Baltic Horizon Fund (NHCBHFFT) Earnings Call Transcript & Summary

Hello. Good afternoon, and welcome to Baltic Horizon Fund's third quarter webinar of 2024. I'm the fund manager, Tarmo Karotam, and as usual, I will be guiding you through the results and trying to answer various questions, which have been received earlier over e-mails. So let's get started. Just to start with a review of our strategy. And yes, Baltic Horizon has gone through a rough patch over the past few years and we have been fine-tuning our strategy, and we still believe in the centrally located assets that we have even though it is a bit difficult to -- it has been challenging to find the last tenants. But we are in good progress there to, as well, reach high occupancies. But yes, we believe in our rental locations. But in addition, we believe in strong tenants. And what we would strive for is a portfolio of centrally located modern city life assets, but also assets which have long-term governmental or social tenants. And we have been in the process of converting many of our properties into the new cycle with new long lease agreements, and that's where we believe the future stable income will come from. Now speaking more specifically about the last couple of quarters, as I think mentioned also before, we believe and we still have seen as well that the last 2 quarters have been the most challenging for us this year. When we look at the occupancy quarter average, then the major thing what happened in second quarter was that our S27 building was vacated. So in the average number, the occupancy still stayed at around 82%, but end of June the occupancy had dropped to 79%. However, these numbers, just to note are also very straightforward occupancy numbers with already moved-in tenants and we do expect these numbers to improve in the fourth quarter. I think the biggest challenge, and there's been also some questions around it that why our vacancies in some properties are still lagging behind our targets and taking more time to fulfill, is that to achieve reasonable and also beneficial long-term, commercial terms with certain tenants is quite difficult. But I think overall, we have been able to keep our average rent at around EUR 13 level as well the EUR 12.8 recorded here, I can say that it's not fully reflecting the results of Meraki, which we have been successfully -- we have successfully leased out over this year. So for us, it's extremely important to keep a focus also on commercial terms, along with occupancy figures and not just filling occupancies when the average rent will be deteriorating and going much lower than we would expect. Then net operating income, overall, we have been generating about EUR 1 million of NOI over the last couple of quarters. And the third quarter shortfall back is due to a couple of things, mainly the change of tenants in Europa since we are refurbishing the ground floor for the restaurants that are set to move in early next year as well. There are some refurbishment works ongoing in H&M store in Galerija Centrs. So we had a package deal with H&M a couple of years ago where last year they refurbished Postimaja. H&M brought in H&M Home. And as well, they are now this year refurbishing their Galerija Centrs store. So that's now happening -- or happened in the third quarter. So overall, with some new tenants moving in, such as MyFitness in December, Narbutas in December then Apollo in January and February, it is reasonable to expect NOI to start increasing and that's what we've been also communicating in the past. And when we talk about KPIs, the other side is, of course, our debt side. Throughout this year, yes, we have been -- what's the right word to use, maybe tackling with our debt, meaning that finding sources to repay the bond, which is, of course, the most expensive debt instrument in our portfolio, refinancing several of our properties in order to refinance the bond, but also achieve additional funds for the fit-outs in order to increase the NOI. So throughout the last quarters, the debt has remained quite the same and our target is continuously to reduce the debt. And I can talk a little bit about that in the coming slides. Average cost of debt started to gradually decrease and as well as the Euribor level, and we're making some small progress also in reducing the LTV. And there's more actions which have been happening in the fourth quarter already, but I will talk a bit more about that in later slides. This is also -- the last role is to demonstrate that we are in the investment mode currently into our premises. And that's why the CapEx, capital expenditure, figure over the past quarters have been quite high, especially in the third quarter. And for that, we have been preparing for and we have the financial means to execute these fit-outs for our long-term tenants coming into our properties. The tenant mix has changed quite a bit over the past couple of years. And as I said, our portfolio properties are being converted into the next cycle with new tenants. And we continued to have Rimi and State Forestry, Latvijas valsts mezi of Latvia, as our 2 key anchor tenants. Apollo Cinema Group and Apollo Group has increased to be our third largest tenant in the portfolio followed by Latvian State Police and MyFitness, who has taken on more premises in our portfolio, especially in regards to Galerija Centrs, a new outlet to be opened in December. Furthermore, our top tenants include Lithuanian Tax Authority in the North Star property and Narbutas moving to Meraki and the State Information Authority of Estonia. And last but not least, IKI and Swedbank. Swedbank is a tenant in our portfolio in Lincona. They will have a lease agreement until the end of 2025 when they will move into their new headquarters. But that may change maybe to be expected in the top 10 at least over the next couple of years. Over the past years, we have been, let's say, reducing our allocation to offices. So our office allocation has dropped a bit and retail or what we know more call it mixed-use property allocation has remained at the 50% level. Then allocation to Latvia is currently the largest and there's no major changes there over the last quarters. Now into the work of increasing the occupancy, and I can only say that it's quite active and heavy work that's been happening on that front over the past year or so. About a year ago, our portfolio occupancy had dropped to 77%. And as you can see also from these figures, which we try to visually show to the stakeholders is that there's a lot of activity, not only in prolonging the agreements, but as well we have had over the past year many tenants leaving the properties for various reasons. That includes also a couple of larger tenants, but also new tenants coming into our properties. So the transition has been quite remarkable. We do expect next year these, let's say, extremes to be somewhat smaller, meaning that less tenants moving out, especially when it comes to larger tenants, and more tenants moving in. For us, the most important aspect is the net figure here and how much net positive we are with the re-tenanting, with leasing out our premises. And I think we can still, regardless of the difficult quarters in the past, be quite satisfied with the new anchor tenants, Narbutas, Apollo, MyFitness and also now the Expo GROUP in Galerija Centrs on the upper floors. Then goals. And again, this is I think one of the more important slides in the portfolio -- or in this portfolio presentation, how we plan to achieve our occupancy targets where we were in September, where we are today and based on LOIs and negotiations where do we see that, where we can be. So let's take property by property. For Lincona, we have achieved what we, I think, can for 2024. We have had State Information Authority complete expansion fit-out, they have moved into the additional floor and the occupancy has increased to 88.5%. There are some small vacancies in the property, but no concrete LOI signed as of November. That doesn't mean that negotiations are not ongoing and the property vacancies are not offered. In Sky, relatively stable there. And so far, we don't expect any changes or any tenants changing there. Now most importantly, there's been also questions on Coca-Cola Plaza, why the occupancy on paper is 82%, but we all know that the property is pretty much fully leased. There are some technicalities involved there as well how to calculate the final net leasable area. But what I can say today, as of 15th of November, that we have signed all and even some additional agreement with Apollo Group. So from beginning of next year, they will take all of the possible premises that can be rented out in this property, including also the fifth floor office part. And then underground parking area is rented out to [ Europark ]. So as of November, yes, we can say it's fully occupied, 100%. And also that final lettable areas have been also measured and calculated. So there should be no changes there now in the coming years. With Europa and there's been also fluctuations in occupancy figure there, and it is to do with us changing the tenants. What is the main thing happening in the property today is that the restaurants area next to Dialogai is being prepared for the new tenants. And opening in first quarter of 2025, it's been slightly delayed due to some technical reasons there. But let me say that the main achievement in the third quarter was as well to sign a concrete, not lease agreement yet, but an LOI with the same Expo GROUP entertainment and exhibition group, who has -- who is a tenant in Galerija and we are working on a lease agreement currently. In addition, to achieve full occupancy of Europa, we basically need 2 additional leases. We have talked about coworking. Those negotiations are tough, but they are processed with many brands and we had achieved sustainably good terms for both sites. And the second lease agreement under discussions today is with, I would say, an international fashion brand. Not sure if this can still be landed all of this in this year, but at least one of them we want to sign this year so that we can get closer to the 90% occupancy and the remainder during the first half of next year in order to achieve what we have here as a target of 96.7% occupancy. Going down further, Pirita, I think we're quite satisfied with the results there currently. Yes, there has been small changes in the satellite tenants, but the latest sign-up now actually in October was MySushi. So that is reflected also in these percentages post September, getting closer to the occupancy goal of 100%. And what I can also say there without more details with the prolongation of Rimi agreement, discussions are also ongoing and we expect positive results there as well. Current Rimi agreement, the term of that is 2026 but we have started those discussions early. I'm moving then property by property to LNK. LNK moved out in April this year and we've been focusing our efforts on finding the right tenant. And we have an LOI for about 3,700 square meters. It's been quite a long negotiation, but we expect that LOI to convert into a lease agreement now very shortly. And further work will be done for the remainder of the week. Vacancy, we have also additional LOI signed with another tenant and work in progress to also sign that LOI or the lease agreement by year-end. Then no real big changes in Vainodes and Postimaja basically. And in Galerija Centrs, the main achievement over the past quarters was to sign up this Expo GROUP on the upper floors, taking 2,000 square meters, making their own investments as well. And at the moment, what I can say about Galerija for the year-end, we don't have let's say, active final stage lease agreement negotiations. We do have one, again, fashion group lead discussions ongoing, but I think those negotiations cannot be finished still this year, but rather in the first quarter of next year. So if you look at the number, [ 2,591 ], then that mostly represents that -- those discussions. North Star. What I can say about North Star is that we've had over this year some changes in tenants there. And up to 2,000 square meters, actually tenants have moved out. But we've been happy to state that, that vacancy has been filled up very quickly by the current tenants, but also by new tenants liking the location of North Star and the offering that we have there. So what I can say is that we are on track to fill in the vacancy fully. We have some fluctuation now in the third quarter, but we believe that by year-end, we will achieve a target in North Star of 98%. And last but not least, Meraki. Narbutas fit-outs are almost finished or being finalized. They want to move in, in December. And by that, we should also achieve a close to 90% occupancy.

There's been some questions now more specific, I'll try to answer them here. Hopefully, I get them all. Has our strategy for Europa and Galerija Centrs, is it the right one? And are we on the right track? Then I can say with -- for Galerija and for Europa as well that, yes, we still believe that we are on the right track. And the main game changer for Galerija was opening of the food hall last year, which has also helped us to bring in MyFitness, Expo GROUP and other main tenants this year. There was a question now how BURZMA, the food hall, is doing on the fourth floor of Galerija. I just had the updated numbers received. So what I can say is that year-on-year, the total turnover of all the tenants on that floor has increased approximately 17%, and on average, we are making a net rental level of EUR 26 per square meter. If you look at the past 3 months, so we believe that it continues to be very, very successful. And as I said, that has generated traffic and helped us also to move in additional tenants, which will further contribute footfall to each other basically because both -- all -- sorry, the BURZMA food hall, MyFitness and Expo GROUP, they are destination tenants. There are tenants where people come as a destination and they also, I think, overlap with each other meaning that the clients can use all of the tenants. And that's what we believe a successful concept of this multi-tenant mixed-use properties is in the future. When it comes to Dialogai and Europa, then, let's say, those results maybe not as impressive as in BURZMA, but they are equally attractive for us. What I can say on rental level basis is that approximately net rent from those premises around EUR 14 we have achieved. And we're looking, of course, ways how to improve the offering further and as well the management continues to be qualitative. There's also a question on the fit-outs of Meraki and approximately EUR 2 million is invested in Narbutas. Not to forget Narbutas is largest tenant in the property, roughly 400 square meters, a little bit more. EUR 400 per square meter for fit-out needs, which is the market, let's say, the average today. And I think the average rent of Meraki of close to EUR 13 is reasonable for these investments to be made into fit-outs. Once again, we have been negotiating with tenants where we look for strong return on investments that makes sense for us for these fit-out investments. And we have avoided negative investments where we don't see a clear rental income on the other side. Then moving forward, I will try to answer as many questions that I received earlier and then take the further questions later. Now into the financial results. They have been mostly impacted by the vacancies that we have discussed, the increase in vacancies, but also the increase in costs that we have had to cover as a fund. So increasing the occupancy will have double effect on us, positive effect, meaning increase in rent, but also further cost coverage of the expenses that we have to currently cover ourselves. So we aim to achieve with a fully let-out portfolio the cost coverage of at least 90%. Currently, it is around 80% so there is definitely room for improvement there. And we see, there also has been a question on the debt management and how do we manage our debtors and the tenants that are in debt. So it's a fully regulated and fully structured process where property management function is also involved where we monitor closely on a monthly basis the levels of 30-, 60-, 90-day debts. And it will, for some time -- let's say, over this year, the debts have relatively remained stable. And we cannot say that some level of debt have increased radically because if there are increases or decreases in debt, then there are clear reasons behind it. So more specifically, we send out regular reminders and they are sent automatically from the first overdue date. And of course, each case is discussed individually with each tenant. But usually, these discussions then involve negotiation of payment schedules. Sometimes we agree on certain delays in payments in case there are temporary financial difficulties. But of course, we also renegotiate other terms of the tenant in this process. So these decisions, whether it's bad debt or not, it's made, of course, at the fund level taking into account each case separately. But as I said, there is a full process around it and we chase tenants as any professional landlord would. But once again, I wouldn't say that an increase in debt has been something very notable over the past quarters in 2024. Then there is also some more specific accounting questions. And in case I'm not answering them all here, then please follow up with an e-mail. But there's also been a question on how do we apply certain paragraphs, regulatory paragraphs, for example, on property, plant and equipment and depreciation. So currently, the tenant improvements are depreciated for the tax purposes. And in the accounting, the properties are measured at fair value, and therefore, tenant improvement being a part of the property are not depreciated. Then there's also been a question of the cash and the free cash, so roughly around what we ourselves consider is, let's say, EUR 3 million of cash in our portfolio is restricted meaning that additional agreements need an additional sort of measures need to be taken in place to free those up. So the rest is free cash. And when it comes to our subsidiaries being able to distribute free cash, then, in most cases, it is possible when certain conditions have been met. And currently, we don't have any issues with our banks with any covenants in that regard. And when we talk about the -- basically, the prolonging of loan agreements then everything that we have been -- that we have needed to prolong, we have prolonged. Latest one has been the LNK and Vainodes loan with SEB in Latvia, where we have received a positive decision to prolong and further increases in occupancy in the property will allow us to prolong the loan agreement even further. So let's say, there is a short-term prolongation and then the longer-term prolongation where when we have actually signed a certain amount of lease agreements, as I noted, currently, we have only LOI signed -- LOIs. There's also been quite specific questions on our loan terms and it is somewhat confidential -- well, it is confidential information, actually, and I wouldn't like to state specific percentages. But I would say that overall, we have been able to prolong our leases at similar terms. In some cases, we have actually refinanced that slightly higher level in order to have more funds to pay back the bond, so replace more expensive debt with cheaper debt and that's where also then the margin has somewhat slightly increased, but not materially. And in certain cases as well, the amortization schedule have been -- schedules have been rediscussed. But overall, I think we finance our properties at market levels at margins between 2%, and say, 4%. And when it comes to prolonging all of our leases, that has not been an issue for us. Now maybe more importantly on the question of the LTV and as we have stated as one of our clear goals to reduce the loan to value, on one hand, the valuations have challenged us on our road to do that. But what I can say is that we continue to have a goal to pay additional amount of the bond that we have the capacity to do and ability to do, this EUR 3 million. We have received a consent from bondholders to do that and also bank loan amortizations approximately, EUR 2 million this year. We plan to pay in order to reduce our overall debt and also improve our debt service coverage ratio, which currently is below 1. And with this strategic plan executed on the finances, we aim to achieve a debt service coverage ratio of at least 1 by the first quarter of next year. And from first quarter, we also expect the rental income and the NOI to continue support -- to offer support for the improvement of the debt service coverage ratio throughout next year. Then let me see, there are some questions. So there is a question on where do we see our average cost of debt as of end of 2025? Currently, our average cost of debt is around 6.3%, 6.4%, we aim to reduce it -- reduce that and pay down more expensive also bond, and by this, achieve a cost of debt below 6% for sure. Now when it comes to the bond and what's our plan with the bond next year, then we have the ability to pay EUR 3 million of the bond, remaining bond, which is EUR 22 million already now, which we're planning to do over the next quarter or so. And the remainder, we have ability to pay by November of 2025 according to the current agreement with the bond investors. And if we remove the bond fully from our balance sheet, then the gain would be at least a reduction of cost of debt of 1%. So overall, we see that the sustainable level of cost of debt for the fund is around 5%. So that's our end goal. So we will see as there are several scenarios for the bond refinancing or upon reduction then. But I think the answer to this question shortly is below 6% for sure, but closer to 5% as much we can -- as much the market allows at that moment. So there's a question also on the -- for next year's plans that we are in the process of transitioning right now our assets into fully occupied properties and what are we going to do the next year? Are we disposing some properties as well? Are we potentially seeing new properties in our portfolio? The answer to that is yes, we're planning still to dispose certain nonstrategic assets. And more and more, we're focusing on social tenants, social assets as one can see also from the makeup of our portfolio. And let's say there are several concepts on the discussion where it could be that 1 property sold in order to have a more strategic property in the portfolio or then see which properties on a long-term basis would offer the best net opting income on a longer term. So let's say, one could expect some changes next year in the portfolio setup, especially as well that we need a solution with the bond. So one way is to refinance the bond. The other one is to use the new equity partially that we raised from our investors now to pay the bond, but also it may need a disposal of another property. So it's a combination of things how we will solve the bond issue next year, but we will do it -- aim is to do it for sure. We don't see any additional unit issues currently in the fund, especially at this point where the unit price is. We want to really demonstrate in the numbers and in the quarter results where we are with our occupancy and really improve the results before we will start to think about any kind of capital increases or further public or placements. So yes, of course, we are constantly monitory market and we're looking for opportunities that, one way or the other, could fit into our portfolio. But as I said, we are rather disposing certain of our nonstrategic assets in order to increase allocation in our strategic allocation segments. There's a question as well on the maintenance CapEx this year. We have -- as usual, we do what we have to do and what is critical. So when a chiller needs to be replaced, then we will do it. And also when LED lights need to be -- need to replace some halogen lights, we will do it so the properties continue to work. So we have a 3-year plan with the property managers and that's beginning of the year we discus. We see what needs to be done this year and that will be executed. So also for next year, probably the maintenance CapEx, we haven't made a final decision yet, but probably it will be somewhere around EUR 1 million overall. But it may fluctuate depending on the latest findings of the property managers. And we will, of course, discuss that what can be sold more -- easier and what we need to plan for. But those decisions will be made in December this year. So there's a question on the bond premium. So as of November 2025, we can redeem the remaining bond with a prepayment fee of 4% that's currently been -- was negotiated with bond investors last year. There's also 2 other questions here. One is the question on the private placement. And how did that go? So the private placement was discussed quite widely over the summer. And then when we had the book building in -- after the summer. And when it was fully subscribed, we decided to go forward with the private placement. The private placement also welcomed a new Baltic investor from Lithuania whose interest in the private placement was quite strong. And so effectively, eventually also with some top investors, including Swedish Church and some other call subscribing on a pro rata basis. The offering was actually oversubscribed slightly. The management also subscribed on a pro rata basis for the last allocation to be made. So that's the conclusion of the private placement. And there is also a question on the -- follow-up question on the management fee calculation and the concept around management fees going forward. So yes, I can say that there has been further discussions on that, the construction of the management fee, and it has been discussed both at Fund Board level and as well at the Board level of Northern Horizon Group. So obviously, it's an ongoing discussion, or if I may say, even a negotiation, but we are looking for a mutually acceptable solution there. And I can only say today that, yes, it has been discussed and I will share more info on that when it's more concrete. And there is just a question as well on the losses on disposals and there's this line in our balance sheet. So in 2023, we sold 2 properties in Vilnius. And there, we had some related NOI guarantee provisions. Overall, they have not materialized to an extent to where we -- what the maximum extent was possible. But yes, there has been some NOI guarantee, let's say, payments to these buyers. And currently, we have recorded EUR 600,000. So to explain it more specifically, the EUR 600,000, which has been recorded as a loss on disposal is made up half -- around half of those NOI guarantee provisions. And half is actually, let's say, on executed transaction costs on certain properties. So that's in the past today. The question is what is the future? Then we have agreed and put the dot on all of these discussions with Domus Pro buyer in the fourth quarter. So there are no further implications from Domus Pro in 2025. But we still have some provisions related to the sale of Duetto and the potential exposure there for next year. Maximum exposure there is calculated to be roughly EUR 0.5 million. But that's the maximum exposure. So currently, we work that this amount will be much smaller next year. Maybe wondering I didn't touch upon was that overall in the third quarter but mainly in the fourth quarter, we've been looking into hedging our interest rates of the loans, bank loan specifically, since is our strategy is to have a majority of our debt hedged. And we have been receiving some quite attractive proposals from the banks. So we continue to look into that, and then more information will be shared in the quarterly number for Q4 report and the webinar. And so there's a question as well here I see. What is our weighted average unexpired lease term, WAULT, goal? As it is currently around 3.4 years, then our goal is to achieve 5 years. And I think that's in the current market where average these agreements are 3 to 5 years, some 10 years and some we've been able to sign even for 14 years, but on average, I think 5 years is what is already a good achievement. And once again, the full occupancy and full NOI and the portfolio yield of -- that our target is 6.5% to 7% that we aim to achieve by 2026, '27. That's the time line that we're currently working on for the full occupancy today to take place and full NOI to also show the results. And once more, there is a question on the rental price. So it's true that when we state that certain rental level, for example, in Europa is EUR 14.7 per square meter then that's the contractual rent basically that we have achieved on average. However, currently, NOI has been suffering because of the vacancies because the cost coverage is much smaller. And with the occupancy improving then and as well the triple-net agreements being signed, then the NOI as a result continues to improve. But yes, we report the rental -- average rental levels based on the contractual signed rents. There's been also a question on the top 5 unitholders on the fund. And we have on our web page our quarterly fact sheet and that's where these names have been listed. We are a listed fund. So many of our investors are behind nominee accounts, so we actually don't know who they are. We know the larger investments because they -- larger investors because they have been in contact with us. And so they have also confirmed what are their investment amounts and they have as well allowed us to use their name. But it's in our fact sheet on our web page. So that can be found there. So hopefully, I have answered all of these questions that have been received before and also during the webinar. As a conclusive remark, I can say that I and the team expected more from the third quarter when it comes to the factual results, but the work continues. And I believe we will have some big news also in the fourth quarter when it comes to the occupancy increases. And we continue to meet our targets, occupancy targets, to be #1, but also a solution on the bond, which will be then the main topic for next year. And we continue reporting on a quarterly basis and happy to receive any questions also over e-mail in case there are any. So thank you for participating, and talk to you soon.