3.7%, retail and the offices. And again, this sort of diversified approach comes in here. This could have dare I say, been a lot worse. But there was leasing activity that we were doing in the portfolio that meant that we were able to mitigate some, albeit not all, some of these downward revisions. And I think it's important to recognize that whilst yields are moving out rental growth, extending income, some of those factors can offset some of this movement that's coming just through the benchmark yields rising.

In terms of occupancy and income, if we turn the page, we're running 90% occupancy at the minute, that equates to about GBP 5.4 million of upside. The majority of it coming through offices and the chart on the right shows you that between the offices in purple and sort of the lighter purple color that we're adopting a more flexible approach to leasing on than industrial and a very, very small component of our portfolio is vacant in the retail sector.

The breakdown on the bottom chart just shows actually quite a bit of that occupancy or vacancy rather, has come back in the last 12 months. In fact, half of it has come back in the last 9 months, which we're on-site, refurbishing 50% of our void is being refurbished as we speak. And there is always that lag between getting the space back, getting on site, refurbishing and remarketing. So we've got more void than we would like because everyone would like to be fully let. But actually, it's being worked through. It's a timing of events and it's about delivering, as I've said right from the beginning, good quality space that occupiers want.

In terms of properties that were acquired during the period, one was at the very beginning of the period and one was during the summer. The common themes with these are they're multi-let they've got retail and offices up above their low entry points from a capital value perspective. Both of these assets, they're slightly different characteristics because one has got more voice than the other, the one in London has more void. But both went fully leased yield between 8% and 9% and I'm not saying they're immune from what's going on in the market, but those are, to my mind, attractive yield profiles of rebased rents and where the underlying value is underpinned by residual value.

The one we bought in Hammersmith in May, we've completed our first swift pace letting there at least as is. We're going to upgrade some of the office suites in the building by the end of the year, and that's been instructed just to make them, I think, easier to lease more amenity space within them, and we're looking at alternative uses on an element of this building as well. In terms of Cheltenham, there's less asset management involved in this particular asset. But actually, we've got one retailer in there that we're probably going to replace with a national retailer, which not only improves the underlying tenant quality, but also will improve the rent roll a bit. But the yield profile of this asset in itself going to 9% through fixed uplifts, we think is quite an attractive entry point in the first place.

So nearly at the end, on the outlook slide, I'd split it into 2. So an element of the market and an element in relation to Pitcoin, I mean I think the real estate sector is repricing due to financing costs, bond yields, et cetera. But occupational markets to outline are more resilient and occupational demand is continuing, notwithstanding all the noise that's going on in the financial markets. We have to be realistic, though, that there's quite a lot of talk of recession. It's not going to be easy, definitely rising cost of living, higher mortgage costs, inflation on food and energy is going to hamper the economy probably toughest for retailers and discretionary spending as well. And that -- all of these factors are contributing to this sort of repricing that is bad for existing assets but positive in terms of buying opportunities.

In terms of our own business, reasonably well insulated. Our financing, as I've mentioned, provides real stability to the income line, which I think is really important. We've got a lot of headroom on our covenants the work that the team are doing around leasing and regearing has definitely offset, and I think we'll continue to offset some of the wider market declines. That's what's led to the outperformance over the 6 months. And also, we don't really own bonds bond-like assets. That's not to say that there isn't a degree of bond proxy pricing and property, but we've not tended to own or wanted to own those assets that are very aggressively priced relative to bond yields because they're the ones that, in my view, are going to experience the sharpest declines looking forward.

I've spoken about occupancy and income upside. And just to end on the positive my point being about things that you can do to offset. We've got a pipeline of around GBP 1 million worth of leasing transactions in lawyers hands at the minute, so they're not signed, but they are agreed and we're working through. And that, to me, just reinforces and hopefully shows to you listening that there is occupational demand, and that's something that I think is really key in this current climate offsetting some of that yield movement. So I'm going to end there and very happily to take questions.

[Operator]

[Operator Instructions] But just before Michael takes a few moment to review those questions submitted today. I'd like to remind you the recording of this presentation, along with a copy of the slides and the published Q&A can be accessed via your Investor dashboard. As you can see, we received a number of questions throughout today's presentation, Michael, if I could just ask you to read out those questions and give response, so it's appropriate to do so. I'll pick up from you at the end.

[Michael Morris, executive]

Yes. So let me try and go through these. The first question just says with rising interest rates and have you seen this impact? And have you seen this impact prices enough to start using the revolving credit facility in the near future. It has impacted pricing. I suppose the key question is here, is it enough? I think we are quite keen to just see what the budget holds and the environment around that, the way financing rates have been on in the last few weeks has sort of just led us to be a bit more cautious on sort of jumping in using the revolving credit facility at the first time we're seeing values move down. So I suspect we will use it but I think we're not going to sort of just jump in at the first opportunity, if that makes sense. So that's the first question.

So someone's asked about the utilization of office space. And I think the question is not strictly occupancy as we would think of it in terms of picture. It's like, well, what are your occupiers doing, how much of their space is in turn being used and, therefore, what that might mean for the office market. I mean I think I would broadly say and a lot seems to happen in a year, really. But if we look back a year ago, from now, I think there were just the starting signs of Omicron and us going back into a place where we are being told by government, if I've got this correct to work from home again and no longer work in the office. I'm sure that was sort of Christmas last year. Since then, the general trend has been for more and more people to my mind, to work in the office, not necessarily 5 days a week, but that trend has only been upwards.

What we see in our portfolio is different businesses are taking very different approaches, so some almost expect everyone in 5 days a week at one extreme. The other extreme is will come in [indiscernible] one or come in a couple of days a week. But I think the majority of people are working in our offices, 3, maybe 4 days a week in the office. But I suppose from a utilization perspective, if it's 3 days of a week in the office, then that's only 60% utilization whether it was ever 100% pre-pandemic, I'm not sure because I don't think everyone worked in the office necessarily every day at the week either. But generally, the trend is upwards. And I think as it gets a bit trickier, I would be surprised if there's a few more people wanting to be in the office. Generally, the biggest challenge, I think, at the minute is, is there a came strike today? Is there a tube strike? Or what -- and those are the reasons that are disrupting people again from being in the office. But I think that the sort of a more normal position is happening now. You have maybe 60% to 70% is standard utilization across our portfolio, I would say. So that's the next question.

And then I've got another question that actually looks like a lot of questions. So let me just try and work through these. Someone asked that our valuations at a property level are holding up better than the market and what's driving this. And I think the key to what's driving this is in part the type of property that we own. I've said, I think that we don't tend to own bond proxy type assets. So those are subtly less sensitive to what's been going on in the market.

Secondly, I think as I said, we were keen to make sure our assets were sort of correctly priced throughout this year as indeed at all times, but particularly we started to move industrial values out early. So maybe to some extent, we didn't capture the very high, but that means that we've not quite got so far to move the other way.

Thirdly, this point about active management and leasing activity offsetting value declines because yield movement is just one driver and rental income or indeed rental value is another driver of value. And what we've had success with particularly this year has been leasing buildings, regearing leases, setting rents considerably above our independent value as estimates. And by achieving those rents, that kind of offset some of those valuation movements. Someone said, well, we've got industrial exposure, which is the part of the market that performed the best over the last 4 or 5 years that has performed less well over the last 6 months, but we've still outperformed what's being missed. And I suppose that's this point that, it's less about sector, it's more about assets. And the things I just described in the first question, I think, tie into the answer for that one. If that's okay.

There's a question about growing the business consolidation in your -- in the sector. I think those comments completely stand today and probably even more relevant in a market where cost bases are under pressure, discounts are wider than perhaps they should be. I genuinely believe that the sector per se would benefit from consolidation. But it has to be done at the right time at the right price. And I think the events of the last 6 or 9 months show that our perhaps prudent approach. Some people might say, it's a lack of action or Pitcoin, you've talked about it, but you haven't done anything. I would sort of suggest the other way that actually being prudent over the last 6 months, has been or 9 months whenever 12 months has been the right thing to do, recognizing the way the market has moved, but my broad thesis that as a marketplace, larger, more liquid, more efficient vehicles wouldn't be a good thing, hasn't changed.

There's another question there that relates to that around M&A. And I suppose that I would refer to the previous answer. And someone's also asked about rent collection rates. Yes, our rent collection is back at pre-pandemic levels. We're not seeing any issues with occupiers currently. I don't think there's any specific sectors that we could draw out in the same way as you could in the pandemic around retail and leisure that were particularly hit hard, but this is very different to them. Businesses are able to trade to operate not saying it's easy, and there are challenges, but that's very different to being told you can't operate, which caused the key issues around rent collection back in the pandemic. So we have a very good view on rent collection borne out by what we're seeing in the portfolio.

[Operator]

Michael, I think you've actually addressed all those questions from investors. And of course, the company will review all the questions from me today, and will publish those responses on the Investor meet company platform. But just before we direct investors to provide you with their feedback, which knows particularly important to you and the company. Could I just ask you for a few closing comments?

[Michael Morris, executive]

Yes, of course. So firstly, it's to thank everyone for dialing in and listening and asking questions of the company. We value your feedback, as has been said. So yes, to fill in the poll at the end and any feedback would be well received. And we look forward to updating you all of this is on our website. And yes, look forward to updating you in the coming months.

[Operator]

Michael, thanks once again for updating investors today. Could I please ask investors not to close the session as you now be automatically redirected to provide dual feedback in order that the management team can better understand your views and expectations. This [indiscernible] take a few ones complete, but I'm sure will be greatly valued by the company. On behalf of the management team of Pitcoin Property Income Limited, would like to thank you for attending today's presentation and good afternoon to you all.