LEG Immobilien SE

XETRA:LEG

Earnings Call Transcript 2018-Q1

[Burkhard Sawazki]

Thank you. Good morning, everyone. This is Burkhard Sawazki. I'm glad you could join us this morning for our Q1 Earnings Call. Our management's board members, Thomas Hegel, Eckhard Schultz and Holger Hentschel will walk you through our presentation and give you more details on LEG's first quarter figures and our business outlook. As usual, this will be followed by Q&A session.With this, I'll hand over to Thomas Hegel.

[Thomas Hegel, Chief Executive Officer]

Thank you, Burkhard. Good morning, and thank you for joining us on the first quarter 2018 earnings call. We saw the expected solid start into fiscal year 2018. In line with our internal planning, we executed lower share of rent adjustments in the first quarter but a higher portion of maintenance in comparison to the very low level in 2017.You can expect a significant acceleration of our organic rental growth and positive earnings momentum in the quarters ahead. The unchanged strong market fundamentals will also be reflected in our Q2 portfolio revaluation where we expect a positive revaluation effect of 4% with further uplift to come in the second half of 2018. In the last few years, the financial strength and the financial flexibility of LEG has steadily improved. We intend to use this increased financial leeway to increase our dividend payout ratio to 70% of our FFO I.Let me now give you, as usual, a brief overview of the development of our key operating and financial performance indicators in the first 3 months of 2018. Our like-for-like rents grew by 2.3%, corresponding to a rent growth of our free-financed portfolio of 3.1%. Although, we generally see a low volatility of our rental growth with our diversified portfolio, we implemented a lower share of rent adjustments this time in the first quarter. This is partially attributable to the execution plan of our CapEx measures. This will revert in the coming quarters, and therefore you can expect a significant growth acceleration in the course of 2018. Our full year rent guidance of around 3% remains unchanged.Our like-for-like vacancy amounted to 3.3%, flat year-on-year. Additionally, regarding this KPI, we expect positive momentum in the coming quarters and a further rising occupancy level. In comparison to the slow start in the previous year, we invested significantly more money into the quality of our portfolio with EUR 4.90 per square meter. Our full year target is [ some ] EUR 29 to EUR 30, but with a significantly higher share of value-enhancing modernization CapEx.Coming to the financials. The earnings momentum is somewhat distorted due to the higher share of maintenance expenses. Therefore, our FFO of EUR 74.2 million was roughly flat in comparison to last year's Q1 result. Adjusted for the higher maintenance, however, the underlying earnings grew by some 7.7%.Our reported NAV at the end of Q1 stands at EUR 48.34 (sic) [ EUR 84.34 ] per share, reflecting a smaller increase to the year-end number of EUR 83.81. You can anticipate a further boost to our NAV from the mentioned expected value uplift in Q2 and eventually, also in Q4.With that, I would like to hand over to Holger.

[Holger Hentschel]

Thank you, Thomas, and good morning, all, from my side. I'm starting with Slide 6, portfolio overview. As already mentioned, we had a comparatively calm start to the year regarding to our rent adjustments. We have a comprehensive bottom-up planning for rent increases and a clear road map for the entire fiscal year. Larger volume of rent adjustment based on several growth drivers, especially our modernization [ effort ], will become effective starting in Q3.Coming to Slide 7, rent development. Nevertheless, as usual, we would like to highlight just a few local markets to illustrate the unchanged sound underlying rent dynamics in our portfolio. In our high-growth market, we saw again a strong rent momentum in Düsseldorf with a growth rate of 3.8%. In the free-financed part, rents even grew by 5.3%. The resi area of Düsseldorf, we saw also very dynamic growth in Monheim with 3.4%. In our higher-yielding markets, we achieved a strong like-for-like rent growth of 3.4% in Duisburg and in Bochum with a growth rate of even 3.7%. Duisburg is a higher-yielding market according to our segmentation, very much benefits from the proximity to Düsseldorf, especially the southern part of the city where we at LEG are mainly exposed. This is a perfect example for us where the over effect from A cities to the commuter belts are becoming increasingly visible. As you know, LEG, with its portfolio composition, is a very beneficiary of this development.Coming to Slide #8. Our like-for-like vacancy stayed flat year-over-year at 3.3%. Last year, we reported that our internal reorganization was associated with some temporary frictions, which should not arise in 2018. Therefore, you can expect a decreasing ratio in the coming quarter. Traditionally, the seasonality in the winter months with lower leasing volume is regularly leading to somewhat weaker vacancy results. I, and this has not changed, feel comfortable with our guidance that our expect -- that you expect a slightly decreasing like-for-like vacancy ratio for the entire fiscal year 2018.On Chart 9, you'll find our maintenance and CapEx spending. In 2017, we invested around EUR 22.40 per square meter in our portfolio, and we stick to our guidance that this number should increase to some EUR 29 to EUR 30 per square meter in 2018. The capacity utilization in the German construction industry is currently at record high level, and therefore our industry cannot ignore that we are facing a certain cost inflation in this area. This is certainly a challenge we have to cope with.In the first quarter, we spent EUR 4.90 per square meter, reflecting an increase of more than 80% from a low Q1 2017 level. This increase also includes a significantly higher share of maintenance expenses. The CapEx ratio in the first quarter was slightly below 53%. In the remainder of the year, you can expect a higher share of value-enhancing, larger modernization measures. Accordingly, you can also expect a significantly higher CapEx and lower maintenance ratio in the coming quarters. Maybe as a help for your modeling, the CapEx ratio of roughly 70% is a fair indication for the entire fiscal year.So with that, I'd like to hand over to Eckhard for more insights to the financials.

[Eckhard Schultz, Chief Financial Officer]

Thank you, Holger, and good morning also from my side. Let's now have a look at the financial key metrics on Slide 10. As already discussed, the headline earnings numbers of the first 3 months were only very limited relevance for the underlying performance of the entire year. A lower volume of rent adjustments but comparatively higher share of maintenance expenses is weighing on the short-term earnings momentum. But as already pointed out, the positive outlook for the organic top line growth and margin expansion remains intact, although the risk factors coming from cost inflation have somewhat increased.Despite the limited relevance, let me give you some more color on some items in our FFO calculation on Slide 12. The increase in staff costs in our net operating income is largely attributable to the rising number of craftsman during the build-up phase of our craftsman entity in 2018 and to the hiring of additional people for managing our enhanced CapEx program as an important growth initiative. The cost ratio for personnel expenses managing our real estate portfolio was stable despite a wage inflation of 2.85%.On the overhead level, adjusted admin costs were nearly stable at EUR 8.7 million. We were able to fully compensate the effects from wage inflation and overall, personnel expenses eventually stayed flat, providing evidence for the productivity gains we are achieving and the scalability of our platform. Despite the mentioned risk factors, we expect a significant boost of our operating margins in the coming quarters, and we stick to our target to achieve an EBITDA margin of 74% in 2019. Moreover, LEG's FFO results benefit from further slightly reduced average cost of debt of 1.76% and lower interest charges despite the higher financing volume. As a result, we also reiterate our FFO growth targets.On Slide 15, you'll find the calculation of our current reported NAV. Our reported NAV, excluding goodwill, increased slightly on a quarterly basis to EUR 84.34 per share. Our portfolio yield has not changed over the quarter, and it stays unchanged at an attractive level of 5.9%, paving way for further yield compression. As you know, the next regular portfolio appraisal will be conducted in the current second quarter. On the back of the expected valuation uplift, you can already pencil in quite a significant NAV boost in our H1 results. I will add some more color on our H1 valuation and our business update later during this presentation.Moreover, I think it is still worth to mention that LEG's business offers additional value to its shareholders besides being just an asset-holding company. The services business is an important hidden gem. In a very simple calculation and without any growth assumption, you can maybe derive the value of this business of nearly EUR 6 based on an expected FFO of our services units of around EUR 16 million.Coming to Chart 17 and Chart 18. Our LTV at the end of Q1 stands at a low level of 42%. Over the last couple of years, with the further progression of the real estate cycle and the ongoing yield compression, we have steadily adjusted our LTV target downward. We presently view an LTV of up to 45% as appropriate for our business model. Given that we expect further value appreciation of our portfolio, you can also anticipate a further decreasing ratio in the short term. This gives us some general headroom for growth investments. We also see the one or the other potential opportunity for acquisitions. We currently consider an LTV of 40% as a kind of floor for us. Going below this level would probably be not efficient for our business model.The following slide, 19, gives you, again, the usual overview of our financing structure. It does not contain significant new information, though it still demonstrates that also [ after the partial ] early redemption of subsidized loans with loan maturities, we maintained a long-term secured financing profile with an average maturity of more than 8 years at a low average cost of debt of 1.76%.Let me now come to our business update with a summary on Chart 21. For our H1 portfolio revaluation, as already pointed out, we expect a valuation uplift of approximately 4%, equating to some EUR 370 million to EUR 390 million. The expected growth will be based on several pillars. Due to the steadily improving market fundamentals, we raised, again, our cash flow assumptions for the coming year and we will also apply a slightly lower discount rate in our valuation model. We clearly expect further capital growth also with our H2 revaluation, but it's currently too early to give you a more precise guidance.You can expect that the H1 revaluation will reflect the broad-based upswing in our markets with a somewhat lower short-term growth in our higher-yielding markets, which in our view still offers huge catch-up potential. The average rental yield of our higher-yielding segment as of Q1 stands at 7.4%.With that, I will hand back to Thomas.

[Thomas Hegel, Chief Executive Officer]

Thank you, Eckhard. We at LEG are primarily a cash flow-driven company, and we have a clear road map for the expansion of our leading FFO profitability based on a [defensive] balance sheet. In the last couple of years, we have done quite a lot to further strengthen our financial profile. We have optimized our financing structure. With a higher share of unsecured debt and lower share, especially of subsidized mortgage debt, we reduced the regular annual cash amortization. We used the value appreciation of our portfolio to steadily reduce the LTV. This now gives us financial headroom to distribute a higher share of our FFO to our shareholders and also to exploit selective additional growth opportunities. Accordingly, we have now raised our dividend payout ratio from 65% to 70%, starting with the dividend for fiscal year 2018.The growth opportunities I'm referring to are, among others, the enhanced CapEx program of EUR 80 million only for this year or for EUR 360 million in total for which we do not need additional equity but also external growth via acquisitions. The environment for acquisitions is and remains extremely challenging. The lower liquidity and the return requirements of certain investor groups currently make it very difficult to show value-accretive external growth. Realistically, we have to focus on special situations in the market where we have a certain special [ angel ]. I'm not overly pessimistic that such deals could come to the market in the second half of this year, but we would see whether such opportunities will materialize.Let me conclude the Q1 presentation summary our outlook for 2018 and 2019. We reiterate our FFO guidance for 2018 and 2019. For 2018, we expect an FFO in the range of EUR 315 million to EUR 323 million and for 2019 of EUR 338 million to EUR 344 million. However, I think it is fair to say that the risks for reaching or exceeding the upper end of the guidance range, which is always our ambition, have increased somewhat. This is mainly due to the mentioned cost inflation, especially with regard to our portfolio investments. On the other hand, as you know, our guidance does not include any effects from planned future acquisitions, which could provide a potential upside to our guidance.Ladies and gentlemen, thank you for your attention. With that, I'd like to open up the call for your questions.

[Operator]

[Operator Instructions] Your first question comes from the line of Chris Fremantle with Morgan Stanley.

[Christopher Richard Fremantle, Executive Director]

I just have 2 questions. The first is on the portfolio valuation. Can you just clarify how much of the portfolio will you have externally valued at the first half? Will it be the whole portfolio, or will it just be a portion? That's my first question. And secondly, I think you said in your commentary that the higher maintenance expenditure would contribute to the valuation uplift. I'm just wondering then why you would choose to expense that cost rather than capitalize it? I wonder if you can just comment on that, please.

[Eckhard Schultz, Chief Financial Officer]

Yes, Chris, this is Eckhard speaking. So on the valuation point, you know that we are doing an internal valuation, and usually we do 100% double check -- external double check by CBRE. We do that regularly on a year-end basis, but we also check that on the half-year valuation. So it's CBRE also has 100% look at our portfolio. So that's the first point. So I think you can expect that as usual, the deviation between our internal valuation and the external CBRE valuation will be or is negligible. And the second point, I haven't really got that point. So we have not said that the higher maintenance expenses have contributed to the valuation uplift. So that was not our statement because the higher maintenance, that's more reactive and that does not contribute to the value uplift.

[Operator]

Your next question comes from the line of Kai Klose with Berenberg.

[Kai Malte Klose, Analyst]

Just 2 quick questions regarding the maintenance spending. Could you indicate in which parts of the portfolio was it spent dominantly other than the high-growth markets, stable markets or higher-yielding markets? And as a follow-up on that, in which parts of the [ Swiss ] portfolios you expect just on the catch-up in rents and value uplift for the remainder of the year?

[Eckhard Schultz, Chief Financial Officer]

Well, to the first question, I think we allocated somewhat more maintenance into our recently acquired portfolios. So that was our clear intention that we bring that portfolio in line with our LEG standards, and therefore it was necessary to have a somewhat stronger allocation here. And going forward, strong rental growth, we do expect, in the higher growth and the stable markets. As you have seen in Q1, the like-for-like rental growth was more or less in line with a somewhat lower rental growth in the higher-yielding market. But going forward, we do expect strong rental growth in high-growth and stable markets.

[Kai Malte Klose, Analyst]

And the follow-up on the personnel expenses. You mentioned that there was a higher number of employees because you hired more craftsman. And can we expect a similar, if we look on a quarterly basis, a similar amount of personnel expenses also for the remainder of the year? Or was it Q1 artificially high because of the hirings coming into the company?

[Eckhard Schultz, Chief Financial Officer]

No, I think you can straight line the Q1 number.

[Operator]

The next question comes from the line of Georg Kanders with Bankhaus Lampe.

[Georg Kanders, Investment Analyst]

I have a question regarding the vacancy rate of 3.9% compared to the like-for-like went from 3.3%. This is mainly due to this acquisitions in the Düsseldorf north area. Is this a big discrepancy? And how fast do you expect to reduce here the vacancy in this newly acquired portfolio?

[Eckhard Schultz, Chief Financial Officer]

Georg, that's right. So the like-for-like increase is due to the Düsseldorf current portfolio. That's true. And according to our business plan for that portfolio, we intend to normalize that vacancy within 3 years. So it was an initial vacancy of 20%. Currently, after a few months, we are spending at around 15%, and we are going to further bring that down. And in our business plan, I think that's more conservative assumption. We will be slightly below 5% after 3 years, but again, conservative assumption, and we are working on bringing that even below the 5%.

[Georg Kanders, Investment Analyst]

And in this portfolio, there's also a quite high need for modernization spending as you bought it in the course of modernization. Was this right?

[Eckhard Schultz, Chief Financial Officer]

No, no. This portfolio, the Düsseldorf current portfolio, that was basically a fully modernized portfolio. I think we have discussed it in the last earnings call that the previous owner spent some EUR 400, EUR 450 per square meter. So the quality for this portfolio is quite good. So the maintenance -- the higher maintenance I had mentioned for the portfolio refer to other acquisitions.

[Georg Kanders, Investment Analyst]

So for this portfolio, there's no additional investment needs? That's all done?

[Eckhard Schultz, Chief Financial Officer]

Yes, it's all done. So I cannot exclude -- if there is a tenant turnover if the tenant moves out, but nothing from a CapEx perspective. So that's done, yes.

[Operator]

The next question comes from the line of Marios Pastou with Crédit Suisse.

[Marios Pastou, Research Analyst]

Very quickly on the investments on the maintenance. You mentioned the higher staff inflation that's going across Germany at the moment. I just wondered if that's baked into your numbers on a square meter basis or whether we could see potential for this number to increase as staff inflation cost continue. And then secondly, you mentioned the limited investment potential in your current markets, and I just wondered if there's any potential you could look outside of NRW for future portfolio investment.

[Eckhard Schultz, Chief Financial Officer]

Your last question refers to acquisitions?

[Marios Pastou, Research Analyst]

It does, yes, sorry. I apologize.

[Eckhard Schultz, Chief Financial Officer]

Yes, yes, okay. Maybe I can start with the last question. So we never excluded -- or we have never limit ourselves to the regional borders of North Rhine-Westphalia. You know that we are thinking in terms of platform, and if you will draw a circle around 1,500 kilometers around North Rhine-Westphalia, we can also acquire in [ Lower Saxony and Rhineland-Palatinate in Hassloch ]. So that's our intention. But its's also clear that a step outside NRW would be only justified if we would find a portfolio with a decent size, which we currently do not see in the market. So we look at the entire German market. But again, outside NRW, a decent size will be necessary. What is a decent size? I would say north of 5,000 units is a minimum. And to your second question, sorry, what's -- can you say it again, please, your first question?

[Marios Pastou, Research Analyst]

It was just on the investment and maintenance spend. You mentioned that there was quite a lot of staff inflation going across Germany in relation to this. So I just wondered if that's already included within your numbers, your expected spend, or whether this has got a potential to increase in the future.

[Eckhard Schultz, Chief Financial Officer]

So what we did basically, and I think we said that a few months ago, that we have [ calculated it ] with an inflation of 2% to 3%. So that was roughly in our numbers. And today, we see that it is more 5% to 6% or delta of some 3 percentage points. I think you have to differentiate. And as long as CapEx is affected, we can still charge the inflation onto the tenants. But for maintenance cost, however, there's a smaller negative earnings impact of perhaps EUR 1 million or EUR 2 million. It is not that much as maintenance only accounts for around 1/3 of our total investments. So we guided for CapEx ratio of 70%. But it's true, the cost inflation will make it more difficult to reach or to exceed, as Thomas said, the upper end of our FFO guidance, as we did in the past. So that was just our statement.

[Operator]

[Operator Instructions] There are no further questions at this time. I hand back to Burkhard Sawazki for closing comments.

[Burkhard Sawazki]

Ladies and gentlemen, thank you for your participation. As you know, the IR team and I are available also after the call to answer your questions. So please feel free to give us a call or send us an e-mail. Thank you, and goodbye.