MERLIN Properties SOCIMI SA

MAD:MRL

Earnings Call Transcript 2021-Q1

[Operator]

Good day, and thank you for standing by. Welcome to the MERLIN Properties 3 Months 2021 Results Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. [Operator Instructions] I would now like to hand the conference over to your first speaker today, Inés Arellano. Please go ahead.

[Inés Arellano, Director]

Thank you very much. Dear ladies and gentlemen, welcome, and thank you for joining MERLIN's First Quarter 2021 Trading Update. We remind you that on quarterly results, there's no presentation available, but only executive summary. Today, Ismael Clemente, our CEO, will do a 10-minute update, and then we will open the lines for Q&A. With no further delay, I'll pass the floor to Ismael. Thank you.

[Ismael Clemente Orrego, CEO & Executive Vice]

Thank you, Inés. Welcome to MERLIN's First Quarter 2021 Results Call. The months of January, February and March have been a tough period for business in Spain, at least for our business in Spain. But as I was reading this morning in a Kepler Cheuvreux research report, nobody said it would be easy. I mean we warned the market and the investors at the end of 2020 that we expected it to happen simply because basically, our sector of activity, real estate, lags the real economy by 1 or 2 quarters. And what happened at the end of 2020 has reflected in the beginning of 2021. That means we expect an equally difficult second quarter, slightly better, particularly from an optical standpoint, because in the first quarter, you compare year-on-year against mostly undisturbed first quarter in 2020, whereas in the second quarter, we will compare with an already disturbed second quarter of 2020. So figures will look optically better. But in real terms, it will also be a tough quarter. Of course, occupancy erosion will be much smaller, but it will continue to be a tough business environment. This has a reason, which is that Spain is trailing behind other countries in terms of vaccination. We are, as we speak, at 14% of the total population, and we do not foresee to reach herd immunity until at least end of September, October, despite the more optimistic forecast, which are being released by public officials. Then third quarter, we expect to be flatter, and the sunshine should be seen again towards the fourth quarter, I mean, in response to a better sanitary management of the crisis towards the end of the year. However, despite this challenging environment, the cash flow of the company has performed basically as expected. In fact, as informed to our Board of Directors, we are running slightly ahead of budget in the first quarter and perfectly on track to beat our cash flow forecast for the whole year, because we expect marginal improvement towards the fourth quarter, plus we expect also some additional rents to the income as a consequence of the entry into operation of work in progress. In terms of consolidated performance, the gross rents of the company fell 2.9% like-for-like on a year-on-year basis. The FFO diminished by 15.3%, and net tangible assets, although no revaluation was carried out during the period, stood at plus 0.3%. The business performance, as I foresaid, was heavily impacted by further mandatory closures decided by both central, autonomous, municipal, and you name it, authorities in different cities. And some tenants are starting to be heavily affected by now, especially in shopping centers. Many of them may drown before they reach the shore, which is now on sight, that eventually, they may lack the forces to simply continue swimming till they reach the shore. However, as commented in our quarterly report, we are seeing a very interesting pace of retenanting in the shopping centers and asset managers are finding slightly easier than expected to replace the tenants that we exit.The rent release in the period amount to EUR 11.6 million, on track to comply with the EUR 19.6 million that we announced for the first semester, because the level of helps provided to tenants in the second quarter will be lower as a consequence of a more widespread normal trading in Spain, except in Catalonia, where trading continues to be heavily restricted and not Spain, but Iberian Peninsula and Lisbon, where also trading is heavily restricted. And in many cases, the scheduled restrictions to shopping centers are taken to closing the shopping center because in the absence of certainty about what time people can go to shopping center, they simply do not go. FFO per share of EUR 0.135 represents, as commented, a 15.3% decline compared to the 3 months of 2020. But as commented as well, this was mostly undisturbed period. The cash flow is on track to meet the guidance, as commented as well, with additional rents from the WIP to be taken into account for the rest of the year, which will be in the region of EUR 14 million in total, which is approximately EUR 0.03 per share. Just in this quarter, the WIP delivered amounted to 135,000 square meters with EUR 5.3 million of incremental rents in the year. And as commented as well, no revaluation in the period. The NTA stands at EUR 15.50. As for the different lines of businesses, in offices, we contracted 70,000 square meters with a negative like-for-like of minus 2.9% and a release spread of plus 2.8%, mainly explained by the fact that our passing rents are trailing market rents. We have commented in many occasions that there is a gap, there is a cushion between the company's passing rents and market rents, which at the end of 2020 was estimated by the appraisers to be 12%. So we are picking up on that gap. And as a consequence, we have a positive release spread. We suffered negative indexation of minus 0.6% on average in offices in the first quarter, although we are seeing inflation quickly picking up in Spain and European Union and Portugal as well. So we believe that we will recapture part of this during the rest of the year in the renewals of contracts.In logistics, we contracted 144,000 square meters with a like-for-like of 0.8% and a release spread of 2.9%. In this case, a consequence of the strength of the market because indexation was also negative at minus 0.6% for logistics. In shopping centers, we relet 7,600 square meters with a negative like-for-like of 2.9% because we lost occupancy, but a positive release spread of 5.5% despite negative indexation of 0.5% in shopping centers. I mean, frankly speaking, this plus 5.5% in release spread has surprised us. It has been mainly concentrated in shopping centers, which have been recently refurbished. So people clearly seems to be betting on those. And well, that pleases us because they are also showing significant resilience in the current circumstances.So with no further delay, we can move into the Q&A. At your disposal, the whole team here for your questions. Thanks a lot.

[Inés Arellano, Director]

Operator, could you please open the line for Q&A? Thank you.

[Operator]

[Operator Instructions] The first question comes from line of Pedro Alves from Banco.

[Pedro Jorge Gouveia Alves, Non]

I have 2, please. The first one regards to the reports of a persistent increase of vacancy in pretty much every submarket of Madrid. I know you had correctly flagged this trend in your previous communications to the market. I just wanted to know how confident you are that in the second half of this year, occupancy can start recovering because according to some press sources, there are apparently some cases in which companies reduced significantly, in some cases, 50% their office space need. So based on the conversations you are having with tenants, are you still seeing a strong winter for occupier demand? And second question related to this. Your expectation for rental prices considering this pressure in occupancy. And I also appreciate your comment on the incentives because in that incentive as a percentage of your gross rental income increased from previous quarters.

[Ismael Clemente Orrego, CEO & Executive Vice]

Okay. Well, Pedro, regarding vacancy, our forecast for the whole year continues to be between 1.5% and 2% loss of occupancy as compared to 2020 or where we finished 2020. Clearly, we are operating under no hopes of a very significant recovery towards the end of the year, simply because we won't be on time. I mean most of the effects of the recovery will only be felt in 2022. So towards the end of the year, we might pick up a little bit. In fact, we believe we will pick up a little bit in occupancy. Very important data for you. This year, we had 15% office contracts up for renewal, of which 13% fell in the first semester and 2% in the second semester. Out of the 13% that fell in the first semester, 8% fell in the first quarter and 5% in the second quarter. So the visibility, as you can imagine, from that 13% is extremely high right now. So we have either gone through the renewal or know how the renewal will look like because it will happen before the 30th of June. And of course, the situation is tough. Companies are destroying employment, particularly in 2020, the destruction of employment in Spain was very, very significant. And I know many people is not linking one thing to the other, but it's very simple. I mean when Spain is creating employment, 80% of those employments are blue collar going to factories, 20% are white collar and appear in carpeted areas. And those carpeted areas, some of them are ours. So of course, every time you see in the headlines employment being created, occupancy trends up. And when employment goes down, occupancy trends down, particularly in a portfolio like ours, which is heavily exposed to industrial companies, companies which are heavy on workforce. I mean, of course, in all the CBD portfolio, which is full of law firms and consulting firms and investment banks, that's all okay. But in the real world, in the new business areas and in the periphery where you have industrial companies, you are extremely sensitive always to employment destruction. So we -- I mean, we are under no delusion that there will be any miracle during 2021. 2021, as commented last year, was really -- was going to be a tough year. Although we know that towards the end, there will be time for us to start recovering part of the occupancy loss and picking up a little bit on our office activity.Regarding rents, well, you have seen the underlying trend. I mean we continue enjoying a significant gap between passing rents and market rents. That gap provides us with a very significant cushion security. So no matter there is pressure on occupancy. The pressure on occupancy, as you correctly pointed out, normally translates with a certain lag into pressure in rents. But first, you need to wipe out completely the difference -- the delta between passing and market, and this hasn't happened yet. I mean as of end of 2021, we will see what is the appraisal, and what the appraisers say in terms of what is the new delta between passing and market that as it stands today in the region of 12%, we normally pick up on the contracts we renewed. It's very simple. It's real estate. Of course, I know people is super focused on the headlines and on the TV news, but this is real estate. Incentives are growing a little bit, yes. We had like EUR 3-point-something million last year, and we have like EUR 5-point-something million this year. But this is, I would say, normal commensurate with what is happening in the market. As you know, our practice is normally not to linearize the incentives given to tenants. So yes, we will need to resort a little bit more to incentives. But even in the toughest moment of the past cycle, we really see a lot of leakage between gross and net in MERLIN. We have our instructions to asset managers. Asset managers abide by the instructions, and they are obliged to provide us rents measured as net rents. So that we avoid that they play with the facial rent as compared to the true net rent. That transpires through all the company. And as a consequence, we are a company where leakage normally is small. And in this market environment, of course, incentives have grown a little bit. I hope this answers your question, but anyway, happy if you have further questions.

[Operator]

The next question comes from the line of Marie Dormeuil.

[Marie Amelie Charlotte Dormeuil, Research Analyst]

I have 2 questions on my side, which, again, relates to the vacancy in the office portfolio. So I wanted to know if you could give us a sense if the vacancy is just on a few buildings or is it actually widespread across your portfolio. And then another question is, in order to reverse potentially this vacancy uptick, would you be able to actually further have more negative reversion? Or is just -- as you suggest, maybe there is no demand because all your occupiers are just cutting jobs and thereby, there's just no demand for the office space? And then just -- sorry. And just another one, just to put it out is the tough office fundamentals on the operational side, how does it translate into the investment markets?

[Ismael Clemente Orrego, CEO & Executive Vice]

Okay. Fantastic. Sorry, if I understand well your second question, basically, you mean whether in order to revert the vacancy, we could simply lower prices and take a bigger dent on the delta between passing and market?

[Marie Amelie Charlotte Dormeuil, Research Analyst]

Yes.

[Ismael Clemente Orrego, CEO & Executive Vice]

Look, I don't think it will make a big difference because today, we are living a period of simply weak demand, and there is very little you can do about it other than wait, I mean, which is always something you can do. We are in the middle of economic recession caused by the pandemic. The pandemic is little by little receding, and we are witnessing what is happening in other countries, which are far more advanced than Spain is in terms of vaccination and attainment of herd immunity, and what we are seeing is very encouraging. I mean I have been recently reading reports on what is happening in Tel Aviv, in New York. And this morning, I was reading about London also being quite interested in terms of demand. So we need to wait a little bit. Spain, as you know, is a very cheap country. I mean in the CBRE Index of most expensive office markets in the world, I think it ranks 56th, Madrid, on par with Bristol. So there is very little you can do rent wise, and we need to wait and see what happens. I mean if we lose some income in office or we have some erosion in our cash flow stemming from the office and the performance, so be it. I mean, we will live with it. Thanks God we are a highly diversified company, and we will withstand that negative. In terms of the vacancy, well, the vacancy, at least, the structural part of the vacancy, which is easily 8 points in this company, remains concentrated in a few buildings in an area which has been suffering from very significant problems with traffic jams, which is one corridor in the past and that creates some negative buzz in the market regarding the hard-core. The works for the new communications in the north of Madrid have already started and are slated to be finished by October 2022. So little by little with the redevelopment of the north of Madrid through the Operación Chamartín, that area will be regaining strength in the future. So for now, we need to wait. Very interesting, the excess vacancy that we have suffered in the first quarter. So not those 8 points that we can call structural vacancy. But the excess vacancy that we have suffered in the quarter have been mainly imputable to the CBD in Madrid and a little bit also to the periphery, where we have had particularly the exits of a couple tech companies that went failed. And we have also suffered the reduction -- significant reduction in Spain in space of 2 call center operators in the periphery. So it's been anecdotically, this is what has happened. Maybe in the second quarter, everything is different. I mean we shouldn't always infer permanent behavior of market by just one quarter, as David Brush has commented many, many times in these kind of calls. I mean only the whole year will provide us with a better picture of what is happening. And of course, the longer the period, the more clearer the picture on what is happening in a given market. You also commented on the investment market. I am very sorry. So on investment market, the first quarter has been much blender than the first quarter last year, minus 60%, approximately EUR 1.5 billion in offices versus like EUR 3.6 billion last year. And in shopping centers, even worse, minus 85%. I mean almost anecdotical the amount of transactions happening in the market in the period. But the market remains reasonable. I mean, we are entertaining conversations with a number of investors regarding some [indiscernible]. And those conversations continue, and there is no panic in the market. It's simply that, of course, people is worried about the level of vaccination, people is worried about the level of economic activity, and people is worried about the economic management of the recovery from the crisis that the Spanish government may finally do. But other than that, the market remains solid. There are no rushed sales in the market, and things are happening as we would expect. So no problems in this side.

[Marie Amelie Charlotte Dormeuil, Research Analyst]

So you don't see a yield expansion happening real time?

[Ismael Clemente Orrego, CEO & Executive Vice]

I couldn't follow you, Marie. Can you repeat?

[Marie Amelie Charlotte Dormeuil, Research Analyst]

Sorry. You've not -- at least from transactions that have happened, you've not noticed yield expansion or significant change in the valuation?

[Ismael Clemente Orrego, CEO & Executive Vice]

Not at all. In fact, counterintuitively, as we commented in the '20 results call, we continue to see yields tightening a little bit, courtesy of the [indiscernible], of course, that yields continue tightening as we speak. It is [indiscernible] is paradoxical, and maybe it is also predicting future increases in value as a consequence of increased activity. We still do not know how things will recover when Spain starts to recover. It is also true that people is starting to take into account much bigger inflation in models. So that inflation, of course, is also putting some pressure on the prices because real estate is starting to be seen as an eventual protection from inflation.

[Operator]

The next question comes from line of Oliver Carruthers from Goldman Sachs.

[Oliver Carruthers, Research Analyst]

Two questions from me. Firstly, on your newly vacant office space, will you look to refurb any of it? Or do you expect to do straight relapse? That's the first question. And then the second point is, given that you don't expect Spain to reach herd immunity until kind of September at the earliest, should we expect a Phase 4 of your commercial rent relief policy, which I believe expires this June?

[Ismael Clemente Orrego, CEO & Executive Vice]

Okay. As for the first one, Oliver, the newly vacant space, the one that has been affected by vacancy in this quarter, especially, frankly speaking, no need for refurbishment. I mean it will be so easy for us to simply take them out of inventory and refer this is a very old trick that we don't intend to do it. As for the second, whether reaching late the herd immunity through September, October will mean exceeding our budgeted help to tenants in shopping centers, we do not expect that for one single reason. Of course, when we compare last 12 months trading till -- March '20 with last 12 months trailing till March '21, we are about in the worst picture possible of retail in Spain because the LTM trading in March '20 was the mostly undisturbed trading period except by 15 days in a 365-day period. However, the LTM till March '21 is 365 [cheeky] days of performance throughout the year. So of course, when we say minus 40% in footfall and sales, of course, we are comparing about the worst we can compare. However, just to give you a brighter picture of what is happening, if you start comparing the weeks of reopening or the month of reopening to the prior month, now that we are starting to reopen some of our shopping centers, you would see that approximately you are posting plus 80% in footfall and sales as compared to the previous period is very simple. I mean empty shopping centers versus full shopping center. So we are seeing a much better pattern of consumer behavior as the centers, little by little, reopen and come back to normality. So we simply expect a better period in the second quarter, except -- as I commented, except that country where restrictions continue to be very heavy, Catalonia, where restrictions are, frankly speaking, absurd and Lisbon where also restrictions are very, very heavy. The rest of the portfolio is now little by little going back to normality. So we expect a much lower level of incentives in the second quarter as compared to the first. So with the remainder of the EUR 8 million to the EUR 19.6 million we commented to market, I think we are safe.

[Oliver Carruthers, Research Analyst]

Okay. That's super clear. And we can follow up afterwards, if not, but do you have that 80% year-on-year comparison in terms of -- I don't know if it was footfall or sales, but do you have that on a 2-year stack basis versus, say, 2019?

[Ismael Clemente Orrego, CEO & Executive Vice]

Not here with me, but the IR will contact you and we'll share with you. I mean, for what is worth, internally, we track everything against '19 because otherwise, tracking to '20 is a rollercoaster because in '20 we have better period, worse period, it's very difficult to compare. We normally track to '19.

[Operator]

[Operator Instructions] The next question comes from the line of Fernando Abril from Alantra.

[Fernando Abril-Martorell]

Only one. So where do you expect to be footfall and tenant sales by the end of the year? I know, basically, it is quite low right now, but well, you are now starting to reopen some of your assets so you can get kind of feeling. And, of course, if there is -- you expect an outperformance of tenant sales versus footfall. I know that consumption is picking up quite fast.

[Ismael Clemente Orrego, CEO & Executive Vice]

Welcome, Fernando. It is difficult to predict a figure with a certain level of accuracy. But if I have to make a forecast, I believe we will be picking up from the minus 40% in to the minus 25% to 30% we are seeing now as compared to what was through '19. And we expect that by year-end, it will be clear to us what component of the drop in footfall and sales per square meter was rent-related and what component was simply related to the pandemic-driven increase in online. Only by then, we will know. You have heard us many times saying that we expect this number to be in the region of 20 -- minus 20%. But however, I have to admit that some of the trading of some of the shopping centers is now surprising. If I look at, for example, what Centro Oeste or Arturo Soria Plaza or even La Vital in Gandia or, of course, X-Madrid, X-Madrid is now wild, but if I look at those shopping centers and I see their performance, it might be lower than that minus 20%. It could be actually something between minus 5% or minus 10% for those, let's say, [ultra old] and ultra dominant, very dominant in their area of catchment shopping centers in the portfolio. Some others will, of course, suffer a little bit more.

[Fernando Abril-Martorell]

Sorry, Ismael, you mean by the end of the year?

[Ismael Clemente Orrego, CEO & Executive Vice]

Yes, because now we will be simply picking up. I mean, we are -- now we are reopening. People come to the shopping centers. They incur in venture spending, as you correctly pointed out, of course, sales exceed the footfall because people normally come to spend, not to wonder. And yes, I mean, we -- that will provoke a gradual recovery of shopping centers. It will not be completely at the beginning because people will take time to continue regaining confidence in that way of spending. But through year-end, we should have a much clearer picture of what is exactly -- I guess, is your point, what is exactly the degree of damage inflicted by growing online sales penetration in the total retail sales in Spain in the shopping center format.

[Fernando Abril-Martorell]

Yes, I was a bit more worried on when your tenants will stop burning cash. So they stop being problematic. But yes, okay. It will depend on the speed of the recovery, of course.

[Ismael Clemente Orrego, CEO & Executive Vice]

Fernando, regarding tenants, by year-end, I tell you that at the rhythm we are evicting, by year-end, most of the what we track as red line or zombie status in our portfolio will have been replaced. So because one of the few things which in Spain is fast is courts regarding commercial evictions. So -- and we are obtaining a super high rate of success. So we are evicting and retenanting. Of course, we are trailing behind a little bit in retenancy. So in the fourth quarter, we evicted 11,200 and retenanted 9,900. So we accumulated, let's say, 1,300. In this first quarter, we evicted like 8,000 and retenanted 7,000 and change. So we are accumulating a little, little lag, but it's surprising us on the positive side.

[Operator]

[Operator Instructions] The next question comes from line of Ignacio Martínez from Bestinver.

[Ignacio Martínez Esnaola, Analyst]

Just a quick one on my side. I would like to know how much are you going -- are you planning to invest to develop the data centers? And what deal are you expecting to achieve?

[Ismael Clemente Orrego, CEO & Executive Vice]

Ignacio, look, as commented in the end of the year results presentation, the basic numbers of our business plan regarding data centers is going to be -- are going to be relief to the market on the first half results presentation because as we are speaking, we are dispositioning a couple of buildings. We are now asking for the different licensing projects. We are elaborating the [anti-projectors] and projector [indiscernible]. We are also going through the costing and only when we have more visibility, of course, not complete visibility, that when we have more visibility on which equipment, for example, needs to be imported from the U.S., which equipment can be locally sourced in Spain and things like that, we will have a better understanding of the numbers of the project. So we will inform the market in due time.

[Operator]

[Operator Instructions] There are no further questions at this time. I would like to hand over back the call to the speaker for the closing remarks. Thank you.

[Inés Arellano, Director]

Thank you, operator. So thank you very much for attending today's call. As always, we remain at your disposal. So if you have further questions, do not hesitate to contact us. You have our e-mails. You have our direct lines as well. And keep safe and talk to you very soon. Thank you so much.

[Operator]

That does conclude our conference for today. Thank you for participating. You may all disconnect. Have a nice day.