MERLIN Properties SOCIMI SA

MAD:MRL

Earnings Call Transcript 2023-Q1

[Ines Arellano, executive]

Good afternoon, ladies and gentlemen. Ines Arellano speaking. Welcome and thank you for joining MERLIN's first quarter trading update. Today, our CEO, Ismael Clemente, will walk you through the main highlights of the quarter described in the executive summary report available on our website. After the brief update, we will open the line for Q&A. [Operator Instructions].

With no further delay, I pass the floor to Ismael. Thank you.

[Ismael Orrego, executive]

Thank you, Ines. Good afternoon. Welcome to MERLIN's First Quarter 2023 Results Call. I'm going to make a very quick intro on how the operations went during the quarter, and then we are going to move straight into Q&A, which I believe will be the most practical way to those things.

Well, following up on the very good dynamics of year 2022, particularly the second half, we have enjoyed a very positive first quarter in 2023, which is extending somehow to the second quarter. I mean we -- visibility as of today is good for year-end. It will be a good year for the company, although we expect slightly slower pace of activity during the second half, amid the preparation for Spanish elections and also as little by little interest rate hikes start affecting the economy and provoke a small slowdown in the economic activity.

In terms of growth of rents, we posted an 8.1% like-for-like increase that -- some of you have mentioned this is the best we have ever posted just by chance, but yes, maybe. What is really important for us is that we significantly [ aid ] on the lower performance that was natural after the sale of BBVA. So the FFO per share came up at minus 5.6%, which is significantly above what we had expected. If you pro forma for the sale of Tree, that was plus 20%.

Again, some of you are now asking for a new guidance for the year, et cetera. It is way too premature. I mean we are expecting a number of CPI indexations in our cost base during the second quarter that will affect the company during the rest of the year.

We also enjoyed very good financial conditions and -- reflected in good financial expenses in the first quarter, which we don't know whether we will continue experiencing during the rest of the year. So yes, we are, of course, making our best efforts to beat the guidance provided to you, but it's too early to try and anticipate a new guidance for year-end.

There were no revaluations in the period. NTA came up minus 3.1%, but we will only reappraise assets in the second quarter. And at year-end, the release spreads, as commented, were very positive across the board: in offices, 2.8%; in logistics, 4.9%; in shopping centers, 7.9%.

Some of you are pointing towards softening release spreads. As commented in a number of calls with you, you know that inflation and release spreads are both sides of the coin. So when you pass high inflation, sometimes you do it at the expense of lowering a little bit your release spread and vice versa. If you are ready not to pass all the inflation that is due, you can, of course, increase the rent a little bit more. So don't be alarmed because of that movement in release spread because it is normal that with inflation we are passing, we are also eating on our reversionary potential, and this is completely in line with what you have seen in many other real estate cycles. I mean you shouldn't be alarmed about that.

Strong operating performance, as commented. Very resilient occupancy, minus 35 -- plus 35 basis points versus the same quarter last year, minus 20 basis points, more or less, overall as compared to year-end. Just for your tranquility, because some of you are asking why occupancy has gone down in logistics, we said logistics was simply a rotation of a client that we moved from an existing facility of ours into a new facility that we built for them. So the previous facility went vacant, and we have now subsequently let up that facility, and we are back as of today at 99% occupancy in logistics. And that occupancy will somehow keep towards year-end. I don't know whether it will be 99% or it will be 97.5% or 98%. But anyway, I would call it pretty much full occupancy.

In shopping centers, we have a number of rotations of clients, which are normal in Spain in the first quarter. But we are leasing up quite rapidly, and we expect also the year to end up on a positive tone. Probably we will end up with the portfolio slightly above 96%, hopefully. I mean, if it is not 96%, you -- I beg your pardon, but we will try to be -- we are working towards achieving that scenario.

In offices, our base case is for a slight decrease in occupancy because we expect a milder second half of the year, owing to a softening of the economic activity. As you may know, Spain has been creating employment recently, but it's -- significant chunk of that is public employment. So in reality, that doesn't translate into a lot of economic activity and particularly office demand.

So we are experiencing a slower market in the first quarter. Take-up in Madrid has been like 113,000 square meters, which is around 20% lower than last year and historical averages, and we expect that trend to continue during the year. Impact of work from home continues to be negligible. I mean what is -- what might cause the slowdown in demand in offices will be, I would say, more economic tone than WFH. I mean WFH continues to have -- the adoption rate in Spain continues to be very, very, very low.

We have been -- we have continued managing our liabilities. We refinanced the 2023 bonds with bank facilities with slightly increased cost of financing but still within a very positive territory. We are now running at 2.2. We have made no investments during the period nor divestments. I mean at the -- following the close of the quarter, we invested a little money in the acquisition of extra area in our Marineda shopping center in Galicia from El Corte Inglés. And we disposed of 2 noncore shopping centers that we have longly -- we have longly waited to dispose. Finally, the market is reopening a little bit, and we were able to dispose those post close of the quarter with a very positive effect in overall occupancy in our shopping centers division.

So that is basically all from my side. We will open the line for Q&A, which probably is the best use of our time.

[Ines Arellano, executive]

Thank you, Ismael. [Operator Instructions]

We have the first question coming from Ignacio Domínguez from JB Capital.

[Ignacio DomÃnguez Ruiz, analyst]

I just have one question on your statement that you expect lower activity in the office market by year-end. I was wondering if you could provide more visibility on this.

[Ismael Orrego, executive]

I have no specific visibility, Ignacio. It's simply the -- a consequence of conversations with the different market factors. We have seen a lower activity in the first quarter than historical averages. We are seeing also a relatively slow second quarter.

Generally speaking, the clients are dragging their feet. They are not taking decisions. They are not expanding business lines. They are not taking relocation decisions. That has a good side, which is that retention rate increases. I guess this year, our retention rate will probably be close to 85%.

However, the churn, the other 15% is more difficult to relet. So it takes a little bit more time. However, [ pension ] in rent remains. I mean rents continue to go up in CBD, and sometimes surprisingly for most of you, even in peripheral areas. And -- so we continue to have a positive market. It's not that we are in a complicated or in a super complicated market. But it's -- I simply wanted to warn all of you or to -- in advance that offices will not perform as strongly as they performed during 2022 because 2002 was clearly a year of catch-up. People took a lot of decisions following the COVID. People did a lot of relocations. People increased space for some of their workforce.

In 2023, we are seeing the companies with a much more cautious stance. In negotiations with them, we see also a clear miscalculation of the real needs of space they have. So if they want to let new space, they normally miscalculate and take less space than they really need. So after 3, 6 months, they come to you and ask for new space when in some cases, we have already let the space. That means basically that, that sets the tone for the market. They are super prudent. People is super prudent now in offices.

Shopping centers, however, we see a continued good performance in all aspects. I mean the sales per square meter have surprised us very clearly on the upside. In some of these calls, we have been commenting on whether the increased sales as compared to 2019 were simply a consequence of inflation. Now we can say that they are well above the accumulated inflation since 2019. So very, very positive tone, and we expect that positive tone to continue during the year because the touristic season will be good. I mean you all know that. So that will have a positive effect in our sales in our shopping centers.

And in logistics, in logistics, the activity is good. Online sales remain stable, of course, not growing as they were in the past or at the same rate they were growing in the past. But there continues to be a strong demand. What is peculiar is that the market is now a little bit more favorable to us because we own land, very good land at very good, very compelling prices. And what we are seeing is that there's a credibility crisis now in the market. So many of the clients now do not dare to go and do a pre-lease with a turnkey delivery of a building with one of the tourist investors that have populated the market for so many years.

So now that people is having more difficulties in finding financing, let alone buying new land because land has become really expensive. So we are seeing a stream of new demand from traditional clients that have now stopped doing experiments and are coming down to -- back to us. So we will be announcing a very significant stream of pre-let starts during the second half of the year that will result in deliveries in the second semester of next year and good cash flow in 2025 in logistics.

[Ines Arellano, executive]

Any other question, Ignacio?

[Ignacio DomÃnguez Ruiz, analyst]

No.

[Ines Arellano, executive]

So we have another question from Florent Laroche from ODDO.

[Florent Laroche-Joubert, analyst]

So I would have maybe 2 question. So would it be possible to have further update on data center so we can see that the recommercialization is moving faster than anticipated? So what can we expect in our models in terms of recognition of rental income? And maybe the second question, could you please tell us how you see the evolution of the investment market in offices in Madrid and Barcelona?

[Ismael Orrego, executive]

Okay. Look, in -- I will start with the investment market for offices. Investment market remains open. Main actors are family offices, some small insurance and mutual companies of a local nature, mainly Spanish. And curiously enough, we have seen a new actor, which is French OPCI. So we are having now a stream of acquisitions, all intended acquisitions that are being attract by French capital, I guess because of the significant arbitrage between the Spanish market and the French market. So we are seeing some interesting activity stemming out from France.

Data centers. Well, we are -- it's too early to extract conclusions, but we are very, very glad with the way they are progressing. As you know, we started with 4.2 megawatts pre-commercialized construction of the 3 data centers we have in Spain that are already licensed and under construction. We haven't yet started the data center in Lisbon for which we have a very, very strong demand.

But what has surprised us a little bit is that during construction, we entered into discussions for a number of [ leads ]. As a consequence, the -- our American partner, Endeavour, ended up signing a global [indiscernible], so a global agreement with a big hyperscaler, of which 2 megawatts have been assigned to Spain. So now the 4.2 moved to 6.2. And we are now also in very advanced conversations with another cloud integrator that will bring between 2 and 5 megawatts extra to our 3 existing data centers in Spain.

So using -- or taking averages, we believe that we have basically finished commercialization of the 9 megawatts with which we started our program and have started procurement immediately to bring another 6 megawatts of equipment because they -- generally speaking, the boxes are already built. So what we are doing now is fitting in additional modules. So we are fitting in additional modules, and we are bringing new equipment in order to raise our 9 megawatts to 15 megawatts.

If you put that in perspective, you might remember that our -- Phase 1 of our data center deployment business plan was to simply demonstrate to the market our technology before the end of 2024. And our internal targets were to have at least 3 data centers up and running and at least 12 megawatts commercialized. It will depend on the -- on when we receive the construction license in Lisbon. But it looks at present like we are going to have the 4 data centers up and running, mainly the one in Lisbon about to open that give or take.

So -- and at the very least, 15 megawatts commercialized, I think it will be more than that, particularly because in the case of Lisbon, we have a very strong market interest. So if we get the construction license for that one, I guess, we are going to sign -- or we are going to start it with a significant amount of pre-let for the first building.

Effects in rental income, [ Florent, ] of course, that is more complicated to assess. But yes, I mean, rental income will be anticipated significantly. So what we were expecting for end of 2024 will probably be advanced to somehow meet 2024, or even second quarter of 2024. So we will go a little bit in advance.

And what is more important, what it is looking is that what we call the rollover phase, the second phase in end of 2027, could be also significantly anticipated. We like what we are seeing, and we need to remain, of course, prudent because this is a new market for us. But we like what we see, and we believe this will be a very significant pillar of growth of the company for the coming months/years.

[Ines Arellano, executive]

The next question comes from the line of Marie Dormeuil from Green Street.

[Marie Amelie Dormeuil, analyst]

I had 2 questions. First one maybe with regards to the refinancing of the bond. Can you -- did you manage -- is it a floating rate? Or have you fixed it? And if you can give us a sense of did you even consider the bond market at one point? Or was it really the spread too big between bank refinancing versus bond market, just to give us a sense?

And then the other question relates more to capital allocation for the rest of the year. Do you -- how do you see maybe '23 and '24? Do you want to continue to be like net seller in putting aside, of course, your development pipeline, but do you want to continue to try to sell? Or are you looking at acquisition opportunities?

[Ismael Orrego, executive]

Okay. Okay. Well, on the refinancing, we chose the bank market because the bond market was giving us a much higher execution cost. So at the time we did the refi, the best we could achieve in the bond market that was in a moment of significant hysteria was like 280 -- around 280, 290 bps credit spread, whereas in the bank market, we ended up achieving 126. So the arbitrage was very significant. Hence, why we chose to go through the bank market.

As you know, one of the advantages of a real estate company is that you can choose a little bit how you finance yourself. You can do it company-unsecured, you can do company-secured, you can do subsidiary-secured, subsidiary-unsecured or even asset-secured if need be. So we will continue exploring different alternatives for financing, trying to obtain cost efficiencies rather than simply fall in the arms of markets when markets are particularly dislocated, like they were at the time we did the refi.

Regarding the rates, we fix them, we swap them. We were extremely lucky at the time we did it because we achieved, what, [indiscernible] cost because the swap was set at [indiscernible]. So we were lucky. And through wonderful execution from the finance department, we were lucky to fix the rate at the convenient moment. So while the [indiscernible] of course, is much higher than the [indiscernible] we were paying, so there was a loss of around EUR 10 million per year in cash flow erosion in that refinancing, but that was immediately more than covered by the increase in the top line [indiscernible] inflation. I mean 3x coverage, we obtained an increase in rent of 30 years -- of EUR 30 million just on that year, and it will be [indiscernible] this year. So we are okay with that.

Regarding capital allocation, the company more or less has done its homework. I mean we are happy with what we have achieved. So we are under no rush to sell asset and particularly fire sale asset into the market. We are in no pressure to raise capital. We are in no problem regarding debt service. So we will try -- we will continue rotating assets. As you know, we have an internal policy, which is to identify every year around 1% of the portfolio that we consider, let's say, the most noncore at every possible moment of our portfolio. And we try to rotate those assets identified into the market.

You will see us doing some other transactions during the year, for sure. We don't know what amount we will achieve. As you know, 1% of our portfolio will be like EUR 110 million, but this year instead of EUR 110 million, it's EUR 80 million or EUR 90 million, we will not become [indiscernible] of noncore sales. I mean we will be happy with whatever good executions we can do in the market and try to protect shareholders' money.

Acquisitions, not for the moment. I mean our cash flow generation is mainly geared towards dividend payment, as you know. And we will continue also fueling our CapEx program. I mean our big priority at present is more CapEx than it is inorganic growth through acquisitions because, first, the market is not yet ripe for it. The damage that little by little, the hike in interest rates will end up [ inflicting ] in the market, is not yet evident. So it will take time to really materialize. And we need to wait.

So for the moment, what we are trying to do is continue CapEx in our portfolio because we have very good growth opportunities, very good opportunities to grow our rents and our cash flow, which is at the end what will move the needle in terms of price because people is increasingly now looking at cash flow generation.

I mean theoretical value of assets, even in credit metrics, LTV has now probably lost a little bit of [indiscernible] and people is starting to look more at net debt to EBITDA and net debt to cash flow. So basically, we -- the only way forward for us is to try to grow cash flow through the development of the business lines that we are at present trying to create for the company.

[Ines Arellano, executive]

[Operator Instructions] If not, you can always call us afterwards. Yes, we don't see further questions over here. All right. Well, thank you all for joining us today at MERLIN's first quarter results presentation. As I said, we remain at your disposal. You can contact us any time. We'll be more than happy to answer your questions. Thank you and have a great weekend. Bye-bye.