Fabege AB

STO:FABG

Earnings Call Analysis

Fabege starts stable in 2024 with rental growth, manages interest rates

Fabege's 2024 Q1 began steadily with rental income at SEK 1 billion, a like-for-like increase of 10% supported by project completions and index increases. However, property divestments and higher heating expenses impacted the surplus ratio, which settled at 71%. Profit from property management dropped to SEK 329 million from SEK 351 million, and unrealized value changes lost SEK 1.4 billion due to increased yield requirements, taking the total property value to SEK 77.4 billion. The loan-to-value ratio edged up to 43%, and interest expenses rose following higher market rates. Yet, robust refinancing efforts and supportive credit facilities underscore Fabege's sound financial footing.

Introduction: Overview of Current Conditions

As we step into the first quarter of 2024, the overall landscape remains stable despite rising geopolitical tensions and economic uncertainty. The funding market is showing signs of improvement since last summer, hinting at a shift towards the first interest rate cut. However, challenges persist as we navigate these turbulent waters.

Financial Performance: Rental Income Insights

The company reported rental income of SEK 1 billion, consistent with the previous year but adjusted for property sales. Notably, rental income on a like-for-like basis surged by 10%, driven primarily by indexation adjustments of 6.5% due to inflation, alongside new occupancy from projects like Convendum in Central Stockholm. This performance reflects proactive management despite increasing operating costs that led to a 71% surplus ratio.

Costs and Interest Rates: Navigating Financial Obligations

While interest expenses rose, influenced by higher average interest rates climbing from 3.13% to 3.29%, the effects were tempered through strategic use of interest rate derivatives and refinancing efforts, which allowed the company to maintain margins. This proactive approach supports the ongoing focus on mitigating financing costs as the average interest coverage rate decreased to 2.4.

Valuation Challenges: Property Market Dynamics

A significant challenge arose in the equity portfolio, with unrealized value changes reflecting a decrease of SEK 1.4 billion. The firm has seen property valuation metrics revert to levels last seen in 2017, with market yield requirements increasing by 8 basis points to 4.51% as property values dropped approximately 15% since their peak in Q3 2022. Despite these hurdles, the company remains resilient, with a robust capacity to absorb further 15% property value declines without impacting internal targets.

Occupancy Trends: A Focus on Recovery

The occupancy rate saw a slight decrease of 0.4%, currently standing at 86%. The organization aims for a long-term goal of restoring occupancy levels to 94% or 95%. Strategies are being prioritized to improve metrics at key locations like Solna Business Park, which is expected to experience tenant influx and improved leasing terms in the upcoming years.

Future Outlook: Revenue Growth Projections

Looking forward, the firm anticipates the rental income from their project portfolio could boost revenue by approximately SEK 380 million. This positive outlook coincides with expectations for completed projects, where tenant occupation is critical for sustaining financial health. The company projects continued improvement into 2025, reinforced by strong demand for well-located properties despite uncertainty in the broader market.

Capital Management: Strong Financial Framework

The capital landscape shows the firm is well-prepared with SEK 6 billion in undrawn credit facilities, ensuring liquidity and stability as market conditions evolve. The company has successfully diversified its loan maturities and retained a solid balance sheet, evidenced by an equity asset ratio at 47% with a loan-to-value ratio at 43%.

Sustainability: Commitment to ESG Principles

Fabege continues to enhance its sustainability commitment, illustrated by its recent inclusion in the OMX Sweden Small Cap 30 ESG Responsible Index. This dedication to environmental, social, and governance (ESG) standards not only augments its market reputation but also aligns with long-term investment goals.

Conclusion: A Year of Transition

Overall, 2024 stands as a transitional year with expectations to return to a more robust financial performance by 2025. The emphasis on cost control, strategic funding, enhanced occupancy, and sustainability will drive future success as the company adapts to market challenges while capitalizing on emerging opportunities.

Earnings Call Transcript 2024-Q1

[Stefan Dahlbo, executive]

Welcome to our presentation for the first quarter of 2024. As usual, you will be able to ask questions at the end of the presentation.This year has begun in a relatively stable way despite the fact that there have been global scene on the global geopolitic terminals has not decreased, it has rather increased during the first 3 months of this year, which is a little bit scary.There are many question marks in relation to the economic situation. But with that said, that the funding market has been functioning better, better since the last summer and we're now functioning well again. And we are getting closer to the first interest rate cut. There are no shortage of challenges, but for guest and strong. And I will now hand over to our CFO, Asa Bergstrom, who will review our numbers and results in a more detailed way.

[Åsa Bergström, executive]

Thank you, Stefan. Please turn to Page 3. The year 2024 has begun in a relatively stable way. Rental income amounted to SEK 1 billion, which is in line with the previous year, a decrease due to property divestment in the autumn was offset by index increases and the taking possession in previous project properties, of which Convendum's occupation in the Property Hagan Mindra was the largest one.On a like-for-like basis, income increased by 10%. The increased operating expenses were mainly due to higher heating expenses due to the winter. The surplus ratio came in at 71%, and central administration costs ended up at minus SEK 29 million.Interest expenses increased compared to the previous year, which was due to a slightly increased loan volume and higher average interest rates. The average interest rate increased from 3.13% at the start of the year to 3.29%.Our active work with interest rate derivatives has partly offset the effect of the higher market interest rates. And we have actually refinanced loans in the capital market at the same or lower margins during the quarter.The result in associated companies amounted to minus SEK 11 million and related to the capital contribution to Arenabolaget. And, we therefore reported profit from property management of SEK 329 million compared to SEK 351 million in the previous year. Unrealized value changes amounted to minus SEK 1.4 billion. I will come back to this very soon. We also recognized a small realized profit of SEK 3 million, which was a time lag from the transaction with NREP in the autumn.The surplus value in the derivatives portfolio increased by SEK 213 million due to higher long-term interest rates. And the tax expense last, which related to deferred tax was positive and amounted to SEK 137 million. Please turn to Page 4. The market-related yield requirements continued to increase, although at a lower rate, which has also had an impact on the valuations. There are still a few transactions, very few transactions in our market. During the quarter, we have once again independently valued a large proportion of the portfolio, approximately 70%. The rest of the properties have been valued internally. The average yield requirement in our portfolio increased by a further 8 basis points in the quarter to 4.51%.Since the values peaked in Q3 2022, we have now written down the property value by about 15% in total. The average real requirement is now back at a level equivalent to what we reported in Q1 2017.The changes in value in Q1 were almost exclusively due to increased yield requirements. The total change in value amounted to minus SEK 1.4 billion, as I mentioned before. And we are now reporting a total property value of SEK 77.4 billion. Please turn to next page. This simulation shows that we can withstand write-downs of a further almost 15% based on today's market valuation without impacting our internal targets. And the margin is even higher in relation to the covenants in our bank agreements.Please turn to Page 6. Reported equity decreased during the quarter and amounted to SEK 123 per share. The long-term asset value, the EPRA NRV amounted to SEK 146 per share. The equity asset ratio was unchanged at 47%, and the loan-to-value ratio increased by 1 percentage point to 43%. Both of these key performance indicators confirm our continued strong balance sheet.The interest coverage rate as expected has decreased in line with the increased interest expenses and amounted to SEK 2.4 million, a decrease of 0.1% since year-end. And now, please turn to Page 7. Financing is naturally still in focus. But as I said in connection with the Q4 report, the market situation now feels significantly more positive. This positive development has strengthened in early 2024. There is a strong interest from investors in the capital market, and the margins have continued to come down to levels that are not competitive compared to banks.The commercial paper market is functioning well. We have reduced the margin in a couple of steps and are now issuing 3 months commercial paper at a margin of 55 basis points. As stated, the bond market is also functioning well.In February, we issued SEK 1 billion in a public transaction, a 3-year bond at a margin of 145 basis points. Since then, the margins have come down further, and we see a strong interest from potential investors.The banks are also continuing to show that they have more capital to lend to the sector and to Fabege. Undrawn revolving credit facilities of total SEK 6 billion provide us with continued security ahead of upcoming refinancings. Please turn to Page 8. We have worked for many years to spread our loan maturities as shown in the graph. The strategy of long-term fixed rate period is unchanged, and we aim for distribution of our loan stock among several sources of financing.The short-term funding via commercial paper, the green bar chart is fully covered by backup facilities. We have facilities in place to cover the upcoming bond maturities in 2024 and also in 2025, if required. However, the market conditions are now more attractive, of course, and we intend to refinance our bond maturities with new bonds.The bank facilities are continually refinanced through extensions. Page 9, please. Of the loan portfolio, 56% is fixed, mainly based on long-term maturities and mostly through straightforward interest rate swaps, supplemented by some fixed rate bonds. Approximately 40% of the current loan portfolio is matched by fixed rate terms beyond 2025.During the spring and autumn, we have continued to work actively with callable interest rate swaps with the aim of reducing our interest expense. The average fixed rate term amounts to 1.9 years. Adjusted for the estimated maturity of the callable swaps, the fixed rate term increases to 2.8 years. Fixed rate terms provide us with protection against rising market interest rates. In the short term, the higher market interest rates will thus have more limited effect on our interest expenses. For a moving 12-month period ahead, an increase in the market interest rate will generate a higher interest expense of approximately SEK 139 million, all else unchanged. And the opposite will, of course, come with decreased interest market rates. And now back to Stefan.

[Stefan Dahlbo, executive]

Thank you, Asa. As Asa mentioned, we choose to external value of about 70% of our portfolio even this quarter. And then there, of course, the valuations of [indiscernible] was the transactions they saw in our market.The transactional market as a whole has continued to remain relatively slow. But the transactions that we have seen have confirmed the valuation of levels. In the Stockholm market, as you know, we don't see any distressed sellers. Of course, there can be distressed sellers in other markets, in other segments outside our core markets.Some of the transactions we saw you can see here on the slide. They are in the city of Stockholm, for example, of Fleminggatan under east of Kungsholmen there were some transactions and also at Vasagatan close to the central station.The yield levels, you can see they come about 4.5 money and the buyers are mainly the pension funds and some of the funds. The pension funds and the fund managers are still a lot to invest actually and we also see the gap between the sellers and the buyers are closing during the last months and hopefully, there will be more transactions during the next rest of the year.When we do any transactions in 2024, maybe and if we will probably be more on the selling side and on the buying side. That's what we said before, too. Next slide, please. When talking about the Stockholm market as a whole, we continue to see increasing vacancy rates, especially in some subareas, for example, in east, I think it's more than 75% now. We have also to increase that we're taking some new tenants to move into Solna, which is still quite attractive even in there. I can see some vacancies. But we also first time see some increasing vacancies in the CBD.There is a stable rent levels, but the increase in vacancies is mainly some companies that are, for example, not only because of the working more flexible work now, but also that has been going from own rooms to more activity-based office. So, there are a lot of reasons.And some of the tech companies, for example, are decreasing because they are not growing the way they expected some years ago. There is, as a whole, some uncertainty in the rental market.For the first time in many years, we can see a decrease in the number of office workers in Stockholm at least flat, it's flattening out. And, of course, as we said before, many companies and public authorities are thinking about how to use your office.I'm a strong believer that they have no doubt about the important role of the office, but they rather discuss how should they use them or how should it look. And that's also when we have an important role as an adviser for them in many of these discussions. The tenants we see that there also tends then be late, for example, in this journey to reduce the number of square meters per employee and that they're doing so now. This has been a trend throughout the whole the last 20, 30 years, but certainly it's not a new trend.But in general, I think we have a lot of discussions but it continues to take time, and I think that's true for all our colleagues in the sector, too. Next slide, please. We have a stable, as you know, a stable customer base, which it's not that some something new, but I think it's important to emphasize when we're discussing our figures.And that also means that we have over the last 2 years, achieved in the intention to go for more than 20% and almost 20%. And Asa also mentioned, that is also the main reason that our rental income increased this quarter by about 10%. Next slide, please. Net letting was negative, a lot disappointing in this quarter. It was mainly due to the fact that some, I think it was 2 public authorities after many years, chose to leave a property in the Stockholm in a city and moved to Stockholm, actually.Take also often more than 20 years, they like to modernize their office, and we couldn't find in our portfolio and a good alternative for the unfortunate. The next slide, please. Renegotiations. As we said before, most of the contracts that we right now are extending as un-change times due to the big increase we have added by the indexation over the last years.One that have been renegotiated is about 0, but it's only SEK 25 million. The renegotiating in the beginning of the year, about SEK 250 million more than that has already been renegotiated last year when the count agreement expires. So, when we're looking forward, of course, some with some leases in the portfolio that are below the market rent still. But we also have to be realistic and see that there are some, as we said before, above the market rent when they will be negotiated in the future. Next slide, please. We have set many for a long time and that the long-term goal is to go back to the level of our occupancy rate for 94%, 95%. And that's what we're working for. This quarter, we saw a small decrease in the occupancy rate. I think it was 0.4 or something, but it looks a little bit bigger here.But the total tenancy for all negotiations right now, and it's continued to take longer time and that there are reluctances to take decisions. And that is nothing what we saw also last year. It has not increased, but we don't see a big improvement of the decision-making forward. But we are not in discussions going on, and that feels positive.What's true, that's even more true today is the expression of location location location. It's about good communication for the public has work is very important. And it's also the flexibility is very high up on the agenda.As we said before, vacancies are increasing slightly in Stockholm as a whole. But I think the rental market continues to be relatively fundamental strong period despite that. Next slide, please. We used this to show you how the rental development will be for the next 4 quarters and it's stable. We will see in second half of this year that Operan/Dramaten, the Royal Opera, and the Royal Dramatic Theatre will move in, in its building in Flemingsberg. And if we look even more further, so we start with transferring 6 as there.With what we know today, the project portfolio will be products going on today will be finished and will increase the rental with about SEK 380 million, I think, it is today. So, next slide, please.On to the investments. As we have said before, this is SEK 2.8 billion this year. The first quarter was SEK 645 million. And we'll be very restrictive in terms of starting new filings in 2024. The only we have been starting, which I will tell you a little bit later on in Birger Bostad residential project.The next slide, please. Yes. This is the same products that we have been showing now for quite a while. And as we said, most of them will be finalized in this year and next year. The positive is that we have been continuing to increase the occupancy rate and is now 86%.We have announced some new agreements in for [indiscernible]. And they also that is positive. We have good discussions for the Haga Norra project. And we also see increasing and we have some, also for the last square meters in summer for. So it looks and as I said, this will add for the coming 16 months it would then another SEK 80 million increase in rental income. So next slide, please.In early 2024, we began the next phase in the development of Haga Norra. When Birger Bostad started built to building 285 apartments, of which 75 will be rental apartments. We see continued interest for housing in this area in good locations. It's a very good location, Haga Norra. And we will stop greatly start to sell the apartments during the second half of 2024 and occupation is expected to take place end of '25 and '26. So, Asa, please tell us a little bit about the sustainability.

[Åsa Bergström, executive]

Yes, I will. Please turn to Page 20. There is not so much happening during a single quarter, but we do have some news at least. There was a cold, a winter start to the year but in spite of that, we managed to keep energy consumption at the same level as the previous year.And, as I have told before, the target is to reach an energy consumption at the level of 70 kilowatt hours per square meters this year. During the quarter, we started the process of recertification of 24 properties in our investment property portfolio. And we also received a very nice acknowledgment that the project property Separaton 1 in Flemingsberg.The office building for Alfa Laval achieved its target level of BREEAM-SE excellence with good margins. In addition, Fabege has been included in the OMX Sweden Small Cap 30 ESG Responsible Index on Nasdaq Stockholm. This is further proof that strengthens our position and shows that our sustainability work is taking very seriously.The index follows the performance of the 30 most liquid companies with a market capitalization up to a certain level that are listed on Nasdaq Stockholm and whose issuers meet the special ESG criteria. Fabege's share is already classified as a green share on Nasdaq Stockholm so-called Green Equity designation. And now back to you again, Stefan.

[Stefan Dahlbo, executive]

So, thank you. And to summer up a little bit, I'd like to share with some of the priorities we are focusing on for this year. Of course, we cannot influence geopolitical turbulence and the big economic situation.Cost control, of course, this is always important in good times and poor times or bad times. And like other companies, we always have to distinguish between good and bad cost in everything we do, and I don't like to talk about the cost at all because that shouldn't exist unfortunately, sometimes they pop up. So we have to work with it.The daily grid is a very important business like ours. We also have to dare to think in new ways and differently in order to bring down, for example, construction cost, we see a big focus for this year to be able to continue the development of our products in the future thus we have a lot of good example of good cost in the daily work, and also how we can use the AI to be more efficient in all that we do.And maybe future products, of course, to the cost of construction is one of the important part. But also, right now continuing the work on our planning processes in our focused areas. So we continue that to be able if we find the right tenant, for example, to start the work in the future. So, we're also be able to start letting works.We have to have approved local development plans. We have continued to marketing and working actively on making all those areas attractive on all the areas. That's one of the main advantages to be focusing on some areas that we can really affect impact the way the tenants and companies are experiencing our areas.And that also means that we can develop the, for example, in providing new services in the area to be able to make it more and more attractive. Another out of focus is, of course, to refinance our bond maturities and secure access to capital. And Asa already has told you already about this and today, I feel comfortable about our refinancing situation, which we've been, I mean, bearer comfortable with this order, giving you this level of times and not also the good relationship with the Nordic banks.Then we should continue to be at the forefront in terms of sustainability. That's a part of our DNA. Many view this as a cost, but I see it as a natural long-term investment. And also, if you don't do it now, we have to do a lot more in the future. And it's like any other debt, you should be on the balance sheet at that time.So, to continue to work with it in the daily with a good planning, it's important and also we reduced the investment for doing it. We also see both internal and external pressure for being in forefront for this.So also, we are continuing the important work on helping to improve safety and well-being in the areas we're operating in. This is also part of the business for us. This to focus on increasing opportunities for meaningful lesser times for the people living and working in the education systems and also to get access to practical training and work. We are working actively along with other companies and other actors to create favorable conditions for positive development and which also, of course, is good for our local business. So, of course, the world that focus on very, I think it's very good for the short-term and long-term business and is not doing it should be disadvantage for us.With that said, we will open up for questions. Maybe you said it before, but we see 2024 as a year maybe of transition into a more positive 2025.

[Operator]

[Operator Instructions] The next question comes from Jonathan Kownator from Goldman Sachs.

[Jonathan Kownator, analyst]

I've got 2 questions, please. One on rental outlook and occupancy and one on the financing. So, first of all, on the rental outlook, I've seen on Page 16, that a few of these bars are going down to the year. Just was wondering if that includes disposals and closing of disposals or if that's already departures that you're aware of?And connected to that, I see that one of your top 10 tenants is departing or sorry, as a year as it expire in 2024. And I just wanted to know if you already had visibility on what was going to happen there. So that's the first question, please.

[Åsa Bergström, executive]

All right. Well, the staples in the graph, they include coming inflows and outflows of rental income. So tenants leaving that we know today are included and the tenants moving in that we know today are also included. So, just as the portfolio looks today is what is reflected in the graph and no further indexation from 2025. So, just as it looks today.

[Stefan Dahlbo, executive]

We can add, maybe you have an upside in the indexation if you look at the 2025 and also we are quite conservative when forecasting the income from the parking.

[Jonathan Kownator, analyst]

The second question is on ICR actually. So, I've seen that it's come to 2.4. Obviously, both your targets and well of covenants. How about discussions with rating agencies? Is there a particular threshold on that ICR where they're comfortable with for your actual rating?Is there a potential threshold that would be that they've indicated to maintain investment-grade rating. Obviously, I know it's a set of factors, but just focusing on ICR, whether it's part of the discussions.

[Åsa Bergström, executive]

We have been in discussions or we are providing a lot of information to Moody's, who put the rating on Fabege. They don't have a specific threshold on the ICR. And as they communicate, they would like it to stay not too much below 3, but they are confident with the levels where we are now.And we have also been very transparent with Moody's on the outlook for 2024 and how it will progress in the next coming years. Since 2024 will show a decline in the ICR and then it will come back in 2025 when we have the tenants moving in from finalized projects. And so, this is information that Moody's already have and which they had also when they made the affirmation of the rating in November 2023.

[Stefan Dahlbo, executive]

We also had another question from first about the tenant that the contracts expire in 2024. That is renegotiated in good terms.

[Jonathan Kownator, analyst]

And just do we know when these Moody's next review is in the spring, typically or?

[Åsa Bergström, executive]

It will most probably be before the summer or shortly after the summer.

[Operator]

The next question comes from John Wong from Van Lanschot Kempen.

[John Wong, analyst]

Could you provide a bit more color on the 10% like-for-like rental growth? I mean October inflation was 6.5%. You signed relettings mostly unchanged. Occupancy only improved by 60 basis points compared to last year. So, what is exactly the bridge here to 10%?

[Åsa Bergström, executive]

Some different items, of course. The major impact is from the indexation of 6.5%, as you mentioned. We also had an extra income of SEK 12 million one-off item for a penalty from a tenant who is going to leave Fabege. And then incoming rents from finalized projects. And the biggest part of that comes from Convendum, moving into a property in Central Stockholm.

[John Wong, analyst]

So projects are included there. So, on comparable portfolio, the only thing excluded is acquisitions and disposals?

[Åsa Bergström, executive]

Yes, that's correct.

[Stefan Dahlbo, executive]

And new build products. So it's all buildings. Projects and buildings.

[John Wong, analyst]

So, renovation is included, but new.

[Stefan Dahlbo, executive]

Convendum is moving into the higher ground in Stockholm and that it's an existing building.

[John Wong, analyst]

And then moving on to your target on occupancy. I think in your report, you mentioned that you want to move towards 95%. How do you plan to move here? Are you moving more assets into the renovation pipeline? Or do you want to wait for a tenant first before you start spending CapEx.

[Stefan Dahlbo, executive]

Normally, yes, yes. You can say part of it is that we hope that we'll be able to fill up and come back to better in Solna Business Park, and we see that trend is moving in the right direction. We also have some other spaces in the city that we hope we can. So, it's a lot of different actions, but we are working hard with the team to go in that direction. And I'm quite optimistic for that.

[John Wong, analyst]

And over what time frame do you expect to move towards?

[Stefan Dahlbo, executive]

We haven't said any target but within the next year, you can say. But it will take some time since, as you know, the discussion will sign a contract now that we're moving next year maybe. And so, in the discussions right now takes some time. So we have to give it some years.

[John Wong, analyst]

And then you just also briefly touched upon Solna Business Park. Of course, you just signed a lease yesterday. How much CapEx are you going to spend on this at least are on moving them in into the building?

[Stefan Dahlbo, executive]

I don't like to mention the exact number, but it's relatively expensive. It has been an area of space that has been really rough before. But that property is we are developing now. It's a big one in Solna Business Park and the largest profit there. And we also have some other areas we are discussing right now with other tenants. So I think it would be a good investment for the whole of Solna Business Park.

[Operator]

The next question comes from Alexander Toto Mano from Green Street.

[Alexander Toto Mano, analyst]

I think only one left that can be asked. With regard to the net letting figure for this quarter, you mentioned it was driven by 2 public sector tenants moving from the NRCP. When do you expect them to move? And have you already started relating discussions for the initial properties? And do you expect the NRCP properties to need expensive development?

[Stefan Dahlbo, executive]

First of all, I think it's second half of 2025. So, it's due in 2025 will move out. They have been sitting with us for a long time. Unfortunately, we lost some since they like to move from owned rooms, so to say, to more activity spaced, we didn't have the space, and they wouldn't like to sit during the refurbishment period and when it's about 5,000 square meters in a very good location. So, I'm also optimistic that we will find new tenants there with maybe even or probably even better terms for us. So, hopefully, over the time, it will come out some positive for this.So, if there are no any further questions, so thank you very much for joining us. Thank you for asking the questions. And, please give you some call to Asa, Peter, or myself if you have any further questions or comments, so anything you'd like to know. So, have a nice day, and thank you.