LEG Immobilien SE

XETRA:LEG

Earnings Call Transcript 2019-Q1

[Operator]

Ladies and gentlemen, thank you for standing by. I'm Ira, your Chorus Call operator. Welcome and thank you for joining the LEG conference call. [Operator Instructions]I would now like to turn the conference over to Mr. Burkhard Sawazki, Head of Investor Relations. Please go ahead, sir.

[Burkhard Sawazki]

Thank you. Good morning, everyone. This is Burkhard Sawazki. I am glad you could join us today for our Q1 earnings call. Our management board members, Lars von Lackum and Eckhard Schultz will guide you through our presentation and give you more insight on our first quarter results and our business outlook. As usual, this will be followed by Q&A session. With this, I'll hand over to Lars von Lackum.

[Lars Von Lackum]

Good morning, ladies and gentlemen, also from my side, and welcome to our first quarter earnings call. As announced in March, Thomas will step down as CEO after our AGM on May 29, so that Eckhard and I will guide you through the figures today.We released a good set of figures this morning, showing us on track to reach our full year targets. We can also guide for further significant capital growth this year with an expected valuation uplift of some 5%, with our interim valuation in Q2 and more to come in Q4. This certainly proves that the fundamentals in our sector remain positive and that LEG's strategy is paying off. Nonetheless, we believe that a successful company should always challenge its strategy and look for further opportunities.In this context, we started a strategic disposal program. The program focuses on noncore assets in more peripheral areas of our portfolio. The sales process is well underway, and we have actually increased the volume to around 2,700 units due to a favorable demand situation.The plan failed following a strategy rationale to streamline and optimize our portfolio structure. As I already pointed out in our last earnings call, we have started a strategy review process in Q1. It is still early days, but I would like to give you some insight into the comprehensive process that we have initiated. We believe that on the acquisition side, we could perhaps become slightly more opportunistic outside our core region, North Rhine-Westphalia. We are experts in managing assets in B as well as in C cities very successfully, and we recognize that these markets and the big commuter belts are benefiting more and more from positive spillover effects.We expect further attractive upside in these market segments and we can take advantage by leveraging our superior knowledge exactly in those locations. However, we will make no adjustments of our acquisition criteria, so that sustainable value creation for our shareholders remains our core focus.Another element of our value process is that we are examining the opportunities from the acceleration and expansion of our development activities. This might include in close cooperation with the municipalities in North Rhine-Westphalia, the acquisition of lands to address the shortage of housing in some cities. Please bear in mind that we have just started our analysis, however, I felt obliged to share first that news with you already. I will further elaborate on this within today's presentation.Let me now summarize the operating and financial highlights of the first quarter. Our like-for-like rents grew by plus 3.1% overall and in line with our full year guidance. The free finance part of our portfolio, which reflects the actual underlying performance even grew by plus 3.9%. The like-for-like vacancy slightly increased by 10 basis points year-on-year, which is mainly the temporary effect of a somewhat higher tenant turnover due to modernization measures. We still expect a slight decrease of the like-for-like vacancy by the end of the fiscal year. Our investment into the portfolio rose significantly by 17.1% to EUR 5.74 per square meter in the first quarter.Coming to the financials. Our FFO I increased by 14.4% year-on-year, also on a per share basis and was driven by sound rental growth and margin expansion across all lines. The pro forma NAV per share, the NAV after simulated, executed conversion of our 2021 convertible, slightly increased by 1% to EUR 94.37. As already indicated, you can expect a decent NAV growth with our next appraisal in Q2 and Eckhard will give you more insight on this later during our presentation.On Slide 6, you can gain a deeper look into our operating performance, the rent development per market. All in all, the in-place rent in the LEG portfolio rose by 3.1% on a like-for-like basis, and is therefore in line with our full year guidance. The free-financed units, which currently represent around 74% of our portfolio increased by as much as 3.9% like-for-like, continuing the very positive trend we saw in the past.And again, we can see a positive momentum in B and C locations. Those segments have shown a similar development with plus 2.9% rent growth in the stable and plus 2.8% growth in the higher-yielding markets. We witnessed the strongest growth in the high-growth markets which also benefited from the modernization program. Like-for-like vacancy was nearly flat, up 10 basis points on the previous year. Modernization measures triggered some higher tenant turnover in the one or other assets and in Duisburg, which is my hometown, and our largest higher-yielding market, we adjusted some of our processes, which has caused a temporary vacancy effect.For the fiscal year 2019 as a whole, we reiterate our forecast of a slightly rising like-for-like occupancy rate year-on-year.The positive rent development in our markets, which you can see on Page 7, is based on the strong performance of important locations in our portfolio. In the high-growth markets, the highest increase was in Cologne, with plus 4.4% like-for-like and in Monheim with even plus 6.4% like-for-like. Monheim, which is located between Cologne and Düsseldorf, has benefited from the modernization program. There is also an ongoing dynamic growth in the Westphalian region, with Gutersloh recording a plus of 8.2% like-for-like, or Bielefeld with a decent 4.1% increase like-for-like. For the remainder of the year, there is potential from the recent new Mietspiegel for Münster, which moved up by 4%, and we also expect that the new Mietspiegel for Düsseldorf will be released shortly. In the stable market, Mönchengladbach showed the strongest growth with plus 4% like-for-like. For Dortmund, while rent increased by plus 2.8% like-for-like, there is larger potential from a recent new Mietspiegel that increased by around 8%. The purple markets' overall the development was similar to the green markets with plus 2.8% like-for-like rent growth overall. We had a strong increase of plus 4.1% like-for-like in Duisburg, also driven by the modernization program. In Gelsenkirchen, rent rose by plus 3.5% like-for-like.And this concludes my remarks on the operating key cities, and I will now hand over to Eckhard.

[Eckhard Schultz, CFO & Member of Management Board]

Thank you, Lars, and good morning, everyone, also from my side. Lars has already mentioned the modernization program.Let's have a look at Slide #8 for more details on our investment. In Q1 2019, total investment rose by roughly 20% to some EUR 50 million, over 17% to EUR 5.74 on a per square meter basis. This was largely driven by higher value enhancing CapEx. You know that there is a certain seasonality and that traditionally, a higher share of value enhancing modernization measures will be executed in the second half. I can confirm our guidance for total investment of EUR 30 to EUR 32 per square meter for 2019.The CapEx ratio rose significantly to 59.4% in the first quarter and will increase to roughly 70% for the entire fiscal year. I was often asked if the new regulation would have an impact on our CapEx plans. Following our internal analysis, we do not see a need to cut our long-term modernization plan. We were and are not overly aggressive as we closely take into account the paying ability of our tenants. Actually, we are currently thinking about an extension of our CapEx program in the years to come.And now I would like to give you some more insights on the financials. At first, let us have a look at the financial highlights on Slide #10. The adjusted net rental and lease income rose by 11.1%, and therefore considerably stronger than the net cold rent. This results into an adjusted NRI margin of 76.8%. And although we have to consider that the maintenance ratio in the previous year was exceptionally high, the NRI margin clearly reflects our ongoing efficiency gains, so does the EBITDA margin, also supported by stable admin personnel costs despite wage inflation.Thanks to our progress and process optimization, we can cope with the challenges from cost inflation and therefore, our sound rental growth translates into further margin expansion across all P&L lines. Accordingly, we can also stick to our guidance of an EBITDA margin of around 73% in 2019 and 74% in 2020.On Slide 11, we prepared the usual calculation of the FFO. On the NOI level, the rise in staff costs is largely attributable to a higher share of in-sourcing of maintenance work, which was offset by a lower amount of externally procured services. On the admin level, we were able to keep staff costs stable despite wage inflation. And we are demonstrating further visible progress on the efficiency side, which is a material part of our bottom line growth stories. In addition to an increase in NRI and EBITDA margin, the FFO also benefited from a further reduction of interest cost, thanks to our refinancing. That is why, despite a higher debt volume, cash interest expenses were slightly below previous year. Our interest coverage ratio, which means adjusted EBITDA to cash interest expenses, improved accordingly to a high level of 560% compared to 490% in Q1 2018.All in all, LEG is well on track to continue its earnings growth path in the coming years despite the dampening effect of further cost inflation, especially for craftsman and a stricter rent regulation.On Slide 14, we present the calculation of our pro forma NAV according to the schemes that we introduced at year-end 2018. You know that we apply this calculation method in order to provide a maximum transparency on potential diluted effects from the conversion of the EUR 300 million 2014/2021 convertible. The pro forma NAV rose by 1% to EUR 94.37 at the end of Q1. This equates to comparatively attractive rental yield of our portfolio of 5.5% and to a still low book value of around EUR 1,200 per square meter. The NAV will further benefit from the positive effect from the interim portfolio revaluation, which we will once again carry out in Q2.Let me give you a first guidance for this. We expect that the remeasurement will result in a value uplift of the portfolio of approximately 5%. I will add some color on this during our business update.Coming to Slide 16 and 17. Our LTV at the end of March 2019 stood at a low level of 40.1%. We are, therefore, well within our target LTV range of 40% to a maximum of 45%. We still consider this range as the most appropriate for our business model. Currently, we have a firepower of around EUR 400 million to EUR 500 million for growth investments. In this context, you should know, despite our low LTV level, we do not intend to aggressively gear up the balance sheet with further yield compression.Coming to the financing structure on Slide 18. At the end of Q1, our average cost of debt stood at 1.62%, with an average remaining maturity of 7.5 years. The overall debt volume stood at nearly EUR 4.2 billion, of which, only EUR 1.2 billion relates to capital market financing and the lion's share consists of mortgage financing. Since last year, we are seeing a situation back to normal, with credit margin for secured mortgage financing again being significantly below the terms for unsecured financing. Therefore, our financing strategy showed better competitive advantage with regards to cost of capital across the cycle. As you know, there is a call option for our 2014 and 2021 convertible becoming effective in July this year. It has not yet been decided whether we are going to exercise this option. This is very much a function of the outlook for external growth. We observe some slight pick up in supply on the investment markets and therefore, there is certain probability for an early conversion, but again, this is an open question and it depends on the growth opportunities and here we are still cautious in this respect. This concludes my general remarks on the financials and we are now coming to our business update.I would like to add a few more words on our H1 portfolio revaluation. The appraisal process has well advanced, and as already mentioned, we anticipate evaluation uplift of -- in Q2, of around 5%. This translates into IFRS gains of some EUR 520 million to EUR 550 million. Value drivers are further catch up effects in B cities and the commuter belts. Additionally, there are also some lagging effects from the strong price development in A cities, which are now feeding through in the portfolio valuation.German resi remains a widely sought asset prize. Prices continue to rise, except for poor-quality assets, which we consider to be a good sign that the market is still in a healthy shape. Accordingly, you can also expect further yield compression at the year's end appraisal. I guess it is fair to say that the LEG portfolio, with its high exposure to the attractive commuter belt of the economic center, is ideally positioned at the current stage of the cycle.With that, I would like to hand over to Lars again for his comments on our disposal program and our strategy review process.

[Lars Von Lackum]

Thanks, Eckhard. Let me start with stages of our disposal program. Maybe to give you some more background, we intend to sell part of our portfolio where we believe that we are not the best owner for these assets. These are typically properties in more peripheral locations, which in our portfolio structure, carry a below-average profitability. Hence, the planned disposals follow the rationale to further streamline and optimize LEG's portfolio structure. Unfortunately, we cannot provide many details as we are still in the final negotiation phase. However, due to the good demand situation, we have increased the total volume of the sales package to now nearly 2,700 units.In light of our strong balance sheet, we are going to utilize the proceeds for growth investments, i.e., for portfolio acquisitions. We have the clear intention to remain a net buyer. And after a very calm start to the year, with hardly any supply in the market, we observe a slight pickup in activity in the investment market. We are currently working on some smaller deals, but there are first indications for the one or other mid-sized deal, which might come to the market in the course of the year. However, the potential outcome is still uncertain. We have already highlighted in our last earnings call that we have started a strategy value process, which is still ongoing. It should be no surprise that external growth will remain a key pillar for our growth strategy.Please excuse me for stating the obvious, certainly, it is all about value accretive growth. Looking at the German residential market, we believe that especially B and C cities, with the yields you can find there, can offer a superior risk-return profile always depending on the quality of the micro locations. In our view, there is a structural trend that B and C cities in the catchment areas of the economic centers will continue to benefit from positive spillover effects and therefore, they are in our focus. We believe that there is still potential to grow in good locations of B and C cities, but we are still reluctant to invest in very opportunistic micro locations in those markets. This is different to A cities, where we would clearly have a preference for secondary micro locations. With our return requirement, it is difficult to generate value with a defensive core asset in an A location of an A city, at least not a buy-and-hold approach. It is the core expertise of LEG to manage properties with higher yields, that means to achieve a best in class letting performance, in combination with a high efficiency. In this context, we are also thinking about becoming slightly more opportunistic and we are analyzing the potential of broadening our geographical scope outside of our core region North Rhine-Westphalia. That does not mean that we are going to dilute our investment criteria that we have defined in the past. It remains absolutely crucial that there is the chance to build up a critical scale in any new market.However, I would like to emphasize, we are definitely not going to start chasing portfolios in highly competitive markets such as Berlin, Hamburg, Frankfurt or Munich. Another source of additional growth we are currently internally discussing, could be the acceleration of our development activities. Our current development pipeline for the coming years comprises around 1,000 units. With our very broad presence in the market, this could be boosted by developments on purchased lands. You have seen the political discussions in the daily press and sometimes in our view, at least, irrational political debate regarding the German residential market. The only viable solution for tight rental markets in metropolitan areas is new construction. We, at LEG, understand our responsibility and we are willing to take it. As we do among other things with our investment into energy efficiency in our existing efforts. We would like to build more homes, but we are still facing major hurdles. The most important ones are availability of land at reasonable prices and the complexity and speed of approval processes. We need further improvement of the regulatory framework and the support from the local municipalities.As usual, I would like to conclude our presentation with a financial outlook. We reiterate our earnings growth targets for 2019 and 2020. Let me quickly repeat the figures. We expect an FFO in the range of EUR 338 million to EUR 344 million for 2019. For the year 2020, we expect a range from EUR 356 million and EUR 364 million. As you know, our guidance does not include any effects from future acquisitions or disposals.Unlike in the past, this chart does not contain an FFO per share guidance. This is not supposed to cause any irritation, but as discussed, a rising visibility on the acquisition side in the coming months may trigger an early conversion of the mentioned convertible. In such a scenario, we cannot rule out a temporary diluted effect on a per share basis. However, we are still very cautious. It is still a very realistic option that we keep the convertible outstanding for the time being. Ladies and gentlemen, thanks for your attention. With that, I would like to open up the call for your questions.

[Operator]

[Operator Instructions] The first question is from Charles Boissier from UBS.

[Charles Boissier, Director and Property Analyst]

I just had a few questions. So you mentioned you're reevaluating the regional focus when you say outside of North Rhine-Westphalia. I just wanted to check -- apologies if you made clear somewhere in the presentation, but is it outside of North Rhine-Westphalia and inside of Germany for sure? Or is it still part of the strategic review? I think also you mentioned that in the past, critical mass was around just 5,000 unique market, just wanted to double check, that's kind of the rough starting point in term of critical mass? And then you talked quite a bit about A cities outside of North Rhine-Westphalia, at the same time you ruled out, I think, Berlin, Frankfurt, Munich, Hamburg, sort of the top 7. Would you be able to just tell us what's A city? Is it a specific definition? Or is it just one of the largely populated area in Germany? And then you mentioned the strategy review is still ongoing, it's still very early days. Just wanted to know what's still on the table from your perspective?

[Lars Von Lackum]

Thank you, Charles, for your questions. So I will try to do my very best to answer all of them and if I miss something, just please, we do a second round. So first question was whether we are searching inside or outside of Germany. Certainly, if we are spreading our regional focus, we do it step by step. So the first focus will be inside Germany. Certainly, we will also look at the adjacencies, like the Netherlands, but this is not something which is our immediate and strategic focus. We are focusing first on Germany and there on the adjacencies, so -- because we have a strong and solid footprint in North Rhine-Westphalia and from there we will spread our focus.If we talk about critical mass, the further we are going away from North Rhine-Westphalia, the higher the demand for critical size. The closer we stay to North Rhine-Westphalia, certainly, the lower the demand for the size we need to be able to manage efficiently. So therefore, we will do more opportunistic deals in the close proximities to North Rhine-Westphalia and to the locations we already have outside of North Rhine-Westphalia, but if we go more than a distance of 200 to 250 kilometers from where we are, then definitely we will need to look for critical size.According to the A cities definitions we have, it is the major cities which have a positive momentum on development with regard to population and growth and purchase power. And I just mentioned those which obviously have been excluded from our pool and focus due to the developments which we have seen and which currently, from our perspective, does not offer them a proper risk-return profile and which should add value for our shareholders.The further topics which are on the table, I think, one we have tabled today, it is the development part. From our perspective, this is something which we can do more and this is not driven by just political considerations, but more by the strong need in most of the cities we are based in North Rhine-Westphalia and the strong demand there and the push for additional rental space. And this, we are willing to match with the -- if we are able to identify property and land at reasonable prices.

[Charles Boissier, Director and Property Analyst]

Can I just follow up on one point on development. I think you, obviously, have a clear particle on modernization. Just wondering, how about new construction, would you bring a skill set in-house with the Q on staffing? Would you be in a position to start ground-up housebuilding at this point?

[Lars Von Lackum]

I think we have a very good qualification within our house. So we used to do new buildings and new development and certainly, we will leverage on our modernization expertise we also have in-house. So I think we are well prepared to expand from there, but certainly, it would just require additional investment, also upskilling the qualifications we have in-house if we want to increase from 1,000 units to a higher number.

[Operator]

The next question is from Kuin, Jaap from ING.

[Jaap Kuin, Research Analyst]

This is Jaap Kuin. Just a question on the slightly political debate. Obviously a lot of focus has been on the Berlin discussions, but could you maybe offer your view on the more local debate on Mietspiegel and then general housing conditions in the North Rhine-Westphalia, including perhaps the willingness for municipalities to increase developments? That would be my first question.

[Lars Von Lackum]

Thanks for your question, Jaap. So the political-local debate, I think, is very, very different to the one we see in Berlin. So we have right liberal government, state government here in North Rhine-Westphalia, which is doing its utmost to help to find joint solutions. So we, as LEG, are in constant contact and we can see already first positive signs not only on a state level, but also within the communities to help us to jointly identify solutions, help to identify additional projects in order to help the current situation to stay calm, but once again, we see already very good signs. This has not materialized in as much land at reasonable prices we had hoped for, but the first contacts we had are raising and helping us to have the hope if we are continuing on this way, we are identifying more options to also do more development.

[Jaap Kuin, Research Analyst]

So does this -- does that suggest a rather shorter lead times for development? Or more stable lead times to development, but maybe more both? Is that -- what's the right way to interpret this?

[Lars Von Lackum]

Honestly, it's still a political discussion. So -- and we are in discussions with the communities based on the buildings we had there on a regular basis, and so we are not starting -- while others have trust issues, we don't have those. We have a trusted relation towards the communities and this, I think, is a sound basis to grow our portfolio. The timing effect still is an issue. Regarding building permissions, zoning, and other stuff, but we are addressing this. And we hope that a continuous dialogue will help to also raise understanding for a quicker decision times within the municipalities to enable us to build more.

[Jaap Kuin, Research Analyst]

Okay. And the final question on rent reversion. You quoted some Mietspiegel data, for example, Dortmund up 8% versus your like-for-like of around 3%. How would you say that your rent reversion potential has evolved or will evolve towards the end of 2019?

[Eckhard Schultz, CFO & Member of Management Board]

Well, I can take this question. So I think the delta between market rent and in-place rent, that is unchanged around 8%. So it has not changed significantly, yes? And if I add some aspect from what Lars said regarding the political situation, please bear in mind that we have 26% of our portfolio which is rent restricted and that with the 74% free-financed, we are less exposed in the heated metropolitan areas. So I think with our portfolio structure, we are, of course, affected by the political discussion, but to a lower extent compared, for example, in Berlin. I think that now comparatively advantage in the current political debate.

[Operator]

The next question is from Jonathan Kownator from Goldman Sachs.

[Jonathan Sacha Kownator, Financial Analyst]

Can you -- on development, could you perhaps help us on this on a bit more the matter we're looking at for development. What kind of development costs you're indulging in terms construction? What does that mean in terms of the rent that you would need to charge to get a decent return on development? And do you have opportunity to be on your land bank to get longer attractive prices so that actually the math works because it strikes me that, obviously, given the level of rent that you have in place, it's fairly low, so the level of rent that you may have to charge on the development would be substantially higher. So if you can comment on that, that would be helpful, please.

[Lars Von Lackum]

Thanks, Jonathan, for the question. So currently, I think we have elaborated on this during the last call already, so we see average building cost per square meters at around EUR 2,200 to EUR 2,400, and we are not doing any modular development, that's stone and stone and individual because we think it has an advantage to be focused on the different neighborhood as well as the requirement of each city. And with regard to the land prices, I think, it will be highly unreasonable to state any prices because the range we are seeing is very diverse, and also with regard to the communities we are building in, there are different requirements with regard to publicly subsidized and state-subsidized units. So the current project we are looking at in Cologne has 30% state-subsidized units, 70% will be free-financed. The free-financed units come to the market at around EUR 10 per square meter and this is a typical project we are envisioning. But once again, it always depends on the land price and there the range is quite big and it would be highly unreasonable to state any range in the current market environment.

[Jonathan Sacha Kownator, Financial Analyst]

And so what return do you think you can achieve on development on the gross basis then given these numbers? And the requirement to have, obviously, a part which is not free-financed, what returns are you guiding?

[Eckhard Schultz, CFO & Member of Management Board]

It's around 4.5% yield on cost in a mix calculation between the subsidized and free-financed, all pre-market rents.

[Jonathan Sacha Kownator, Financial Analyst]

All right. And do you see any opportunity? Obviously, you're talking about collaborations with local authorities, then do you see opportunities where land could come at attractive conditions from local municipalities? We assume that they own any, and by attractive, I say, attractive to very attractive. Let's put it this way.

[Lars Von Lackum]

Yes. We see affecting those opportunities, and based on our reach within North Rhine-Westphalia, I think, we are ideally positioned to take advantage of this and therefore, we have invested heavily in starting those talks. They have not materialized now in very substantial acquisitions, but I'm quite hopeful that if we are continuing those talks, we will be able to realize more development in the communities we are active in and which are growing.

[Operator]

[Operator Instructions] There are no more questions at this time.

[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 email. Thank you, goodbye.

[Operator]

Ladies and gentlemen, the conference is now concluded, and you may disconnect your telephone. Thank you for joining and have a pleasant day. Goodbye.