Citycon Oyj (CTY1S) Earnings Call Transcript & Summary

So good morning, everyone, and welcome to Citycon's Q3 2020 Result Audiocast. We have this morning published our Q3 2020 interim report, which you can find as usual from our web page under the Investors section. I'm Laura Jauhiainen. I'm the Head of Investor Relations at Citycon. Today, here with me, you have in the audiocast our CEO, Mr. Scott Ball; and our CFO and Executive Vice President, Mr. Eero Sihvonen. Scott will start today's audiocast with an overview of the quarter and Citycon's performance in the COVID-19 environment. This will be followed by Eero's overview of the financials. Scott will conclude today's presentation by providing you insight on our strategy and plans going forward. After the presentation, you will have a chance to ask questions. As usual, there will be a separate Q&A session held after the gentlemen have finished. Scott, please go ahead.

Thank you, Laura. Good morning, everyone. We're pleased to present Citycon's Q3 results that, again, were solid even during the greatest stress test of our time. I'll present a short summary of Q3 results and the key highlights of the quarter. And while I'm happy to discuss the strong performance of our portfolio, I'm even more excited to provide you additional color on the progress of our long-term plans, which I will review at the end of this presentation. And in between, Eero will provide Citycon's financial overview and outline where we stand after 3 quarters of 2020. Citycon's financial and operational performance were again solid in the COVID-19 environment. The decline in net rental income remained modest for January through September. Total NRI adjusted for exchange rates was 2.2% behind last year. Our like-for-like NRI, excluding the impact of currency changes, declined by 4.7%. Collection rates for previous months continued to increase. H1 stands currently at 95%, and year-to-date, we're at 94%. To date, we have collected 93% of Q3 rents. We expect the final collection rates to be higher as there continues to be some slowness in payments during the COVID-19 pandemic. Year-to-date, administrative costs have also declined by 5% compared to the corresponding period in 2019. The decline in fair values of properties was modest at 0.6%. This reflects the stability of our business, which is based on a large share of necessity and municipal service tenants. Our LTV slightly increased to 46.8% at the end of the period. We remain fully committed to strengthening our balance sheet and lowering the LTV ratio. We are taking steps to accomplish this, which include monitoring the disposal market and acting accordingly. This financial performance was possible as a result of our strong operating KPIs, reflecting the stability of our strategy and the strength of the Nordics as an operating region. Footfall ran between 85% and 90% compared to Q3 2019. However, tenant sales continued at prior year level, with sales being up 0.3% compared to last year. Like-for-like sales were down slightly by 3.7%. This is a result of higher average purchases by the consumer, which in the first 9 months was 15% higher compared to last year. Leasing activity has remained strong in 2020. As of Q3, we have commenced leases for 175,000 square meters compared to 113,000 square meters in 2019. Our strong and stable performance allows us to narrow our guidance to the upper end of the previously communicated range. The decline in net rental income remained modest, and rent collection further strengthened during Q3. As mentioned, our total NRI declined by 2.2% and like-for-like NRI by 4.7%. Both figures have been adjusted for currency exchange rate impact. Without adjusting for currencies, our total NRI declined by 5.2%. Of this decline, we estimate that 4.1% results from direct COVID-19 impacts and 3% from FX rates. Our rent collection for H1 increased to 95%, resulting in a year-to-date collection rate of 94%. These results reflect both our strategy, which is focused on necessity-based tenant mix, as well as operating in the Nordics that have been thus far less affected by the pandemic. And I would add because of the dedicated work of our team in all of our countries. Tenant sales have remained strong as the consumer seeks us out for necessity purchases. All of our centers have remained open for the entire year, and in Q3, all tenants continued to be open for business. As mentioned previously, year-to-date footfall has stabilized in the 85% to 90% range. And more importantly, total tenant sales are now even with last year. The consumer has adapted to the current situation and visits our centers less frequently but with a clear intention to make purchases. This is evidenced in the average purchase increase per visitor, which is 15% higher compared to last year. As mentioned previously, our leasing momentum remains strong in 2020. Leasing activity has continued, and we have leased 175,000 square meters of space compared to 113,000 square meters in 2019. Signed leases include tenants supporting our mixed-use strategies such as the city library of Espoo, which will open up in Lippulaiva; a family health center in Oasen; Elixia gym chain in both Iso Omena and Lippulaiva; as well as grocery stores in Högdalen and elsewhere. This strength and stability are a direct result of having a larger share of necessity municipal tenants. This adds to the resilience of our portfolio and brings stability to the business and cash flows. As mentioned in previous quarters, over 35% of our GRI comes from stable, necessity-based tenants, and only a very small portion, about 2.9%, are based on turnover. In line with this tenant mix strategy, the public sector is a growing part of our business. Currently, the public sector and health care services account for 7% of our GLA with strong credit behind these leases. Our average cost of occupancy has remained low as a result of stable tenant sales. This is an indication of our tenant's ability to maintain profitable businesses in our centers, which is an attractive selling point to potential new tenants. Furthermore, this means that there is room for rent growth through indexation and reletting. Our year-to-date occupancy rate has been affected slightly by 1% as a direct result of COVID-19. However, occupancy has stabilized and grew ever so slightly in Q3. The earlier dip in occupancy relates to losing a few individual tenants at the beginning of the crisis. However, we are very pleased to see leasing activity level picking up again. With comparable rates, the average rent was EUR 22.9 per square meter. The average rent per square meter decreased slightly due to weaker exchange rates. Our leasing spreads of renewals and relettings were positive in Sweden, Estonia and Denmark. Leasing spreads were down slightly in Finland in part due to a very small sample size. The impact of COVID-19 on our business has thus far been limited. Just to recap, 100% of our centers have remained open. And at the end of Q3, all of our tenants were open for business. Footfall has stabilized at a level of 85% to 90%. But more importantly, tenant sales are close to prior year level due to a change in consumer behavior and a 15% higher average purchase. Rent collections have further strengthened, and year-to-date standing is currently at 94% and Q3 at 93%. We provided no new COVID-19 discounts in the last quarter. Occupancy has stabilized, and retail occupancy is currently at 94.1%. And the valuation decline remained minimal at 0.6% with a financial impact of EUR 29 million in Q3. Throughout 2020, we have remained focused on our long-term goal of diversification through densification. The majority of our assets are located in connection to the most important transportation hubs in the top cities in the Nordics where there's natural demand for densification and new residential and office space. Our aim is to continue our capital recycling and to diversify our retail exposure through densification. Value creation through zoning on property already owned by Citycon will provide a future value increase of EUR 200 million on building rights alone. I will discuss this in more detail following Eero's financial overview. With this, I'd like to turn it over to Eero.

Thank you, Scott, and good morning, everybody. I will go through the financials in a little bit more detail, starting with the quarterly performance. And as Scott mentioned, we did have a good quarter in the circumstances. And if we start from the net rental income level, we had a quarterly net rental income of EUR 52.9 million, which, as you can see, is 2.4% below last year's corresponding quarter. But actually, the COVID-19 impact was approximately EUR 2.3 million, and the currencies had a negative impact of EUR 1.1 million due to particularly the weakness of Norwegian krone. So actually, on a corresponding comparable basis, with stable FX rates and neutralizing the impact of COVID, actually, we were slightly ahead of last year's result on net rental income, which I think is a good achievement. On EPRA earnings level, we were 5.7% below last year's level on a quarterly basis, like EUR 2 million behind. And actually, the same reasons were behind that as in the net rental income side. Then having a look at the first 9 months together. And on first 9 months basis, net rental income level, we were EUR 8.5 million behind last year's result. And I will be going in details through the net rental income bridge in a while. And we have there also added a complete COVID bridge. So for the first time, we are going to disclose quite exactly -- what exactly were the impacts of COVID to our results. On net rent -- sorry, EPRA earnings level, we were EUR 5.5 million behind, i.e., 5% behind. And EPRA earnings was less, below last year level compared to net rental income largely because we have, on the other hand, been able to save on SG&A costs to the -- due to the tough cost control that we have in the company and also due to the lower financing expenses. I already alluded to the weaker currencies. As you can see here, particularly the Norwegian krone took quite a dip in March, late March. It had to do, of course, with the COVID, but particularly also with the price of oil and Norwegian krone being associated with oil. And both currencies strengthened quite nicely in Q2. And actually, Swedish krona is pretty much back to the level of last year-end, but Norwegian krone continues to be weak. And as a result, that has impacted our results. Then the net rental income bridge that I promised. And here, you can see that, on the other hand, we had 2 properties. We used to be a co-owner of Stovner and Torvbyen also previously. But in the beginning of the year, we acquired the remaining stake of these 2 centers in Norway. That did had an impact -- did have an impact of EUR 6.7 million. We -- on the other hand, we disposed of certain assets in Finland, 2 of them, and that had an impact -- negative impact of EUR 2.4 million. Like-for-like net rental income was negative by EUR 5.9 million, largely due to the COVID impact, which I'm going to reconciliate in a moment. And then this negative FX had an impact of approximately EUR 5 million on net rental income level. And that completes the net rental income bridge, which, like I mentioned, still finalized at a very good level of EUR 155.5 million. Then to the new disclosure on the impacts of COVID-19. And of course, these are estimates, seeing that we have not, like, reconciled them to the last thousand, and these are management estimates, but anyway, we feel that -- and trust that they are accurate and it gives you some kind of a view on what is the impact on several line items. First of all, the capital/gross rents, which mainly has to do with the increased vacancy due to COVID and certain other items, the impact of that is EUR 2 million on the first 9 months basis. Then the straight-line impact of all COVID-related rental discounts for this period is EUR 1.1 million. And then there is a multitude of some other quite important topics like turnover-based rents, specialty leasing, parking fees and other, and you can see their impact here. I would also like to raise the impact of credit losses and credit provisions -- credit loss provisions and that due to COVID has increased by EUR 1.7 million, totaling currently approximately EUR 3 million. And here, I would like to highlight that they are mostly credit loss provisions, and we have had very few actual bankruptcies and full losses so far. So this completes the COVID-19 bridge. On the fair value changes, we have in Q3 a so-called internal valuation, but in a way that we are provided by JLL and CBRE, JLL for Finland and Sweden, CBRE for Norway, Denmark and Estonia. So they provide us market rents and cap rates -- are advising us on cap rates, and we base then the valuation on those advices. And the result was that the cap rate was slightly wider. And for the full '20 so far, the cap rate has been, on average, widened by approximately 20 basis points from 5.3% to the current 5.5%. And additionally, of course, there has been some element of market rents to the valuation. For the quarter, the negative valuation was EUR 21.6 million. And together with the IFRS adjustment of EUR 1.4 million, it was added up to EUR 23.1 million. And when we take into account the 50% of Kista, then the number is EUR 28.7 million. And the first 9 months valuation result, EUR 110.5 million without Kista; and EUR 128.1 million. So I think that also this is a fairly stable performance and highlights the fact that in the Nordics, the fair valuations tend to be, over the cycle, more stable than in some other places. Then the EPRA net asset value bridge, we did end up at EUR 11.14 NAV. And here, the EPRA earnings naturally had a positive impact. Then all of the valuation items that can be found under indirect result had an impact. And also the translation reserve means the equity that we have in foreign subsidiaries denominated in Swedish krona and particularly the Norwegian krone, and that had a negative impact of EUR 0.54. And as a total result of everything mentioned here, the NAV ended up at EUR 11.14. No major changes in the financing metrics. Loan-to-value ended up at 46.8%. We still have very well-staggered loan portfolio with ample liquidity, which I'm going to highlight over the -- one of the next slides. And before that, the financing key figures. Like mentioned, available liquidity is considered very good, and all of our revolving credit facility is completely undrawn. So we haven't drawn anything of our revolving credit facility. The average loan term is approximately 4 years, 3.9 to be exact. We have 81% approximately of our debt portfolio in fixed interest, and approximately 2.4% was the average cost of debt. And in more details, the average liquidity. So we had nearly EUR 600 million of liquidity available, EUR 588 million to be exact. And the liquidity continues to be excellent, and we don't have a lot of debt maturities to worry about and are in discussions right now to basically take care of the -- whatever we have outstanding. Then finalizing my part with the outlook and guidance, and this is an important message as well. We have substantially narrowed our guidance, and we have increased the midpoint of the guidance, sort of highlighting our confidence to the underlying business. And basically, the direct operating profit guidance range has been now tightened to EUR 178 million to EUR 185 million and EPRA EPS EUR 0.74 to EUR 0.78, and then the adjusted EPRA EPS, as can be seen here, between EUR 0.65 and EUR 0.69. And with this, I would like to hand back to you, Scott.

Thanks, Eero. A good quarter, obviously. I'd like to provide you a bit more insight into our strategy of diversification through densification, something that we've kind of hinted at over the last year or so and have been doing a lot of work behind the scenes, and I think we feel like it's time to share some of our insights on this with you. All of our assets are located in cities with strong country-level economics. Furthermore, the majority of our assets experience strong local demographics with high consumer purchase power and strong customer inflow driven by urbanization. The environmentally and socially conscious culture in the Nordics encourages densification that has clear environmental benefits. For municipalities, urbanization creates a clear need to invest in infrastructure and to accommodate the growing number of citizens. It also means ensuring the availability of housing and office premises for people to live and work. Simultaneously, sustainability of area development and developing services that attract wealthy citizens and companies is a key concern when designing these areas. All of this creates strong demand for densification. We're in a natural position to participate in this densification. We already own assets in prime locations in these areas with direct connection to the most important transportation hubs. These properties have additional capacity to gain new building rights through the zoning process. Furthermore, existing and strong relationships with municipalities and working with area development make Citycon the preferred partner. In addition to these great existing locations, we have a proven track record for creating award-winning destinations. We are also known for developing green assets with innovative energy and recycling solutions that are important for the Nordic community hubs. For Citycon, densification provides attractive add-on business on top of our already strong retail assets, creating significant portfolio diversification as a result. It also increases the number of people in the catchment area, creating synergies with the existing retail portfolio and balances intraday fluctuation of customers in the existing centers. We intend to continue shifting the portfolio composition further towards mixed-use through maximizing this densification potential on our existing sites. This would be complemented with making selective disposals of noncore assets. Fully implementing the current identified development potential of 600,000 square meters would significantly diversify Citycon's portfolio, and the future share of retail will decrease to a level of approximately 65%. It's currently at 82%. The 600,000 square meters is inclusive of 200,000 square meters of condos that will not, because of their nature, remain in the portfolio. Completing this densification plan will increase GLA and create synergies with our retail assets. It's important to highlight that the value creation from densification starts in the zoning process once salable building rights are received and prior to potential CapEx outlays. Another important point to emphasize is the long planning and zoning process that allows case-by-case decision-making on execution of individual developments. All decisions can be made gradually with the balance sheet allowing. The geography of the development portfolio includes 22 potential development sites in 4 countries with a total GLA of 600,000 square meters. Of this, 285,000 square meters are residential and 325,000 square meters are commercial, meaning mostly services, offices and depending on future market demand, potentially even hotel. The 285,000 square meters of potential residential development consist of 2 parts: 100,000 square meters of rental premises and 185,000 square meters of condos. As mentioned earlier, these projects create value upon completion of the planning and zoning phase through acquiring building rights. This value creation in connection to our existing locations is estimated to be EUR 200 million. Advancing through the planning and zoning process requires minimal CapEx. The decision on whether to invest, sell or contribute building rights on a JV is made at a later stage in the process. We already own these sites, which makes this essentially free land for Citycon. As you can see from the graph, there's a multiyear time horizon for execution of this strategy. Decision-making on how to proceed with individual developments will be made on a case-by-case basis. Balance sheet and financing remains a key consideration in this decision-making. So to summarize, Q3 was a strong quarter for Citycon and places us in a solid position to move forward with our diversification through densification program. This was demonstrated by strong operational and financial metrics. These reflect our strategy that thus far has proven successful. We are also fortunate to operate in the Nordics, which is one of the most stable parts of the world and has outperformed in the COVID-19 environment. We believe in the diversification through densification potential in connection to our existing assets and have begun to work on transforming the portfolio. Capitalization on the densification potential not only diversifies the portfolio but also is an opportunity to increase GLA with premises that create clear synergies with our retail assets. Value creation in these initiatives starts early in the process, and decisions on the execution of any development can be made later in the process. We have in place a strong and capable organization to execute these plans in a manner we choose after our case-by-case assessment of each individual development. With that, I'd like to thank you and hand it back over to Laura.

Thank you, Scott and Eero, for the presentations. Now we have time for questions, and we turn the audio line on. So operator, please go ahead.

[Operator Instructions] We have a question from Anssi Kiviniemi.

I have a couple of them, so I will take them one by one, if that's okay for you. First of all, thanks for the COVID-19 bridge that you highlighted now for the first time. Do you think that the FX will reverse in 2021? Or what is your thinking on the brokers going forward?

Yes. I think -- I don't know if reverse is the right word. I think we see it stabilizing in Q3 as we look at leasing, which seems to be kind of a forward-looking indicator. And sales have flattened -- or have basically come back to the 2019 level. So I think -- I don't think there's a full recovery in '21 that would bring us back to where our original plan was in '21. But I do think it's stabilized, and we should start to build upon where we are in '20. So we're cautiously optimistic. We're not out of the woods yet. Who knows if there's a significant second lockdown. But we are cautiously optimistic as evidenced by what we're doing with our guidance, tightening it and taking up the midpoint. So we're feeling pretty good. But again, that's -- I put that big caveat out there about what might or might not happen kind of on a macro level.

Okay. Then the second question is on consumer sentiment. We have seen really strong figures coming out in retail in your key markets on consumer spending, also in shopping centers. Do you think that this situation has supported you substantially during the weak time? So how do you see the situation there? And also kind of do you have any ideas how things will play out when we enter into the next quarter or next year?

Yes. I think we've been the beneficiary of the fact that we're heavily grocery, pharmacy influenced. And I think because of that necessity-based, the consumers have sought us out even during the worst of the crisis. But that being said, as you mentioned, the consumer numbers are looking better, and we're actually starting to see that even in the last month. Fashion and apparel, which was probably, at least in our portfolio, the most dramatically impacted through the worst of the COVID, that has come back. It's still not back to last year's levels, but it's -- instead of being down double digits, it's now down single-digit in the last month. So it does seem like the consumer is feeling better. And I would anticipate going into holiday season that, that will continue. Again, I hate to be a broken record, but I'm going to put the caveat of assuming that there's not some big second lockdown kind of coming through.

Good. And on the guidance, you highlighted that you don't expect -- in the guidance, it's baked in that you don't expect a big COVID-19 second wave lockdowns coming. So basically, you have baked in a guidance that assumes that things remain as they are currently. Is this the right read?

This is the correct way to look at it, yes.

Yes. And I would add to that, Anssi, obviously, we're already -- not halfway through the quarter, but we're pretty far into the quarter, so we feel pretty good about it.

Okay. Then the last question is on the -- your strategy and the development projects. Could you give us a little bit more flavor on how do you calculate and define the EUR 200 million that you see value creation potential there? That would be really helpful.

Yes. We -- well, it starts with -- we take the portfolio and we went asset-by-asset and determined what the opportunity was for each of the assets in terms of densification and how much GLA could we add in each of the assets. And then we take a look at where do we think it's going to be more commercial versus more residential. And then we assign a value to that building right, if you will, depending on whether it's commercial or residential. And that's how we develop it. It's very high level. It's not a precise number, but we feel pretty good about it. And again, I would remind you, this is only for the building rights. This doesn't even include what the upside is for us as we develop it.

Okay. So there are no development gains included in the figure.

Correct. This is just the value created because of the zoning and the acquisition of the building rights. At which point -- and as I said in the presentation, after we get those building rights and create that value, we could then make a decision. Do we sell them? Do we JV? Or do build we it ourselves?

Okay. And if you decide to develop themselves, could you kind of indicate to us what's the investment cost of the development? That -- probably more than EUR 1 billion, right?

Well, I can't imagine the scenario where we go build all this ourselves. So that's -- we just don't have the balance sheet to do that. We're going to be very mindful of that as we proceed, which is why at this point, we're prepared to talk about what the value creation is in the building rights, but in terms of the actual execution, we're not prepared to get into that yet.

We have a question from Tobias Kaj.

I also would like to take -- I have some few questions and take them one by one, if that's okay. I would like to start with the rent collection of 93% in Q3. Is that based on gross rent or net rental income?

This is based on net rental income.

Okay. And does that mean for the full year that you have some -- almost EUR 10 million in outstanding rent receivables?

No. I don't think that we have that much, no. If you look at our cash flow, you see that we have a slightly higher negative working capital development, but it's not like EUR 10 million.

No, I see the change from last year is not that much, but the total negative effect of working capital is almost EUR 14 million. What's that more than rent receivables?

There are, of course, many things like, for example, VAT receivables relating to the development projects. This is normally a big item.

Okay. And for the counterparts, regarding your outstanding rent receivables, can you say something about the mix? What kind of tenants are mainly related to that?

I think that it reflects pretty much our average exposure. And as you know, we have clearly less fashion compared to the other. Other retail real estate landlords, we have like 25% of fashion. So I don't think that we have given any exact breakdown of where these receivables come from, but they are fairly representative to our overall mix.

Yes. Maybe I can help you a little bit. This is maybe oversimplifying it, but how I think about the collections. If we are at 94% year-to-date and we had roughly 2% in terms of rent concessions that were provided in Q2, and roughly about 1% of our rent is -- was a part of bankruptcy, that gives you 3% of the remaining 6%. So we have about 3% of our rent outstanding to collect. So it's -- as I say, it's maybe oversimplifying it, but that's kind of how I think about it.

Okay. That's helpful. Also, regarding -- you reported that you have very minor negative impact on the turnover-based income. Can you say how much turnover-based income you have in total?

It's 2.9%. I don't know what the euro number is, but it's about 2.9%.

Yes. We don't -- we are not disclosing now the exact numbers, but the percentage is approximately what Scott mentioned.

Is the turnover-based rent related to some specific tenant groups? Or is it also widely spread?