Citycon Oyj (CTY1S) Earnings Call Transcript & Summary

Good morning, everyone, and welcome to Citycon's First Half 2021 Result Audiocast. We have this morning published our financial statements, and as usual, those can be found on our web page under the Investors section. My name is Laura Jauhiainen, I'm the Vice President of Strategy and Investor Relations. Today, in this call, as usual, you have our CEO, Mr. Scott Ball; and our CFO and Executive Vice President, Eero Sihvonen. We'll start today with the presentation of the Q2 results and the main events of the quarter. After the presentation, as usual, you will have a chance to ask questions. Scott, please go ahead.

Thank you, and good morning, everyone. We're pleased to present Citycon's Q2 results. I'll start with a summary of Q2 and H1 as well as the highlights from the quarter. Eero will then review Citycon's financial results and where we stand now after the first half of this financial year. I will conclude our presentation with an update on our portfolio transformation strategy and the most recent developments on the residential side. In addition to outperforming the sector during the pandemic last year, Citycon's financial and operational results continued to improve in Q2 with increases in NRI and valuations compared to both the prior quarter and Q2 in 2020. NRI for the period was EUR 50.8 million, which is 1.2% over Q2 2020 levels and a 0.7% increase over Q1 of this year. The operating profit is similarly ahead of Q1 and 2020 levels, standing at EUR 44.1 million in Q2 of 2021. Portfolio valuations continued to grow for the second consecutive quarter. During the first half of the year, the total increase stands at EUR 140.5 million, with EUR 24.4 million attributed to fair value gains. On the operational side, footfall continued to increase, like-for-like footfall standing at 11.9% over Q2 2020 levels. Tenant sales grew accordingly with like-for-like tenant sales 1.8% above the first half of 2020. It's noteworthy that in June, tenant sales have recovered to pre-pandemic levels of June 2019. Rent collections have remained at high levels, and for the first half of the year, we stand at 95%. Final collection rates are again expected to increase beyond this already high level. And I should note that these are non-adjusted collection figures. We signed over 50,000 square meters of new leases during the quarter, with average rents being higher than Q2 2020. The ongoing solid performance demonstrates the strength of our strategy, which is based on a large share of necessity tenants and assets in densely populated Nordic urban markets with a connection to mass transportation. It is worth highlighting that this Q2 '21 improvement is on top of last year's already strong and resilient performance as Citycon clearly outperformed the industry averages during the pandemic. On the financing side, one of the important highlights was the upgraded outlook from both Standard & Poor's and Moody's. We now have investment-grade ratings with stable outlook from all 3 rating agencies: Standard & Poor's, Moody's and Fitch. On the heels of our successful senior bond offering in Q1, we also issued a green hybrid bond of EUR 350 million, with great demand from investors. The bond issuance, combined with the divestment of 3 noncore assets in Q1, improves our liquidity, which allows us to speed up our portfolio transformation strategy. It also reduced our loan-to-value to 38.9%. As we have communicated previously, one of our key initiatives is the recycling of capital and transforming our portfolio towards more residential. The Nordic transaction market has been active during the first half of '21, and we've had reverse inquiries for several of our assets. The current transaction market also supports selective strategic acquisitions that we may pursue in the residential space. This transformation also entails active development of building rights in our portfolio. At the moment, we have identified EUR 220 million worth of building rights, which is approximately EUR 20 million above the previously communicated figure. And of this, approximately EUR 50 million of this is on our balance sheet, leaving the large majority of value as additional upside for the company. Last but not least this quarter, we appointed Bret McLeod as CFO elect to continue Eero's great work as he retires at the end of the year. Bret will become CFO and a member of the Corporate Management Committee in January of '22, after which Eero will continue to support us as an adviser through June of '22. We warmly welcome Bret, and we thank Eero for ensuring a seamless transition. Another benchmark of our continued strengthening is the second consecutive quarter of fair value growth. This is a result of the positive development of the financial and operative key metrics, combined with the fact that the Nordic commercial real estate market is proving to be very attractive to many international investors. We realized a fair value change of over EUR 24 million during the first half of '21. And as we previously mentioned, the spread between cap rates and interest rates is at historically wide levels, and we are beginning to see some cap rate compression in some markets, which revert to the mean. The Nordics have proven to be a safe haven, which provides stability in our business. Consumer confidence has remained at relatively high levels throughout the pandemic and has grown significantly during the second quarter of the year. It's one of the most important metrics in forecasting consumer behavior and demonstrates that we are on track for a rapid recovery from the pandemic. Consistent with our strategy, we have a large share of necessity and municipal tenants, which adds to the resilience of our portfolio and bring stability to the business and cash flows. Over 35% of our GRI comes from stable, necessity tenants, and only 5% of our leases are turnover-based. We do not see this turnover-based leasing population growing. I should also point out that 92% of our leases are tied to indexation, providing protection against potential inflation. The public sector continues to be a growing part of our business. Currently, public sector and health care services account for 10% of our contracted GLA, with strong credit behind these leases. We have continued to increase this proportion of public services. As mentioned, footfall and tenant sales are showing positive development. Like-for-like footfall was approximately 12% over the comparable period to Q2 of 2020. Tenant sales also developed positively in the first half of '21, with a 5% increase in grocery sales and 2% increase in like-for-like total tenant sales. Towards the summer in June, we have even exceeded comparable pre-pandemic tenant sales figures from 2019. These are all forward-leading indicators, and rents typically follow these trends. We continue to see progress on the leasing front, as the number of leases signed has grown both quarters this year. We have signed over 100,000 square meters of new leases this year, putting us in a good position for the remainder of the year. In Q2 '21, the new leases measured in square meters almost doubled compared to Q2 of 2020. The occupancy rate has also remained at a high level, thanks to our strategy of necessity-based urban hubs. In Q2 '21, the retail occupancy rate, excluding Kista, was at 94.1% compared to 94.1% in Q2 of 2020 when the pandemic first hit our markets. So to summarize, quarter-over-quarter growth has highlighted several key metrics, including NRI and fair value changes. The trajectory of the Q2 results also bodes well for the remainder of '21. As a result, we have tightened our previously announced guidance. I will now hand it over to Eero, who will give a more thorough review on our financial development.

Thank you, Scott, and I will start from the Page 11, Q2 financials. And like Scott mentioned, we had a strong second quarter and strong first 6 months. For the 3 months ending at the end of June, basically, we had a net rental income of EUR 50.8 million, which was EUR 600,000 better than 1 year ago or 1.2% over. EPRA earnings ended up at EUR 32.7 million, which is close to previous Q2's level, EUR 3.6 million below. And earnings were slightly below due to somewhat higher financing costs, JV results and due to the deferred tax items, which were still positive, but we had quite extraordinarily positive deferred tax items in Q2 2020. Quite notably also, our net replacement value improved. And net replacement value for -- of course, most of you already know, that replaced net asset value by -- as a new EPRA KPI. So NAV/NRV also did improve. Then going over to the first 6 months, net rental income for the first 6 months was EUR 101 million, which was only EUR 1.4 million below last year's level, and I say only because the comparison year obviously naturally included Q1, which was pre-COVID period. So partially, we are comparing ourselves to the pre-COVID situation. But still, they're very, very close to that level. So overall, a good strong quarter and 6 months. Then on Page 13, the exchange rates. Both Swedish krona and the Norwegian krona were impacted by the beginning of the pandemic and were quite weak, particularly around Q1, Q2 last year, but have thereafter strengthened. And in a while, I will go through the exact impact of the currencies. But on the net rental income level, we were supported by a stronger both NOK and SEK. Then a more detailed net rental income bridge. And here you can see that the impact of currencies for the first 6 months was indeed positive, approximately EUR 3 million. We had like-for-like result which was only modestly negative, and again, I would say modestly negative because we are comparing ourselves partly to the non-COVID period. Then on next page, you can see the estimated COVID-19 impact on our rental income. And of course, this is not exact science, and these are not like exact numbers but based on our best estimates. And here can be seen that the estimated COVID-19 impact on our net rental income for the first 6 months was EUR 4.3 million. And can be seen here how it splits between different line items, i.e., slightly higher vacancy, rental discounts, turnover-based rents, specialty leasing, parking, credit losses and so on. Then a very important aspect of our results was the positive valuation, and we had a second consecutive positive valuation quarter. And this quarter, we had a full external valuation by CBRE for our Norwegian, Danish and Estonian portfolio and by JLL for our Finnish and Swedish portfolio. And we conduct a full external valuation twice a year, i.e., Q2 and Q4. So can be seen here that the positive valuation for the quarter was EUR 15.5 million; and for the first 6 months, EUR 23.4 million. And here, the change has really been significant. Can be seen that last year in Q2, we had a negative EUR 76 million. So the impact is approximately EUR 90 million better valuation result on a quarterly basis and naturally reflects the stability of our business model and the quality of our centers, but also reflects the investment market and M&A market, which is picking up. And there are more comps in all of -- essentially all of our markets, particularly now recently in Norway. I already mentioned that the NRV is up, and here can be seen the bridge. And the biggest component, of course, is the good positive results. Also, we were, this time, helped by the translation reserve, and that means a positive currency effect on our equity in the Swedish and Norwegian subsidiaries, so EUR 11.66 NRV for the quarter. Then a few words about the financing, and we had a particularly successful hybrid issuance in the beginning of June. We issued EUR 350 million of hybrid securities, which are subordinated to our debt obligations and treated as equity in our IFRS statements. And the rating agencies essentially give the hybrids a 50% equity credits. And much of these proceeds are still in our balance sheet, waiting to be employed, to be -- to expedite our strategy execution and drive the net rental income and earnings further. A very successful transaction. And as a result of the hybrid issuance and as a result of our stable and improving results, like Scott mentioned, both Moody's and S&P upgraded our outlook to stable, and now all 3 ratings are stable. And this is naturally very important also for us, as management is extremely committed to the IG, investment-grade, ratings and because a majority of our financing does come from the bond markets. Main financing metrics can be seen here. We are mostly based on fixed interest rates, so we are not among the companies who would suffer when the interest rates eventually would start to increase. Essentially, all of our financing is unsecured, so essentially, most of our assets are unencumbered. Part of the EUR 250 million of the revolving credit facilities is secured, but none of that is drawn currently. And we do, of course, now have a substantial liquidity buffer, i.e. of EUR 800 million, and do have any refinancing needs anytime soon, so the next maturity apart from the short-term commercial papers is in September '22, EUR 162 million maturing then. And financing key figures can be seen on Page 21. And most notably, loan-to-value IFRS is now within management’s target of 40% to 45% or actually even slightly better. And that is very important from the rating aspects and also generally and other main KPIs as can be seen here. The liquidity position, as mentioned, is reconciled here. And most of the liquidity, of course, derives from the totally unutilized revolving credit facility, committed credit facility of EUR 500 million. Then we have certain other facilities. And as mentioned, we still have approximately 285 million of the hybrid proceeds in liquid money market funds, and they are in liquid money market funds because maintaining those funds in the bank accounts would cost money. And as mentioned, these funds are awaiting to be employed in strategic purposes. And the Plan B, of course, could be to repay our next maturity -- maturing bond, this EUR 162 million, which can be quite flexibly called, and that is EUR 162 million and maturing in September '22. Then turning over to the outlook. Due to the fact that the results were strong and following our practice of previous years, we have narrowed the guidance, maintaining the same midpoint, apart from the adjusted EPRA EPS. And in the adjusted EPRA EPS, which includes hybrid coupons, we have maintained the previous low point and narrowed data as well. And the midpoint has there not been kept the same because since the previous updating, we have issued more hybrids, and the hybrid coupons do impact this line. But otherwise, the same midpoint and clearly narrowed guidance ranges. That concludes my part. Back to you, Scott.

Thank you, Eero. As we previously highlighted, our strategy reflects a stable core business partnered with attractive organic growth opportunities which have clear synergies with our business. We have assets in prime locations and are located in the top 2 cities in each country with strong urbanization and direct connection to public transportation. The tenant mix is primarily necessity goods and services layered with a growing share of municipal tenants. On top of the stable assets, the densification plans associated with our urban hubs provide significant growth potential. This entails developing new residential, office and municipal services space adjacent to our existing assets. We also have strong social and community relationships, which makes us the preferred partner for municipalities to develop the areas around our assets. We continue to remain deliberate in our efforts to dispose of noncore assets at pricing that confirms our valuations. We've been very vocal about our intentions and have not deviated from this plan. We have a strong development pipeline and look for opportunities to exploit our improved liquidity for strategic acquisitions. Speaking of our development pipeline, we have approximately EUR 220 million of building rights embedded in our portfolio. These building rights provide significant organic growth potential, mainly in residential developments close to our existing hubs. It is worth keeping in mind that a large majority of this value is not on our balance sheet, with over 75% of the estimated value as additional upside for the company and its investors. The estimated building rights value is backed by a detailed project pipeline. We have this detailed by specific asset, but what we provided for you here is a detail by country. This pipeline stretches across our operating countries, with around half of the total building rights value in Sweden. These building rights include a total of approximately 5,400 apartment units and is in line with our strategy of densification through diversification. To give you some further color on our residential pipeline, we have over 300,000 square meters of residential building rights. Over 20 projects covering all of our operating countries are in various stages of the development pipeline. This means that we anticipate having a steady flow of new residential buildings coming online every year over the upcoming 5 to 10 years. Lippulaiva will be a showcase of this strategy and will open in April of '22. This project will consist of 44,000 square meters of grocery stores in necessity-anchored retail space, along with a significant quantity of residential units, offices and health care all connected to a mass transit hub. The residential portion will consist of 8 towers with 450 units. 7 of these towers are now under construction, including the picture that you see on the cover of this presentation. This will be a textbook example of what we will accomplish with our development pipeline, and we estimate an annual NRI uplift of approximately EUR 19 million from Lippulaiva. Two other interesting projects, which are currently in development, are Herkules in Norway and Liljeholmen in suburban Stockholm. We've just begun the construction of the first 2 residential blocks in connection to Herkules and have had strong interest towards the apartments being developed there. Liljeholmen, on the other hand, is a large-scale development project already connected to a train station. The project is being done with the City of Stockholm, and the area will become an attractive urban environment with approximately 120 new apartments and 3,000 workplaces. In addition to the organic development pipeline, we are also now in a position to accelerate this transformation through select acquisitions. The market has continued to pick up, and we've gotten reverse inquiries from potential investors in several of our assets as we continue our capital recycling initiatives. Thanks to the Q1 divestments and the successful hybrid bond issuance, our liquidity position allows us to accelerate our transformation through select acquisitions of residential buildings. So to summarize, in terms of quarterly performance, financial and operational results were positive, with quarter-over-quarter growth, both against Q1 this year and Q2 of last year. Rent collections remained strong, and our leading indicators in our business are signaling a positive trajectory. We received upgraded credit rating outlooks from both Standard & Poor's and Moody's, meaning that we have -- now have 3 investment-grade credit ratings, with stable outlooks from all 3 major credit agencies. We completed a successful issuance of a green hybrid bond of EUR 350 million, with high demand from investors, leading to an LTV of 38.9% and a very strong liquidity position. Our densification through diversification strategy is progressing well. In addition to the organic developments, the Nordic transactions market is looking very attractive, and select acquisitions could be used as a tool to accelerate the portfolio transformation. These positive results allow us to narrow our full year guidance. With that, I'd like to thank you for your time and hand it back over to Laura.

Thank you, Scott and Eero, for the presentation. So we now have time for questions, and we turn the line on. Operator, please go ahead.

[Operator Instructions] Our first question is from Erik Granström of Carnegie.

I have a few questions. If we could start off a little bit with the value changes in Q2, I noticed that there were some changes to your yield requirements, and they seemed to have decreased about 10 basis points compared to Q1, mainly in Finland and Norway. Could you say something about how the external valuations have taken place? And why those markets seem to have strengthened more than perhaps Sweden?

This is Scott. Thanks for the question. I think it's interesting, we've been kind of beating the drum that grocery-anchored retail is a different animal than traditional shopping malls that are geared towards fashion. I think that we're beginning -- because of the results that we've generated last year as well as the first half of this year, I think we're kind of proving the point, and the appraisers are recognizing that performance, not just the appraisers but also the -- obviously, the rating agencies as well. So we have seen -- and as mentioned in the call, we are seeing the beginning -- some green shoots in terms of yield compression in some of our markets, including the markets you just mentioned. I should also add that we mentioned that we've had reverse inquiries on some assets. There is an asset that we may trade on that I think kind of further validates the position that we've taken. And I think the trade that we've made in Sweden in the first quarter with the 3 assets also validated kind of valuation. So I think it's a combination of the strong performance as well as the fact that we have transacted and continued to show that we can continue to transact at pricing that is at or above our valuations, has convinced the appraisers that they can begin to compress yields a bit.

Maybe the only other thing I would like to highlight, this is Eero, there has been, particularly Norway, real transactions and new like comps, where the appraisers can basically hang their hat and can basically compare to our properties as well. So there has been clearly more transactions. So this is one of the background.

Good point.

All right. Fair enough. And in terms of these inquiries, do you consider them to be interesting enough to actually make some transactions? Or have they been made at levels that are not interesting enough or assets that you simply don't want to divest?

I think that the inquiries are clearly at levels that are interesting for us. We are going to remain very deliberate about which assets we will transact on. As mentioned, I think there is at least one of the reverse inquiries that we will, in fact, transact on, which will further validate our pricing and as a noncore asset. There's a second one that we are also considering. We haven't made the determination just yet, but I think the pricing on the ones I'm mentioning are at or above our book, so they would validate our pricing. We -- of course, you always get reverse inquiries on a regular basis at pricing that is not something you would even consider or transact on. But the ones I'm referencing are ones -- are only the ones that we would actually consider.

Yes. Understood. And in terms of potential acquisitions, it sounded almost like you were perhaps looking at residential acquisitions in terms of perhaps building rights, I don't know, or actual portfolios. How do you view your position on the residential market? Is it still going to be purely construction in terms of development of your own building rights? Or are you perhaps looking at other type of transactions within the resi space as well?

Great question. We are -- we have been focused on our building rights, and that's -- the organic growth that we referenced is our existing portfolio and where we have densification opportunities. Now that we have this improved liquidity, we are looking at how we might accelerate our transformation by buying existing residential buildings and existing income because what we're trying to do is obviously diversify our income stream away from just pure or from predominantly retail. So any potential acquisitions would not be a building rights because we have enough of that already in our pipeline, quite frankly, and would be of existing buildings with existing income stream. The other thing I would remind you is that, and we've mentioned this in the past, we have sufficient building rights in our portfolio that we could also use some of that as currency if we wanted to transact because we have a lot of, again, reverse inquiries from residential developers who would be interested in buying or partnering up with us on these building rights. Frankly, we're not focused on selling those building rights at this point, but we could potentially use them as currency to JV or do other -- look at other opportunities to acquire some existing residential units and existing income stream. So it's kind of a two-pronged approach, if you will. We have our organic piece, and then we have potential acquisitions as a way to accelerate it.

Okay. Good. And then my final question is regarding like-for-like NRI development. You mentioned that it's progressively getting better as we're moving along. And does that mean that you think that you could end up in a positive like-for-like development for the full year this year? Or is it -- is that still too early to sort of make any decision or any comment on that?

We certainly hope so that we would end up positive. And as you can see, we are already very, very near. So it's not, by any means, impossible that that would be the outcome. But we haven't given any guidance on the like-for-like NRI, but yes, we are very close at least.