Baltic Horizon Fund (NHCBHFFT) Earnings Call Transcript & Summary

Hello, good afternoon. This is Tarmo Karotam, Fund Manager at Baltic Horizon, and would host the webinar of the third quarter to give an overview of the fund's third quarter results and talk about the situations, the events that are happening in the fund. So let's kick this off. As usual, 30 to 40 minutes presentation, and then open to questions, which I will then address afterwards. I will also try to already address some of the questions that were asked before the webinar as we go along with the presentation. So the main events for us in the third quarter were related to our refurbishment projects. And mainly, we have fully completed the refurbishment of the Europa shopping center, and as we like to call it, more a community center. And we have totally turned around the ground floor and refurbished the facade elements as well. In regards to the tenants, yes, we have a food hall, which has 10 different food outlets, and I'm very happy to say that's working very well. On the other side, we have Huracan cafe and another cafeteria that offers busy business people in the area in the city center [indiscernible] morning snacks and lunches and evening drinks as well. So generally, we're quite happy with the results. And as well, Meraki first tower completion took place and over as well. Its first building is fully operational. We had also an opening event there and now it's in the same -- as you know, in the same vicinity as we have our Domus Pro complex, so it is now a big complex of office and retail mixed-use complex in Vilnius. And I will give more details about this later. Also, as we are preparing for the refinancing of the bonds, as everybody knows the term is May 2023, and we have for that engaged as well Standard & Poor's to give us a rating, and they have confirmed this also at late summer, so our rating has remained unchanged. And furthermore, what happened in the third quarter that we got back our GRESB rating scores, which is just a sustainability benchmark. So I'd be happy to say that we've made some progress there, not only trying to make our -- or making our properties more efficient, but also focusing on the processes that we have in place and upgrading them to a level to a level where we were able to receive 4 star rating. There's still a lot of work to be done there, but that's definitely good progress for us. And there's last but not least, for the past quarter and as well in the fourth quarter, we are working on prorogation of many of our loans, mostly office building loans. So that is definitely a work in process. To comment on the portfolio. So generally, the quarter was relatively, let's say, relatively as predicted. And overall, maybe a big change here is that we have included now Meraki in the -- in these tables -- in the occupancy rate table. So Meraki currently is about 24% leased. We're working on an anchor tenant. So that should definitely increase the NOI and the occupancy and the yields of the property. So our plan was -- and what we did last year, we sold State Forests building and sort of changed State Forest Meraki a brand new building, BREEAM excellence certification that was just finished. So we have some tenants already moved in. Now in regards to the yields, there are property yields that one can see here. We definitely expect much more improvement in both Galerija and the Europa center as well in Postimaja. And mainly while the yield has been still so low and especially in Europa and Galerija is ongoing reconstructions that we've had there and that's why we have to sort of complete them before new tenants could move in. So already now you could see that, Europa's occupancy is increasing and would be increasing further in Q4. I'm also happy to say that all tenants that have moved in, in terms of turnovers they have done better as well as they expected, but is also better than expected. So that's -- that gives us good comfort about the concept change that we're definitely on the right track. So otherwise, yes, relatively stable. We have prolonged many leases, maybe also look at and show the NOI development and comparisons. So as one can see, most of our properties developed very positively. And in -- I think worth commenting here is Europa. And we received less rental income than we expected and that was, again, mainly to do with the reconstruction also some discounts that we had to give to some tenants because of the reconstruction and areas that were not well accessible to the people, but we definitely see Q4 to be an improvement here and as well next year. Overall, we have been indexing rents. And I think yesterday, we had an announcement about October. And of course, these results show up until September. But yes, with the improvement of occupancy and indexation, the rental increase was quite notable. So we're quite happy that finally, the numbers are starting to show some evidence of the results. So overall, the portfolio is in the same shape as it was before. We have most of our assets in Lithuania and Latvia, so no -- we haven't made any acquisitions. We are still having a retail office portfolio. And when it comes to the anchor tenants, then they are still the -- it's the anchor tenants. And there was a question about what -- are we planning any changes in the portfolio. And yes, I think we have said it openly that we are in the process of selling Lincona and as well Sky. So the time -- the process has taken a bit more time than expected, but let's say, negotiations are ongoing, and we expect to finalize those still this year. So that's definitely the goal. We're working on potentially another sale of a smaller property. But I think more news will come to that when this is made public. So effectively focusing on the city centers, that's what our goal is, and on our strategic assets. So more details about the main events in our properties, and especially with our tenants. And I think a change that we had, which is also notable is that Newsec property management. They are the most well-connected, let's say, property management company has taken over Europa's management as of 1st of November and at the same time, several lease deals and material terms have been signed. For example, Sportland, we prolonged in Galerija Centrs. They expanded from the fourth floor where now the new food hall is coming. They moved to the third floor, so destination -- future destination on the third floor. And as well in Galerija, we are employing on stages of signing a new international anchor tenant for the properties starting from third quarter next year, opening the doors. And when it comes to Postimaja that we opened the pharmacy and ongoing works are for a brand-new and World Cup fare, which is also an expansion to the street level. So all of this, we believe, makes properties more lively again and definitely increases the footfall, but also overall retail spending. So what's interesting to see in the shopping centers today is that, the tenant visits -- sorry, the footfall hasn't yet reached the 2019 levels, but turnovers have. So yes, tourists are not all back and still some aftermath of COVID happening. But, yes, the turnovers are back to 2019 levels. And that's probably to do with some inflated or inflation in terms of the products and services that are being sold, but also that people are visiting less and spending more. That's definitely the trend across the board. And then quite a few interesting tenants in Europa, which I didn't mention before was, for example, a retailer -- an electronic gadget shop, so not selling washing machines, but rather gadgets -- electronical gadgets for everyday use of office workers. So that has opened very successfully. And as well Odore D'amore, new concept, so it's sort of a beauty salon, sales makeup products and at the same time has a bar. So definitely worth a visit when in Europa. And then a few other expansions and extensions like MyFitness and dental clinic and erect a Red Cross office sort of outlet that we brought to the third floor of Europa, but they also service customers. And especially during this time in the world, they found a good location in our AR shopping center. Then, yes, Domino's Pizza, I didn't mention. This is a tenant that we would like to introduce to Sky next year -- probably in the second half of next year. And overall, lots of work with tenants to prolong leases -- prolonged several releases and in -- when it comes to the office segment and the North Star, we have filled in the vacancy 1,000 square meters that was due to the -- due to some premises given back by the Lithuanian tax authority last year. But now that is almost fully leased out. And I think another notable event for us is one of our assets, cinema building in Tallinn that was in the Postimaja complex, the tenant has changed. So Apollo Group has taken over this property with their operations. And now the Dark (sic) [ Black ] Nights Film Festival is happening and people are visiting the cinema increasingly a lot. So the plan with the Postimaja complex is to expand -- Reval Cafe and the anchor tenants are thinking there be, let's say, rejuvenation plans, which they plan to work on next year. And the cinema building, our plan there is to work together with Apollo on the ground floor to bring in some additional tenants over the next year to make this a real entertainment -- and entertainment center at least for -- but also for sort of good services and some fashion. So more words about Meraki, it's also pictured here. So we decided to do the first tower first and that's now been completed. So that included as well a large underground parking, which we have also completed. So the second tower currently is not built and will be built only if we find additional anchor tenants. But we have tenants already moving in Meraki, which is a clinic, IT company also, a financing company and moving also a bank and several tenants already moved in and starting to pay some rent now in Q4 and going forward. So we do expect -- maybe one thing I did mention, we made some sort of analysis. And for example, our portfolio yield current is around 5%. And with now the increased occupancies that we foresee both in Europa and Galerija after the reconstruction is completed, also, Meraki turnovers and some indexation, that our goal is to achieve -- when our portfolio is in sort of close to fully leased out and the portfolio yield can increase up to 6.5%, but maybe even higher. So that's our definite different goal and to continuously increase the portfolio yield by operations. Some pictures of Meraki. And yes, it's a brand-new building with the park in front. So very happy to have completed it. And as well Newsec is -- let's say, seeing us together with CBRE with the anchor tenants. We have participated actually in several -- in 2 tenders where we have got the second place, but there are tenders upcoming and we'll continue to participate in them once we get property filled out. It's definitely the most -- the highest quality building in this area, so still some pictures. Now I think latest news was also that -- we shared some visualizations of how Galerija Centrs' the fourth floor food hall will start to look. And one picture is seen also here. And we have worked on the name of the new food hall in Europa and it was called Dialogai. And in Galerija Centrs, it would be called something else, maybe too early to still say it here. And the construction works have started and it's going as planned. So beginning of first quarter, we plan to open it. And let's say that the big opening probably in April, beginning of the spring. It is half of the first floor and also a small tariffs will be included there. So there will be a different type of -- so in terms of tenants, we have actually signed up 90% of them already, and half of them are grab-and-go tenants, but half of them are also stay in dine sort of tenants. And we expect to have an offering throughout the day, the breakfast, the lunch dinner and definitely make it a destination on its own in Riga Old Town and there's no really food hall in this level in Riga today. And I have a few more pictures of the Europa refurbishment that was just finished. And we also with the -- with new escalators and the -- my amphitheater and [ Dali ] cafe and bakeries and coffee and cakes, very popular. So some more pictures on the Galerija Centrs' food hall and we aim to complete it pretty much as it is in the future. So now a bit more about the numbers and where we are today. So in terms of our portfolio and when we were hit by the COVID lockdowns into 2020 and '21, then much of the work has been to rejuvenate our centers, and it has taken a bit more time as spoken before Galerija, and Europa. So by the end of this year, we have completed our investment program fully and beginning of next year in the Galerija food hall. So in that sense, the investment program as such -- yes, has ended. So we have focused and we will see more improvement now in the NOI next year because of this contract signed. And currently, I think for this year, we expect similar NOI than last year. And regardless that G4S was sold last year, and it's not contributing to the NOI this year. So there's already has been an improvement about EUR 1 million. And for next year, with this portfolio that we have, we forecast the NOI to increase to EUR 19 million based on the contracts and what we see today in our portfolio. So I think that's something important to consider. And it's definitely for us a realistic goal given the current circumstances. We estimate the gross asset value and the valuations to remain quite stable by year-end. Yes, there is a push on one hand with discounted cash flow valuation, but the discount rate, whether that will change a bit or not. But on the other hand, indexation of rents, that's definitely a balancing act, setting off. So I think the valuations should remain quite stable. We are indexing our rents. I think everybody in the real estate -- commercial real estate market is doing that. And as we have various lease agreements the, let's say, many of them have European Union CPI and that inflation in the European Union is, what, 8%, 9% today. But many of them are also local CPI contracts. However, some of them do have caps around 5%, but some don't. So it's a big mix. But we are definitely indexing as much as we can. And I think that's also represented in our NOI forecast for next year. A comment here on the net rental income and probably cost of rental activities that it was much higher than comparatively last year. And this is mainly to do with uncovered owners cost to the vacancy in Europa and Galerija. Those vacancies also had utilities to be used and that when the premises vacant and the owner has to pay for it. So also in August, when many of the vacancies were placed still, the energy prices, especially the electricity price and especially in Lithuania skyrocketed. So that was a considerable amount that was sort of increase in the owner's cost, and I think that's represented here. What I see now is because of the different support measures across all politic states for private citizens and as well for companies and for our tenants as well. So I think it has calm down, a bit the situation, and the big fear of nuclear winter and energy prices increasing 10x, maybe has clam down a bit. That's what I see from the discussions with our partners, with our tenants. However, cost of energy and cost of, I would say, utilities overall has been increasing. And -- but as well, I see that many of the tenants are pushing this sort of inflated costs already to the end customers. So I guess that's how everybody is trying to cope with it, cope with the increase in utilities and other expenses. So the next year, of course, will be challenging, I think. And -- but I think as well, what we hear and what we read is that there will also the consumption of the utilities has decreased overall, giving some comfort. But still very unexpected environment will continue. That's what we believe. I note on the trade receivables, that hasn't really changed much, that's on -- which means basically unpaid invoices at any given moment. So I think that's generally fine. And -- as well, we are in the process of refinancing some more obligations. I think one deadline is actually next Monday, when Meraki, EUR 4 million bonds become payable. So we are going to refinance those and as well in the process with the banks to refinance our loans, and increase also the loan terms. So we're discussing another 5-year loans with the banks. And yes, I bit got ahead of me already. One thing I think I need to mention, and it's been mentioned, I think, before, is that whenever we have taken the loan in 2018 or '17 or '19, we have always tried to hedge it and try to fix as much as possible the interest rate. And one way to hedge it is with us well. But also, we have had quite a few caps, which is capping the Euribor increase. So many of our caps are at 1% Euribor, or 2% Euribor and 3% Euribor. So Euribor goes to 5% or more, then in that sense, we're quite well protected. However, in terms of cost of debt, currently, our cost of debt is around 2.8% also in the third quarter, but I think we also estimate some increase in the cost of debt. It is currently difficult to say what it will be as we are in negotiations with the banks. And as well, I think the main influencer will also be the bond. So I think it's fair to say that in -- what one should expect is maybe, let's say, quite stable margins with the banks. But I think we will have some more amortization now in our loans going forward. Currently, up until now, we've almost had no amortization, and that has been, as one may, remember our goal to keep the cash in the fund level and not amortize. But definitely, amortization is probably going to be increasing across our portfolio, not in all loans, but in the new loans. And then the bond market is quite volatile today and I think there will be some news about the bond as well very -- quite shortly. And basically, the bond is maturing in May 2023. So we are going to visit the bond investors and bond market in that regard as well already now. It is also probably one can expect that we would try to get a bit more bank loans this time around from the bank and then see if we can issue a lower amount of the bond, not EUR 50 million, but slightly lower. But again, these are -- this is work in progress and so I think at the moment, all I can comment. But we definitely want to be ready for some increase in cost of debt, and that's why working on our NOI and occupancies as well as indexing our rents at reasonable levels is very important for us.

And last but not least, question on the dividends. And overall, in the past, we have aimed to pay out the majority of our net cash flow from operations to dividends. And over the past quarters generated net cash flow as well increased and expected to increase as we continue with the occupancy increases and new tenants indexing our rents. Again, it's a bit difficult to say at the moment what will be the new dividend level considering everything. But our priority is to pay dividends and do it regularly. We have decreased the frequency due to this turbulent times to semiannual dividend. So next time, a decision has to be made in February -- early February, late January based on the situation. And in regards to -- maybe a comment on the unit price, which is on the market stock exchange right now. And it is almost 35% or even more percent below the net asset value based on the last evaluation. And many have asked also me that what could have been the reasons for that. And I can only say what I sort of monitored and viewed that, of course, when corona started then it was the lockdown of -- that affected our central located assets and that was the first sort of drop. But also, we saw a major drop now after the war has broken out and the uncertainty around energy costs and uncertainty about the Euribor and the financing costs. So I think those are the main reasons. Of course, what we saw as well was that when the war are broke out and many Swedish retail investors sold their stake in the fund quite quickly, trying to exit this region with all kinds of investments that they may have had. So that push probably the price down even further. And at the same time, when we speak to our largest investors, the Swedish pension funds and family offices, then many of them have actually even bought some more. There was a question that whether the management has bought any fund units over the past year. So that's also the case. -- and to also that, there was one other question. Yes. So how do we -- what do we plan to do and the buyback program that we had put in place. So yes, buyback program is definitely a tool in our toolbox. And it's something that we are still thinking about using. The question is, of course, when. And -- but it's a highly regulated process. So we had to clarify many things with the financial supervisory authority about the intention and how it's being done. So I have to be careful here in terms of more regulation and to avoid any kind of market price manipulation. So this is definitely not our goal. But it's -- in an organized fashion this is -- this tool is in place for 3 years. So we're happy that's in place. Many things -- we have to ask our investors' approval in an Annual General Meeting, so we don't need to ask that anymore. So let me see if there's any more questions. So maybe a few more words on Meraki. And maybe what our analysis has been that why we have lost those 2 anchor tenants. So one reason, it was that we competed with an older property in a similar location, let's say, in Vilnius. But what we understood is that they dumped their rent price very low, so we have taken note of that. And let's say, are open for negotiations with the tenants in terms of rental level. But at that level, we thought it was not reasonable to compete. And the other actually interesting one was that the tenant preferred another location, even though we understood that they paid more than our rent level was. So it's quite an interesting to analyze the logic of the tenants, but they have to also think where the employees are working. And our properties in the -- on [indiscernible] and in a densely populated area where even behind our center the dwelling houses are currently being built. So it is the fastest-growing region in Vilnius as far as I know. So we do wait for -- look for a tenant and have some discussions already with those that want to be in that location predominantly. Then I see another question here. So I think I answered it already that during August, mainly in August, the energy bill was very high. And we did pass all the utility charges across to our tenants. But due to the vacancy -- according to the contract. But according to the contracts, yes, but then we have vacancy and then we had to cover some of these high energy bills also. And let's say, it has stabilized. The utilities cost slightly has increased, but across the board I don't -- what I know from the latest numbers, it hasn't -- now it has stabilized to the levels which are not extreme. So yes, everything is getting more expensive, but still at reasonable rates. So I mentioned the rental income, the NOI target according to our view to be EUR 19 million for next year and closer to EUR 20 million for 2024, given the current portfolio. And that we estimate comes from increase in occupancy layer rates in our shopping centers and also some removal of discounts, but as well indexation of rent and the Meraki will also hopefully contribute to that. In terms of triple net leases, then I think there's a good number to monitor in our quarter reports and that's the margin. And so usually, the margin of costs being covered or the net rental margin means that how much of the utilities and all surcharges are being covered by the tenants, usually it has been around 90%. Now last quarter, it was 84% and again, because of the vacancies. So we estimate this to increase to around 90% also in the upcoming periods back to the levels because the rental agreements also in retail centers are triple net, the new ones. There are a few old agreements that are not triple net for some specific reasons, and it is sort of up to 10% of the portfolio. Of course, when these rental agreements become renewable or their goal is to have -- yes, have this renewed. So a new question correct -- so without selling Sky and Lincona currently, that's our NOI targets. If we sell them then the aim is, of course, to reinvest the money. But current target is $90 million. So there is a good question about risk management and currently, our -- in order to decrease the financial exposure, and that's something we are very actively also discussing. And actually, over the past quarter -- actually during the last quarters, we have repaid back some of our loans, especially regarding Europa and Galerija. So this is something definitely our table that we are discussing. And also selling Lincona and maybe another property here would decrease the loan-to-value ratio. So yes, so another this -- I think I answered these questions. So in that sense maybe a last question here just to repeat that there are a few nonstrategic assets that we are selling at the moment, and to decrease our LTV and to be ready for newer acquisitions into newer buildings next year. Let me see there's few more questions. So I think I hope I have answered the other questions. I'm not going to repeat. Anybody can always follow up with an e-mail if something remained unclear. There's a question here as well that what happens in another situation where valuations drop and because we have our loan-to-value maximum at 65%. And of course, then there's ways how to reduce the LTV by increasing -- or issuing new equity to our top investors and new investors, possibly. So that's also something that we are currently planning for or thinking about for early next year, just also from the sake of view that opportunities may arise and probably will arise -- investment opportunities. But overall, yes, then if suddenly this 65% is reached, then the management has to pass -- according to the fund rules, has to sort of remedy the situation over a certain period of time. And then there's a question of, yes, new equity or paying back some of the loans from the cash flows. And then of course, in that's an adverse situation then of course, dividends might be at risk. But again, these are the thoughts that -- or risk scenarios that we're also thinking about. But currently, as of today, I don't have that expectations for the year-end. But yes, I think maybe just to repeat that some of the properties that we're considering selling is, yes, some of them are good cash flow properties, but they are not strategically important for us today. And if we get a good price for them, then we will complete the sales for new opportunities. So I think that's all the questions that are here. So I think on a summarized note, lots of hard work is being put in by our team and to work on our occupancies and that we're happy to see very positive results in our new refurbished centers and next year is going to be also quite unexpected. And we know that the cost of lending is increasing across the board for everybody. For those who would never had hedging or fixed rates will probably increase faster than for the others. But eventually, what we see and forecast for the next 10 years is that -- and I think it was also well described in one of the questions that I received, that it will be quite an inflationary period, and that is mostly also -- or somewhat to do with the geopolitical situation continuing to be as dense as it has been, not only in our region, but also in China and Middle East to some extent. But also we do estimate as well that last decade was amazing decade where money didn't cost anything, and that is not -- has changed. Money will cost always something and now it's interesting to see where the equilibrium will be found in terms of, for example, Euribor or any other rates that -- what is the variable for the different economies and countries, as we know, lots of debt has been printed over the past 2 years, especially. So definitely, lots of variables in the picture. But what number I always also focus on in the Baltics is the employment. And because the balance sheets of the companies generally is very strong, lots of profits have been made. And some segments have been already hit because of the war, but that doesn't seem to be systemic. So in that sense, equity-wise, the economies in the Baltics are in much better shape, so that gives some positive views for the future. But then again, plan for the worst and be ready for the good times. So thank you very much. I don't think I see any more questions. So welcome to follow up, if any of my comments or topics or e-mail. And we'll keep you posted, always NASDAQ Stock Exchange releases about events happening in the fund in the future.