Fabege AB

STO:FABG

Earnings Call Transcript 2018-Q2

[Christian Hermelin, President & CEO]

Welcome to Fabege's Half-Year Report 2018. With an excellent first quarter and now an even better second quarter behind us, essentially all our most important key ratios are strong. For example, if we look at the 3 key ratios that are the most significant in terms of long-term profitability. Net lettings have, as expected, seen a substantial increase in the second quarter, ending up at SEK 123 (sic) [ SEK 123 million ] for the first 6 months.We're now on page 2. And on this page, we're also seeing the return on projects has remained persistently very high for the first half of the year, which will contribute to both income and value growth for many years to come. If we look at the third significant key ratio for our long-term profitability, we can see that rental increase in renegotiations are also continuing at a high level and large volume owing to healthy demand. The fact that all 3 of our most important key ratios have performed so well during the first half of the year has a significant impact on earnings for the same period, but the long-term effect is even greater, both on value growth and growth in income.If we examine value growth for the first half of the year, EPRA NAV is our long-term network has risen from SEK 100 per share to SEK 116. We're very proud about this development, but we're not surprised, because we have managed to cultivate almost perfect conditions through a combination of luck and EBITDA scale.Page 3. As 100% of our portfolio is in one of our -- is in one of Europe's best property markets and we also, in page 4, can see that we have maintaining an exclusive focus on office in this market. And being on this market with a very strong demand and healthy rental trend is also an -- a big advantage. And thirdly, the fact that we also have the benefit of being able to expand via newly built value-adding projects, where with low risk, we are developing a portfolio that is becoming increasingly modern is a great position to be in. Naturally, these 3 fantastic conditions enable us to deliver strong earnings, but I would like to point out that we have been performing over and above expectation for a long time now.Page 6. And partly that is due to our prudent approach. And on page 7, we -- I also would like to say that it's also because of our effective and committed workforce. And now I will hand over to Åsa who will go through our financial result in more details.

[Åsa Bergström]

Thank you, Christian. We are reporting fantastic earnings for the first half of the year. All the positive factors that we have seen over the past few quarters are persisting, with increasing rental income, improved earnings from Property Management, sustained value growth and strengthened key ratios. Rental income amounted to SEK 1.2 billion, an increase of almost 12% compared with the previous year. In an identical portfolio, income increased by just over 10%, around half of which was attributable to project occupancy and half to growth via renegotiations and new lettings at higher levels.The surplus ratio ended up at 73%, which is in line with our expectations. Administrative costs are slightly higher than before. More employees cost money, but they also help contribute to our growing earnings. Interest expenses are at the same level as last year in absolute terms. Overall, we are borrowing more but at a lower average cost. Earnings in associated companies totaled minus SEK 40 million and related capital contributions to Arenabolaget during the period. We believe that the costs are a little front-loaded, and that we will see an improvement in the second half of the year. We, therefore, reported earnings from Property Management of SEK 572 million, which is an increase of 27%, compared with the previous year. We sold 2 properties in the first half of the year. Since both transactions were finalized before the release of the Q1 report, the gain was recorded as an unrealized value change of SEK 132 million in the first quarter. To coincide with the properties being taken over in the second quarter, we have recognized a smaller realized profit of SEK 5 million. The remaining realized value changed of SEK 83 million was attributable to an additional consideration paid regarding a transaction that was concluded in 2010.The unrealized change in value attributable to the property transactions also appears in our segment reporting. A large proportion, around 57% of the portfolio was externally evaluated in Q2. Transactions on the market, particularly on our own sales, indicate a persistent decline in yield requirements. The changes in value amounted to SEK 5.3 billion, corresponding to roughly 9% value growth, roughly the same in Q2 as for the first quarter. Values in the project portfolio rose by SEK 1.6 billion, producing a return on invested capital during the period of 121%. Q1 saw an upward revision of the value of Pyramiden 4 in connection with the project's completion. Although allowing for upward adjustments of some of the investment forward costs, we see that high rent levels and lower yield requirements have a positive impact on estimated final values. Values in the investment portfolio were driven to 2/3 by rent increases and 1/3 by lower yield requirements. The average yield in the portfolio is now 4.18% compared with 4.36% at the year-end.The negative value of the derivatives portfolio saw a slight increase in the second quarter. Old costly swaps have expired, but we have also taken out more new long-term interest rate swaps. Tax involved slightly more complicated calculations this time. Following a decision by the Swedish Parliament to implement the proposed change to corporate taxation, we have recalculated our tax liability. The tax liability has now been calculated based on a rate of 20.6%, adjusted for anticipated use of loss carryforwards based on current tax rates over the next few years.This produced a one-off positive effect of around SEK 380 million in the second quarter. The 2 property transactions also account for a positive effect of SEK 130 million in the first half year. Otherwise, the deferred tax expense for the year is calculated at 22% of current earnings, in accordant with current regulations. And now please turn to page 11. In February, we received an investment grade rating from Moody's. I've spoken about this in the previous quarter, but we think it's a significant piece of news and worth repeating. We've had a number of positive reactions to the rating and can already see that it has had a substantial positive price effect on our bonds and that we are reaching a broader investor base. And now over to financing on page 12. We are seeing a sustained high level of interest in lending to Fabege from both banks and the capital market.Efforts are continuing on expanding the proportion of green financing, and we are pleased to see that it is available to us in all our Swedish banks and on the capital market, both via SFF and through our own MTN programme. We have continued to work on strengthening our financial profile via longer fixed term maturities and new fixed interest terms to gradually replace the old swaps that are due to expire during the year. In the most recent refinancing round, we extended the fixed term maturity, which is now an average of 4.7 years. This can be compared with 4.0 years, 6 months ago. The fixed term maturity was extended, in part, in order to catch back slightly on outstanding commercial paper and replace them with bonds. However, we will continue to use our commercial paper program as a source of financing and a complement to other financing, and we believe that we have achieved a good level now of just over SEK 3 billion. Capital market financing has offered better terms than the banks over the past year and in recent years. We are now delighted to see that several banks are offering financing without a STIBOR floor, which is -- which clearly strengthens their competitive capability.We're also pleased to see new opportunities for tying up capital for longer maturities of up to 10 years. Our old expensive callable interest swaps finally expired in June. As I've said before, this had a significant effect on the average interest rate which was 1.83% at the end of June. This can be compared with 2.2% at year-end. We're therefore entering second half of the year with a significantly lower level of interest. And we'll still continue to take out new interest rate swaps. In the first half year, we've tied up a total of SEK 2.2 billion in new long-term interest rate swaps. The expiry of further expensive interests rate swaps in the autumn will also have a positive effect during the second half year. Unutilized facilities at the end of the quarter totaled SEK 3.5 billion. We're confident about both refinancing and access to capital for continued investment. To finish, just a few words about the new tax legislation. In June, the Swedish Parliament resolved to implement a proposal on new corporate taxation announced in March this year. The new rules apply from January 1, 2019. The decision is fairly close to the EU Corporate Tax Directive and from our perspective, it's an improvement on the proposals that we have seen previously. However, there is no doubt that there will be a complex calculation ahead. To summarize, it means that the tax rate we will be reduced in 2 stages from 22% to 20.6% by 2021. It will also mean interest deduction will be limited to a 30% of EBITDA.For companies and groups that have carryforward losses like Fabege, the deduction would be recalculated at a lower amount. However, it's positive that it is not entirely offset but can -- we can still benefit from the interest deductions when offsetting against carryforward losses. For Fabege, it means that we will use up carryforward losses at a faster pace. Based on the 2018 budget, the proposal would mean an increase in deferred tax expense of roughly SEK 50 million. Tax paid will still be very close to 0. And now back to Christian.

[Christian Hermelin, President & CEO]

Thank you, Åsa. And on page 12, I will talk a little bit about our rental market. A robust demand, combined with low vacancies mean that the upswing in rents is continuing in all our submarkets. In other words, we haven't reached a rental peak yet in Stockholm. During the period, we achieved an average rental increase of 29% in our renegotiations which was more than in the first quarter, but the biggest difference is that the renegotiated volumes has, as expected, seen a substantial increase in the second quarter. The biggest renegotiations have been carried out in the blocks in the top slides, the Bocken block in CBD and Barnhusväderkvarnen in the block just outside CBD. Seasonal effects caused a sharp increase in net lettings in the second quarter. Some SEK 114 million of the SEK 123 million was generated in the second quarter. The biggest projects are shown in the lower images, including a hotel and an additional letting to ICA.Page 13. Since we didn't carry out any transactions in the second quarter, we will look, instead, at where our values growth is coming from. In this graph, you can see the percentage of value changes attributable to rising rents, falling yield requirements and value increases in our ongoing projects. The purple volume, at the bottom, represents the operations in our projects operations, and also, it fluctuates considerably between quarters. It is very stable over time compared with the other 2. We believe that the contribution from project operation will remain persistently relatively stable. I will come back to this point later. If we look at the pink area, it represents the value increase resulting from rise in rent. We can see here that rising rents are making increasingly a significant contribution to the total change in values, and it has also increased over the period shown here. We believe that increasing rents will continue to have a big impact on value over the next year. The green section represents changes in value resulting from declining yield requirements.The effect of this decline has been falling sharply, and I thought it would disappear entirely in 2017, but I was wrong, and we can see, instead, that it has risen slightly due to several transactions completed at new record low yield levels over the past years. I believe we will continue to see this effect throughout the rest of this year. Page 14. Here you see one of our new developments, which we have decided to start during the second quarter. And it's a new hotel in Arenastaden. It's a 3-star hotel next to Friends Arena, which will be run by Nordic Choice Hotels, and it will add 336 new hotel rooms to the area. It also includes the creation of 88 long-stay rooms, and Nordic Choice will also have their Swedish headquarter in the property. This is -- isn't just an isolated property transaction for us as the investment will create considerably added value for the district. Long-stay accommodation and hotel rooms constitute a valuable service for our tenants, and more hotel rooms are the top of the wish list in helping to further improve conditions for events at Friends Arena. These new hotel rooms, combined with the 250 additional hotel rooms that will be created above the existing entrance building, that you can see in the inset image down to the right, will bring the total number of the hotel rooms in the district from 400 to 1,000 hotel rooms.Page 15. This is the second project that we took a decision on during the quarter. It's also hotel and long-stay accommodation. In the vicinity of Arenastaden. This facility will be run by Kom Hotel, which is owned by KFUM. Page 16. We haven't -- we have presented a wishing for solar station in collaboration with the City of Solna and Skanska. Not only, we'll be creating new development rights, we will also be improving access to Arenastaden by separating different modes of transport. Page 17. Our project operations account for a large proportion of our earnings. We have had a target of 25% return on invested capital in our projects and investment volume of SEK 1.5 billion each year, and we have been outperforming these targets for sometimes now, and here you can see the average for the past 10 years also.Page 18. Furthermore, you can here see that both our return on project volume have risen in recent years alongside increasing appeal of our areas.Page 19. The question is then whether our profitability and project volume will remain strong going forward?Page 20. The factors behind our increasing project returns include our low development rights cost, rising rents and declining yield requirements. So what does the future look like for these factors? Since our existing development rights portfolio extends for 10 years, our development rights cost will remain low. Rents have risen and yield requirements have dropped significantly in recent years, and even if we were to take into account the possibility of rents falling by as much as SEK 500 per square meters and yield rising by 0.5 percentage in the long term, we would feel still achieve a margin of 50%. That is why we are setting a new return target of at least 50% over a business cycle. Now turn to page 21. Similarly, if we look at our investment volume, there are 3 main factors that have fueled our increasing volume, which are that we have attractive development rights, we have a lot of locations, big volumes and a strong demand on the market. So what might change? Firstly, our areas are only going to become more attractive, so rent advantage is unlikely to change. And as I said earlier, our development rights extend for 10 years. Our portfolio is relatively concentrated to Solna, so in order to have more alternatives that we believe will benefit or project volume in the long term, we will also in the long term, be looking for project opportunities in more locations than just Solna. Stockholm will continue to grow in the long term, and the number of office employees is expected to continue to increase. That's why we also decided to raise the target for all investment volume in the project and investment portfolio to SEK 2.5 billion in average every year. Page 22. Here are some of the projects that we will be working on over the next 3 years. And if we go to the next page, Page 23, you also see a slide with a lot of possibility. And if it -- and if there is something our organization is good at so is -- it's to take advantage of opportunities, which is why I continue to maintain a positive outlook in our future. Thank you, and that was the presentation from Åsa and me, and now we are ready for questions.

[Operator]

[Operator Instructions] And as there are no questions, I'll hand back to you, speakers.

[Åsa Bergström]

We have some questions from coming by e-mail from Green Street Advisors. The first one is, how do you see re-leasing spreads evolving in each of Q3 and Q4? Is it likely that reported print remain above 25%? And yes, we are expecting renegotiations also in the second half of this year to remain at the same levels that we have seen during the first half of the year. The second question is, how many years will it take to use up the 100% of carryforward tax losses based on today's profit and loss before cash starts to be payable? It will depend a little on how we sell properties, but from what we see today, with -- it will take more than 5 years before we will be in a position with paid tax. And the third question is, is there a minimum pre-leasing rate requirement before new projects are launched as part of the SEK 2.5 billion on investment program per annum going forward?

[Christian Hermelin, President & CEO]

No, it's a separate decision, every project. And sometimes, we start on pure speculation. In other situations, we start fully let, and as the demand is very strong on the market, we prefer to have it pre-booked on a quite high level. But every decision is unique. Is there any more questions? Okay. I get the information that we don't have any more questions, so therefore, I thank you for listening to our report and have a good summer.

[Åsa Bergström]

Thank you.

[Christian Hermelin, President & CEO]

Thank you.