Entra ASA
OSE:ENTRA
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Earnings Call Analysis
Q2-2024 Analysis
Entra ASA
In the latest quarter, the company reported stable rental income of NOK 853 million, consistent with expectations but reflecting a NOK 25 million decrease from the previous quarter due to the divestment of the Trondheim property. However, net income from property management rose to NOK 348 million, showcasing a 7% increase from the first quarter and an impressive 18% increase from the fourth quarter of the previous year. This growth was primarily driven by decreasing financing costs and a favorable CPI adjustment, signaling a positive trend after several challenging quarters.
The successful divestment of the Trondheim portfolio and the sale of Hotel Savoy for NOK 225 million facilitated a significant debt repayment of NOK 6.2 billion, effectively improving the company's leverage metrics. The leverage ratio improved by approximately 4 percentage points, leading to a Moody's LTV of 50.4%. Such moves are expected to enhance the company's financial stability as it navigates a challenging market landscape.
The property market is showing encouraging signs, with rental growth in the Oslo market running at 18% over the past two years, indicating strong demand. The company estimates a 14% reversion potential for its portfolio and a 16% potential specifically in the Oslo area. This is bolstered by expectations of low vacancy rates and a strong demand for quality spaces in good locations, although the overall occupancy has seen a slight increase in vacancy levels recently.
The company is actively pursuing redevelopment projects, with a focus on improving its existing asset quality. Currently, they are undertaking three refurbishment projects aimed at upgrading these properties to meet future energy directives. Specifically, the yield on cost for one project is estimated at 5.8%, while another is forecasted at 5.7%. Completion phases have commenced and are expected to stabilize rental income once fully occupied, indicating a strategic approach to enhance asset value over time.
Looking ahead, the company anticipates that the prime yields may start to decline slightly from 2025. They are optimistic due to the expected GDP growth and a potential interest rate cut anticipated for early next year. Moreover, the debt markets show signs of improvement with tighter credit margins, suggesting a favorable environment for strategic acquisitions and further property investments. The company forecasts a continued increase in rental income driven by positive employment growth and a reduced supply of new builds.
The company's financial health is strengthening, evidenced by a cash earnings trajectory of 7.1% and a net debt-to-EBITDA ratio of 11.9%. The Interest Coverage Ratio (ICR) is projected to slide below 2 in the coming quarters, indicating a robust capacity to cover interest expenses. Such metrics not only portray improved cash flow predictability but also enhance investor confidence in the company's financial stability.
In summary, the company has adeptly navigated recent challenges through strategic divestments and proactive debt management. With a focus on redevelopment projects and a favorable market outlook driven by strong employment growth, they are poised for future recovery. Investors can anticipate growth supported by an improving rental market, solid financial metrics, and an effective management strategy aimed at maximizing asset values.
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Presentation here in Oslo. Directly to the highlights, our rental income was NOK 853 million in the quarter. That is fairly stable compared to same quarter last year. However, when adjusted for one-offs and divestments, income growth of 4%. Net income from property management of NOK 348 million in the quarter. That's also stable compared to same quarter last year. However, up with as much as 7% from the first quarter this year and almost 18% compared to the fourth quarter last year, driven then by CPI feeding into our numbers from the first quarter and now also reduced financing costs in the second quarter.
Net value changes of NOK 2 million in the quarter and very happy to once again see that we can report profits before tax this quarter of NOK 344 million. We have successfully closed the Trondheim transaction in the quarter, and we have also sold Hotel Savoy enabling us to repay debt with NOK 6.2 billion in the quarter and thereby improving the effective leverage with 4 percentage points this quarter. We have also finalized 1 redevelopment and started 3 refurbishment projects this quarter, and we have had positive net letting of NOK 12 million in the quarter.
We move on to operations. As it's been a very active quarter once again, where we have signed new and renewed leases of NOK 176 million in the quarter. That's around 61,000 square meters. At the same time, rental contracts with an income of NOK 59 million were terminated, which is -- and out of that NOK 59 million, 21% has been resigned in our portfolio.
Net letting then positive of NOK 12 million. You can see some of the largest contracts we signed in the quarter in the table below. The largest one this quarter was with Oslo Municipality in Brynsengfaret 6 almost 10,000 square meters there, which also means that we reached occupancy rate there of 76% and now have started the refurbishment of that building.
We are experiencing that the letting market is solid and holding up very well. And as you can see from the bottom right graph, our team has done a great job ensuring that we've had very high signing volumes now for 3 consecutive quarters. And in spite of then the attractive market environment we experienced to be in and also the high signing volumes, we see that our -- sorry, vacancy is increasing slightly in the quarter and our occupancy is currently at 94.8%.
Following the Oslo Areal acquisition, our lease expiries in 2023 and 2024 almost doubled in volumes compared to what we have had in a historical perspective in Entra. At the same time, we have completed several projects, which all have been feeding into the management portfolio with some vacancy. So when the vacancy now is increasing, it is also a consequence of the fact that we have a much more letting-intense portfolio now than we've had in a historical perspective.
This also, however, represents an upside potential for us going forward, seeing that the market is very attractive. And around 75% of the vacant space in our portfolio is quality assets with good locations. So we are pretty confident that we should be able to rent out this space. It may, however, take some time as we, at the same time, are trying to chase the reversion potential or rent uplift potential in the portfolio. If you take a look at our average lease duration, it has increased this quarter from 6.4 to 6.6 years. That's including the projects. That's following the divestment of the Trondheim portfolio. And that has also affected our percentage of rental income from public tenants, which currently is at 52%.
As mentioned, we were very pleased to see that we successfully closed the Trondheim transaction. Our team has done a great job ensuring that, that has been done according to plan. And we have also sold Hotel Savoy for a transaction value of NOK 225 million in the quarter. That was 28% above our Q1 books. This is a building, which was acquired by Entra in 2021 during COVID for what we found to be an attractive price at that point in time. And our interest was then also to ensure that this hotel, which is ready for a redevelopment, would contribute to the development of the Tullin quarter, which is one of our largest clusters.
When we now have chosen to sell this property to a developer, which is also more experienced with hotels, it enables us to focus our own CapEx on our core business, developing offices. And we were very pleased also to see that there was a very competitive transaction process here. We had 12 interested parties. And the final buyer is also an experienced hotel developer. They have developed similar hotels in Bergen and Stavanger and partnered up with an operator, which will develop this into a boutique hotel. Pretty confident also that they will continue to add and enhance the urban qualities in the Tullin quarter.
The proceeds have been used to strengthen our balance sheet. The transaction closed end of June and debt was repaid then in July. We also finalized one redevelopment project in the quarter. Schweigaards gate 15 in Oslo. It's the old customs building located right next to the central station, beautiful building with a lot of character, 23,000 square meters. We started the redevelopment on a low pre-let ratio of 31% and pleased to see that we now have reached 93%.
The total project cost here is NOK 1.4 billion, and we will be getting BREEAM NOR Very Good certification here. The yield on cost on this building is 5.3%, which is up from our initial started reporting of 4.7% mainly driven by us achieving higher rental income than we anticipated and also that we have resolved some of the cost provisions now upon completion. We are starting to report on 3 refurbishment projects this quarter. The first one here in Brynsengfaret 6. This is located at [ Bryn ] on the Eastern fringe of Oslo.
That's actually the second largest communication hub in Oslo. It's a large building, 34,000 square meter, which has been occupied by the Norwegian Road Administration previously, and we have been working with the letting of this building for quite some time. So we're very happy to see that we now have signed several leases and reached a pre-let ratio of 76% and we will -- we have already started the refurbishment of this building. It will be completed in 2 phases, where the first tenants will move in, in the first quarter of '25 and the last -- completion of the last tenants in Q4 '25, maybe also into '26.
The project will be -- the building will be upgraded and also converted from single-tenant to multi-tenant building, complying with also future energy directives and will be certified BREEAM-In-Use Excellent. Yield on cost here is expected to be around 5.8%. The second project is Bergen in Nonnesetergaten 4. This is a beautiful building located next to the central bus terminal in Bergen and also the train station. It's one of the tallest buildings in Bergen and really great office location. The Norwegian tax authorities have been sitting in this building since it was new. And they earlier this year, signed a lease contract with us for 55% of the space.
They will be occupying the lower floors in the buildings, leaving us to work on solving the top floors, which also are some of the best spaces available in the market in Bergen. So here, we will be targeting high rent levels, but it will also then take some time to achieve these levels, but we have 2 years to solve the letting until completion. The first part will be completed in the third quarter where the tax administration moves in and then in Q3 '26, the remaining building should be ready. Yielding cost here is expected to be around 5.7%.
Finally, in Sandvika, we have started a small project. This is the old courthouse, which we now have signed a new lease agreement with the District Court of Asker and Bærum for 20 years. They will be signing or letting -- renting the old court building. And as you can see from the picture here, we'll be putting in infill volume between the quartiles and the neighboring building, where the courts also will rent some space.
So total project cost around NOK 200 million. We expect this to be completed in the third quarter next year with an expected yield on cost around 5.3%. Now we have brought down the project intensity in our portfolio as part of our disciplined approach to strengthening our balance sheet. And currently, we only have 2 ongoing projects we're reporting on. One in Sandvika will be completed in the third quarter this year. That's progressing according to plan and at cost, and the last one is in Trondheim, a project, which has been forward sold as the portfolio in Trondheim. And also that is progressing according to plan and at cost.
If we move on to a few words on the market situation. But first of all, the Norwegian economy is expected to pick up as a lower interest rates and also solid wage growth starts feeding into consumption, combined also with increased public spending. We are now seeing increased projections also for GDP and employment growth and inflation is on a downward trend.
The CPI for June came in at 2.6%, which was actually 20 basis points below the Central Bank's expectations for June. The key policy rate is currently at 4.5% and has been there since December, and the Central Bank has stated that they expect that the first cut may come in the first quarter next year. However, we're now seeing following the June CPI, that market is also expecting that it may come in the fourth quarter.
If you take a look at the property market, we follow the letting volumes in the market through Areal statistics database. And there, we can see that the number of square meters, which have been signed, both in the first and second quarter are in line with historic levels. And if you take a look at the top right graph here, you can see that the market specialists in our consensus report are now expecting to see a higher rental growth going forward than what they stated in the last quarter. So market rent is expected to continue to grow with more than 3% for the next 3 years. And that is also supported by the fact that we have a positive employment growth. We have low vacancies in our markets and the low build volumes have been low for 3 consecutive years now.
If you look at the new build volumes at the bottom right, you can see that there's quite a lot of volume coming into the market next year. That's explained by 2 large projects, one is the first part of the government offices, which is, of course, fully let. And the second is Construction City, which is more than 80% let. And these tenants will be moving from buildings, which will need some time of refurbishment before they are back into the market.
So the limited new supply coming into the market and also the current situation where we see that breakeven rents for new builds still is quite a bit higher than market rents in most parts of the city means that we expect to see favorable conditions or fundamentals for renegotiations going forward.
If we move on to the transaction market. We are seeing that the rates and inflation levels have believed to be topped out. The activity in the transaction market has also really picked up. And in the first half of this year, we've seen transaction volumes of as much as NOK 40 billion. which is compared then to NOK 56 billion for the full year last year.
We are also now clearly seeing that the financing markets, in general, have opened up, both banks and bonds are available and credit margins have come in. So we expect to see a continued improvement also in the transaction market in the second half. From our side, we are getting more incoming interest on our portfolio and also from a wide representation of buyers, both pension funds, real estate companies, family offices, syndicates, basically, the whole investor community is back looking into investments.
And just one final commentary, you can see that the prime yields now, from our consensus report, are expected to have topped out and also expectations are that they will start to decline slightly from 2025. So that leaves it for me and the floor is yours, Knut.
Thank you Sonja. Q2 was a straightforward quarter with the positive effects of the Trondheim transaction starting to feed in on the financing costs and the debt metrics. Rental income came in as expected at NOK 853 million, on point with the estimate provided in last quarter and down NOK 25 million from Q1, mainly due to the divestment of Trondheim.
Net income from property management was NOK 348 million. This was flat quarter-on-quarter. But as Sonja mentioned, it was a 7% increase from Q1 and 18% increase since Q4. The increase from Q1 is mainly a result of decreasing financing costs stemming from lower interest rates and reduced debt. And the increase from Q4 was also impacted by a high CPI adjustment. And after many quarters of negative results, it feels good to finally be back and report positive profit with a profit before tax of NOK 344 million. The effects described on the previous slide can also be seen in the per share numbers presented on this slide.
The cash earnings rolling 4 quarters bottomed out in Q1 and came in at 7.1% in Q2 with a CAGR since the IPO of 6%. If you analyze Q2 stand-alone, the cash earnings per share was NOK 7.6. And the NRV seems to have bottomed out as well at NOK 158 giving a CAGR since the IPO of 7% or 9% when including dividends.
Revenues and operations were in line with expectations, and the other revenues and other costs are grossed with the effects of the forward sold development project in Trondheim, giving a net effect of NOK 1 million in the quarter. Financing costs are up compared to last quarter, but are trending downwards from the last few quarters due to lower interest rates and reduced debt. And we had net value changes of NOK 2 million in the quarter, resulting from 3 effects.
First, the negative value changes of NOK 414 million on the property portfolio, I'll get back to that in a few slides later. And we had -- second, we had a gain of NOK 397 million. That was a technical accounting gain with no effect on the NRV. And we had -- and third, we had a positive value change on our financial instruments of NOK 19 million. This resulted in a profit after tax of NOK 345 million in the quarter.
Rental income will based on the reported events decreased by 9% in Q3. This is mainly due to the divestment of the Trondheim portfolio, but also includes a reduction of NOK 3 million due to the sale of Hotel Savoy. And the other column reflects a one-off effect due to a lease buyout agreement that will not be carried forward into Q3.
The [ Trondheim ] office space has already been relet to another tenant. And from Q1 '25, we have included a CPI adjustment of 3.5%. This quarter, we finally closed the Trondheim transaction and sold Hotel Savoy reducing the property portfolio by NOK 6.7 billion, and our appraisers reduced the inflation expectations by 50 bps and have increased discount rates on a few properties in Oslo portfolio by 10 bps, leaving us with a negative value change on the property portfolio of NOK 414 million.
The property net yield is currently at 4.99% and would be 5.72% if the portfolio was fully let at market trends. Following the divestment of Trondheim and the receipt of a seller's credit issued last year, we reduced debt by NOK 6.2 billion. In Q2, we have issued 6 commercial papers at attractive margins with a total amount of NOK 1.6 billion. And we're pleased to see that the CP market has opened up again. The bond market is open as well with spreads approaching at attractive levels, and the bank market continues to be open and available.
Our debt metrics improved in Q2 and are expected to continue to improve in the quarters to come. The LTV metrics has improved by approximately 4 percentage points and the effective leverage, the Moody's LTV came in at 50.4%. Net debt to EBITDA improved to 11.9% last 12 months and 11.6% for Q2 isolated. And our reported ICR is based on 12 months rolling, and it will take some quarters to get the full effect of the divestments and deleveraging into the ratio. For Q2 isolated, we had an ICR of 1.91. And based on the current interest forward curve and the rental income estimate, we expect to see the ICR for Q3 isolated to slide below 2.
Interest -- average interest rate saw a sharp decline of 31 bps in -- from last quarter. This is mainly due to the repayment of the most expensive debt following the divestment of the Trondheim portfolio. Based on the current forward NIBOR curve, existing hedges and current loan agreements, it seems like the interest rates have stabilized. The deleveraging also had a positive effect on our hedge ratio, which currently is at 70.7%, which has given further predictability on Entra's future cash flows.
We currently have an ample supply of liquidity, which increased significantly following the divestments in Q2, and we plan to tune the liquidity buffer to a more normalized level in the next few quarters. And as mentioned earlier, the debt markets are open and available at increasingly attractive terms. And back to you, Sonja, for some closing remarks.
Thank you, Knut. Okay. So to sum it up, first of all, the outlook for our Norwegian economy are positive. We have seen increased projections for employment growth and GDP growth. And the interest rates are believed to have topped out and expectations are that we will now see a cut in the first quarter. The letting market remains solid with increasing also market trends going forward. We see low vacancies in the market and the expectations for future growth is also supported by the employment growth in the market and the low new build volumes and the fact that breakeven rents still are quite a bit above market trends in most parts of the cities when it comes to new builds.
The debt markets have really opened up and margins have come in. This has given a positive stimuli to the transaction market and our consensus report now states that prime yields are expected to come slightly down from 2025. Entra has, following the divestments we have done, now a solid balance sheet and we have improving debt metrics. And we are also very pleased to see that Moody's affirmed our BAA3 rating with a stable outlook now in June.
So I think that concludes it for now, and I think we can check with Tone if we have any questions.
We have a few questions. And the first one being, do you have further vacant buildings or soon to be that you will need to refurbish or redevelop?
Well, now we have just started reporting on the 3 projects. We have one more building where we potentially could also start refurbishment if or when we see that the leasing is solved. But other than that I think for the next 12 months, there's no big projects in the pipeline.
Can you comment on the reversion potential in the portfolio?
Yes. The market rental growth has been pretty strong the last couple of years, almost 18% in the Oslo market. So clearly above CPI, which means that currently, we see that our portfolio has a reversion potential of 14%, whereas of 16% in the Oslo market. So clearly, an opportunity for us when we work on renegotiations and also the letting space -- vacant space, sorry.
How do you expect property values to evolve over the second half of '24?
Well, we use 2 external appraisers every quarter, and we will just say the same thing, as we said last quarter that we expect to see that we are close to the bottom, and that we have bottomed out. So no expectations of further declines; however, there are external appraisers. We saw that they had different views this quarter, where one of the appraisers took up the yields on some assets, while the other one remained stable. So there is also some differences in how they assess the situation.
And on that note, what was the difference in valuations between the appraisers?
This quarter, we've increased and the difference is at 4.3%, I believe. So that's a bit higher than we typically have.
And is there any plans for any further disposals?
Well, we have now done a big job with divestments and the balance sheet is at a level we are very comfortable with in line with our policy and seeing now that the valuations are bottoming out. So we expect also that the inflation will start feeding into our valuations going forward and also help in improving our debt metrics, both ICR and LTV.
So we're comfortable with the situation, but we still have some nonstrategic assets, which we are working on and which we would be willing to sell if we get the right pricing. But we are -- consider this to be more like a normal portfolio rotation like the Hotel Savoy where we did a good transaction and found it right to sell. We have the opportunity to do more of that and potentially up to NOK 2 billion, around NOK 2 billion if we get the right interest. And also, it's an opportunity for us to do transactions also to finance the future CapEx, if we see that we want to start more projects -- profitable projects.
Thank you. That concludes the Q&A.
Thank you, Tone. Thank you all for following us. So I think it just remains to say have a nice summer holiday, and we look forward to seeing you back in the third quarter.