Citycon Oyj (CTY1S) Earnings Call Transcript & Summary

Good morning, everyone, and welcome to Citycon's Third Quarter Results Audiocast. We've just published our third quarter '22 interim report which, as usual, you will find alongside all other results materials in the Investors section of our website. My name is Sakari Järvelä, and I'm the Vice President for Investor Relations and Corporate Finance at Citycon, and I'll be hosting the call today. With me here in the call, as usual, are our CEO, Mr. Scott Ball; and our CFO, Mr. Bret McLeod. We'll start the presentation by Scott going through a summary of our business and operational highlights for the third quarter. And following that, Bret will go through our financial result and our financial guidance for the full year '22. After the presentations, there will be a separate Q&A session, so we will be opening the line for questions from the audience. With that, I will pass on to Scott. Please go ahead.

Thanks, Sakari. We're really happy to share our results with you this morning. The company continued to demonstrate strong performance despite macroeconomic headwinds. Just as the company outperformed during the COVID crisis, our business model continues to prove itself in good times and bad. Like-for-like net rental income increased 5.2% year-to-date and 3.4% for the quarter. This improvement was driven by like-for-like tenant sales, which were 7% above year-to-date 2021. Footfall continued its positive development as like-for-like. Footfall year-to-date was 12.1% above the same period last year. Operational key figures have surpassed pre-COVID 2019 levels. Like-for-like tenant sales were 7.2% above year-to-date 2019, and average rent has increased EUR 0.80 compared to Q3 2019. I should also point out that our collections remained in the high 90% range even through COVID. These all reflects the stability of Citycon's grocery and municipal anchored centers, which are connected to transportation hubs. Our leasing activity remained strong in Q3 as we signed 21,000 square meters of new leases with a positive leasing spread of 1.7%. Retail occupancy at the quarter's end was 94.9%. This is a testament to the attractiveness of our locations for our tenants to generate sales and operate profitably. This leasing activity contributed to retail occupancy remaining high and an average rent increase of EUR 1 to EUR 23.6 per square meter for the year-end 2021. 92% of our leases are indexed to inflation. We adjust for inflation at the end of each calendar year. And in our markets, inflation averages approximately 7% to 8%, which bodes well for growth in 2023. It should be noted that our tenants have some of the lowest occupancy cost ratios in the retail space and the tenant mix of grocery and municipal tenants means that there is the highest level of credit behind these leases. Inclusive of service charges, the average OCR of our portfolio was 9%, providing ample headroom for rent growth in a rising sales environment. Further, our limited reliance on fashion in favor of necessity-based goods and services, such as groceries, are less dependent on discretionary income. With the completion of the retail phase of Lippulaiva, along with the recently announced opening of the Metro station on December 3 of this year and limited capital commitments in 2023, we anticipate that Citycon's capital expenditures will be materially lower in 2023. In addition to typical maintenance and TI CapEx, in 2023, we have only approximately EUR 8 million of committed development CapEx, which is done at a guaranteed fixed price. We continue to make progress on creating development rights requiring minimal capital. These building rights will continue to support our valuations in addition to providing future income. This significant reduction in capital commitments increases our free cash flow, providing additional support for the balance sheet. Looking at the balance sheet, Citycon continues to recycle capital in order to strengthen its investment-grade balance sheet and maintain flexibility. In September and subsequent to quarter end, we purchased additional unsecured bonds at a discount in the open market for EUR 29 million notional. Year-to-date, Citycon has now repurchased EUR 108.3 million of notional bonds during 2022 by using approximately EUR 98.7 million of cash at an average yield of 4.9%. You will notice that during the quarter, Citycon registered an additional 2 assets worth approximately EUR 125 million as held for sale. These transactions are in due diligence and are expected to close by year-end, with the sales proceeds earmarked to pay down debt. Prior to the sale, we have sold EUR 400 million of assets since 2021 and over the next 24 months, Citycon is targeting EUR 500 million of asset sales, including the 2 asset sales that I just mentioned that are held for sale. And then we intend to use the proceeds to repay debt. Net fair value gains of our investment properties was up slightly in Q3 and increased EUR 23.1 million on a year-to-date basis, primarily due to building rights development, mainly at Trekanten where zoning was approved in the third quarter. These actions, combined with continued strong operating metrics, reduced CapEx spend and positive future growth driven by indexation, further stabilized Citycon's well-laddered maturity profile and credit metrics. We have no significant maturities until October of '24. 95% of our consolidated debt is fixed. 100% of our assets are unencumbered, and we have over EUR 500 million of liquidity. As a result, Citycon is well positioned to continue to thrive despite near-term disruption in the credit market. The business model of urban hubs containing assessed retail and residential units in major markets attached to public transportation has proven to be a bulletproof concept when others struggle during COVID. The growth in all of our operating metrics and our positioning going into 2023 bodes well for the future. As a result of the solid quarter and the confidence we have in the business, we are reaffirming our guidance. With that, I'll turn it over to Bret.

Thanks, Scott, and good morning, everyone. As Scott said, it was a solid quarter and a continuation of the positive operating trends we have witnessed year-to-date. Looking at the details of our direct EPRA results for the quarter on Slide 8. Net rental income growth was strong, up 5.3% resulting from the standing portfolio, which excludes dispositions and includes Lippulaiva. This strong performance was great to see, given the high energy cost increases we witnessed in the quarter, particularly in Estonia, the only one of our markets where we are unable to hedge energy cost. I think it is worth pointing out that we are one of the few owners in our spaces -- in our markets, excluding Estonia, that hedge energy costs, which is a clear benefit for our tenants and their overall costs. The good news is we were able to offset much of this increase through higher service charges, which provided for continued strong NOI growth. This growth flowed nicely to standing direct operating profit where we were up 5.1% as savings in G&A were offset by lower direct other income due to the exiting of our Norway managed center business in Q3 '21. As a result of this performance and the reduction in share count, due to our strategic share repurchase late last year, both standing EPRA EPS and adjusted EPRA EPS was up 7.7% quarter-to-date, representing strong improvements in the entirety of our operations. Lastly, we recorded a net fair value gain in the quarter of EUR 0.9 million, which resulted in EPRA NRV per share of EUR 11.68 or an increase of 80 basis points from the same time last year. Moving to our year-to-date results on Slide 9. The story remains consistent led by strong year-to-date net rental income growth for the standing portfolio of 7.8% and essentially flat for the total portfolio, which includes disposed properties. Again, this is in the face of increasing energy costs and property expenses, which we were able to offset with increasing service charge income. Year-to-date, direct operating profit was up 5.7% for the standing portfolio, translating to EPRA EPS up 10.8% versus the same time last year. For the standing portfolio, adjusted EPRA EPS was up only 2.5% year-to-date as we issued a hybrid bond in late June 2021, which resulted in a difficult comp for this metric in the first half of this year. On Slide 10, we've provided bridges for both net rental income and EPRA earnings. During the quarter, like-for-like properties contributed an incremental EUR 1.3 million of NRI over the same period in 2021 while redevelopment projects contributed an additional EUR 1.4 million. These amounts were slightly offset by EUR 3.3 million in lost NRI from dispositions and a small amount due to weaker performance for non-euro currencies. Year-to-date, like-for-like NRI contributed an incremental EUR 5.8 million, driven by a combination of improved occupancy and indexation. Redevelopment projects, primarily driven by Lippulaiva, contributed an incremental EUR 5.3 million. Again, these gains were offset by lost NRI from dispositions of EUR 11 million and a slight loss from FX weakness. However, even with dispositions, net rental income year-to-date was essentially flat to the same period last year. Looking to the complete EPRA earnings bridge for the quarter, inclusive of asset sales, the incremental benefit in direct administrative expenses was offset by small amounts in direct other operating income and expenses, direct net financial income and expenses, direct share of JV results and direct current and deferred taxes. The quarter-over-quarter declines in the direct share of JV results is primarily due to the increased financing costs at Kista where 25% of the secured mortgage loan on that asset is unhedged and subject to rising stibor. The change in direct current and deferred taxes is primarily due to taxable profit recognized in Q3 2022 compared to a loss at the same time in 2021. Year-to-date, EPRA earnings for the total portfolio was most positively impacted by an incremental improvement in direct net financial expenses of EUR 1.4 million due to lower interest expense following debt repayments. This was offset by higher direct admin expenses due to the accounting treatment of CEO IFRS share-based compensation, which we have discussed in prior quarters. The largest negative incremental impact on EPRA earnings came from higher direct current and deferred taxes, again, due to the taxable profit year-to-date versus the same period last year. Looking to fair value changes on Slide 11. Net fair value increased by EUR 900,000 in Q3, bringing the total net fair value increase year-to-date to EUR 23.1 million. The net fair value gains this quarter were driven by positive indexation impact on future cash flows as well as the value of building rights coming online at our asset in Trekanten in Norway, as Scott mentioned. Fair value gains in Norway, Sweden and Denmark were offset mainly by onetime accounting adjustments in Finland related to capitalized interest and real estate taxes at Lippulaiva. Those adjustments were applied as the center is now open and the development project has been closed out. As mentioned, EPRA NRV per share was up 80 basis points over Q3 2021. However, similar to last quarter, this figure was negatively impacted by FX movement year-to-date of EUR 128 million, primarily as a result of weakness in both NOK and SEK currencies. This impacted asset value and ultimately, EPRA NRV by EUR 0.76. Excluding the FX impact, EPRA NRV would have been approximately EUR [ 12.44 ] per share. As noted on Slide 12, we continue to be focused on maintaining a strong, flexible and investment-grade balance sheet with ample liquidity. Our weighted average interest rate is 2.38% with 95% of our rates fixed, and we have no significant maturities until October of 2024. Further, with total available liquidity of EUR 537 million and 100% of our assets unencumbered, we have multiple levers to maintain that balance sheet flexibility. We remain focused on continuing to strengthen our overall portfolio and our balance sheet going forward through capital recycling, while looking to generate appropriate risk-adjusted returns versus our cost of capital. During and subsequent to the third quarter, we repurchased an additional EUR 29 million of notional bonds, bringing our year-to-date total repurchases to EUR 108.3 million notional at an average yield of 4.9%. Scott mentioned the introduction of a measured asset sale target -- EUR 500 million asset sale target over the next 24 months, inclusive of the assets we noted as held for sale this morning. It is our intention that proceeds from asset sales over that period will be used to pay down debt and strengthen the balance sheet and our credit metrics. I also think it is worth reinforcing again what Scott said that while we are still in the budgeting phase for 2023, with the completion of Phase 1 of Lippulaiva and committed development CapEx of only EUR 8 million next year, it is our expectation that CapEx will be materially lower than from the past several years, increasing free cash flow. Speaking of credit metrics and as noted on Slide 13, our metrics remain stable across the board. I would point out that similar to the impact I mentioned on EPRA NRV per share, changes in FX also impacted IFRS LTV this quarter. Excluding the impact of currency changes, our LTV would have been lower by approximately 80 basis points or 40.9% versus the 41.7% we recorded. As Scott mentioned, given our continued solid operational performance, we have reaffirmed our guidance for the full year as noted on Slide 14. Despite continued macro and geopolitical uncertainty -- certainty, we are confident in the performance of our assets, the stability of our business and the strength of our necessity-based Nordic-centric strategy. With that, we are now happy to take your questions.

Okay. Thank you, Scott and Bret for [indiscernible].

[Operator Instructions]

This is Neeraj here from Barclays. I had a couple of questions. So first, regarding the disposal plan, including the EUR 150 million you have marked as held for sale. Can you please provide us more color on how liquid the transaction market is currently? And are we looking to dispose assets around book value? Or we are looking at some sort of discounts due to the current market environment? .

Yes. So I think I'll start. First, the assets we have sold, as we've talked about previously, we've sold at book. The assets that we're discussing for the current potential transaction is close to book. It's our expectation that asset sales moving forward would be at or close to book. I guess, taking the first part of your question in terms of the liquidity in the market. I think for the asset type that we have and the product that we're looking to sell, which are in the smaller markets, therefore, smaller kind of price tag for each asset, there is more liquidity in that space than there might be in some of the larger fashion-oriented properties. I'll be the first to acknowledge that the financing market is more expensive than it was previously. But I do think buyers are able to obtain mortgage debt. And so I think it's going to factor into the equation. I think the good news for us is that as we won, we're saying we're going to sell this over 24 months. But secondly, I think when you think about the product type that we're selling, we actually have a larger buyer pool than others might have who are out trying to sell their product. And in some instances, we're actually talking to local buyers. So...

Yes. And I think, obviously, the benefits of indexation and cash flow probably helps our property class, which is, I think, unique in the retail space and probably helps also aid in the liquidity in the transaction market.

Yes. I think because we do have some time there, Bret makes a great point. I think that when you look at the rent growth that we anticipate seeing leading into next year, that provides another tailwind, if you will, for us to be able to transact and for buyers as they look at trying to offset what might potentially be higher cost of financing.

Yes. That's very helpful. Just to sort of gauge. Did you say decision to like sort of around EUR 500 million. Is this like purely financing and deleveraging oriented? Or there is some other angles to it?

No, I think as we look, I think it is, as we said, the proceeds we plan to use to repay debt. So I think from our mind, we are committed to the investment-grade rating, and we think that this is a reasonable and measured step, as Scott said, over the next 24 months to begin to prepay debt at frankly levels. The credit markets have been out of whack. And for us to be able to recycle capital from asset sales close to book value and be able to repurchase debt at the discounts we've been able to do, that's a pretty unique opportunity. And I think that we will take advantage of that and hopefully be able to continue to strengthen the balance sheet.

Yes. It's a weird time where you can look to delever and it almost be accretive. It's a very unusual time, and we're looking to try to take advantage of that dynamic.

Yes, that's perfectly understandable. I have 2 more questions around the similar lines that you mentioned. Regarding your bond buyback program or like debt repurchase, which you plan to do with this sort of disposals, are you planning to include hybrids as well? I do understand there are restrictions around -- from S&P regarding hybrids, but I think companies are allowed to do 10% of the outstanding anyways in a given year. So do you plan to include hybrids as well? Or are we just looking at the unsecured bonds?

Yes, you're correct. You've made a good point on the hybrids. There are restrictions around the hybrid of course. And I think what I would say, as I've said many times before, is we're committed to maintaining the investment-grade rating. So we wouldn't do anything that would jeopardize that. It's certainly one of the things we would look at, at a small level. But I would say primarily, we're looking at obviously our near-term maturities and making sure we tackle those with these bond repayment plans.

Got it. And probably the last question is tied to the answer you gave regarding the IG rating. I mean we see that it's currently BAA3 from Moody's with negative outlook and BBB- from S&P, so like probably the last like stage before it sort of gets longer to high yield. And we understand that all the actions regarding disposals and bond buyback and potential deleveraging is sort of going in a positive direction from a rating standpoint of view, but of late, we have seen that rating agencies are being a bit more aggressive in terms of like the forecast for the future given recession and everything and increased cost of capital. How committed you are in terms of your investment grade rating? Are you having any discussions with rating agencies? I just wanted to understand a bit more on the commitment towards the IG rating. How we are looking at it?

Yes. I would say we have a very open and good dialogue, I believe, with the rating agencies and are constantly in contact with them. I would say, obviously, I said before, we're committed to maintaining the investment-grade rating and taking the steps, which I think we've started here this morning to announce that we'll continue to maintain that level of where we are today. But I would also tell you, you have to think a bit about the operations of our underlying business, right? And I think that's important. Yes, there's some macroeconomic headwinds. But as Scott and I have laid out this morning, we have a very strong operational business. It was very strong through COVID. It's uniquely positioned given its indexation and position looking forward to increase cash flow going forward and then continue to grow and be solid with the types of tenants we have. And so I think that the fundamentals of our underlying business are strong. If we are reducing CapEx, as we also talked about today, that increases free cash flow. So I think it's not just capital markets and balance sheet items and steps we're taking. But I think the underlying business is something that should be recognized by the rating agencies.

Yes, and I would add to that. To their credit, I do think the rating agencies understand that we have a different business model than some of our peers. The grocery anchored, sitting in the middle of these kind of urban hubs with the trains connected to it, it's just a very different mousetrap than some other -- some of our peers. And I think the rating agencies have understood that. They saw what happened during COVID and the fact that we outperformed. And I think to the extent there are these headwinds, potential headwinds, as Bret rightly outlined, I think we have enough tailwinds to kind of more than offset those headwinds, and I think the rating agencies see that.

The next question comes from Rob Virdee from Green Street.

Thank you for doing the call after the interims. It's very helpful. Just one more on the balance sheet and the hybrids. Can you remind me when the first call option is on those hybrids?

Yes. The first one, Rob, is EUR 350 million, I believe it's late November 24, with the reset date in February of '25.

Okay. So, okay, end of '24. Brilliant. And then just focusing again on the solid operations, completely appreciate everything that you said. On the indexation point, are you having any conversations with tenants that suggest maybe you can't pass all of this indexation on? The reason why I asked, obviously, is in some of your peers are having those conversations are struggling a little bit. And of course, some governments are also putting caps on some of the indexation you can pass through. You see anything like that?

So great question. We have not had any pushback yet. Now again, remember that the indexation really takes effect in '23. That being said, our low OCRs give us a pretty good starting point versus maybe some others. We haven't had any indication that there will be caps in the countries that we operate in as it relates to indexation. So it feels like we're in a -- again, in a very good position here, if you will, moving into '23 and don't anticipate having significant pushback. And again, it's -- when our sales are up 7% over even more than 7% over the COVID period, I mean sales is really the driver of all of this at the end of the day. And so if we have low OCRs and we have growing sales, there should be plenty of capacity for tenants to absorb this. The other thing I would point out, I think what the landlords that you referenced who are having conversations today, I think what we understand from the tenant community is that a lot of those conversations are around the energy cost that landlords have been forced to pass through because they didn't hedge their energy cost. We were very fortunate, as Bret mentioned, in all of our countries except for Estonia, where there was not the opportunity, we hedge those energy costs. So we have not passed along the same kind of increases that tenants have seen in some of those other landlords.

Makes a lot of sense. And then just further along on some of the asset sales that you remarked, that EUR 500 million number. I appreciate lower ticket and the grocery anchor and there is a market for that. We have no doubt. Are there any particular geographies where you're looking to make these kind of portfolio trims?

Yes. I mean, I think -- listen, I think it's not geography by country per se. I think it's geography around markets. And if you look at where we have traction, it tends to be in those markets that are not in the largest urban hubs because those are smaller centers and have a smaller price tag attached to them. So I think they're a bit more digestible. And as I mentioned earlier, I think it expands the buyer pool pretty significantly. And I do think that there are people who -- if you think about investing in an inflationary environment, you want to own real assets. And I do think that there is -- there are smaller investors out there who see this as a real opportunity.

The next question comes from [ Vince Elias ] from Kempen.

This is Vince from Kempen. Quite a few positive announcements today on disposals, but I'm curious, what is your view on disposals beyond the next 2 years?

Beyond the next 2 years. Is that the question? .

Yes.

I mean it's -- I think that we will continue to -- if you look at what we have done as a company, we are, in the last few years have been, I think, pretty good at recycling capital by kind of using our asset management team, which has done a phenomenal job of improving the quality of an asset and then we haven't been bashful about selling those assets as they've as we've been able to increase the value. I guess most recently was Columbus in Finland. So I would see that as our business model going forward. I don't think there's anything that changes there. If we develop an asset and we feel like we've done everything we can kind of do to maximize value. I see us as a seller of that particular asset and at the same time, reallocating that capital, whether it be because we're building residential attached to one of our properties or whatever. Again, I see that being kind of -- when you say 2 years out, I see that being the model for us after these 2 years.

Okay, very clear. And then on the building rights, so you have a few options to realize them. And what would you say is the most likely one?

It's interesting, I think that in today's environment until the credit markets kind of stabilize, we will probably -- we're going to continue to try to achieve these building rights. But I see us kind of sitting on them until the credit markets kind of stabilize, hopefully in the next call it, 6 months or whatever. And then I see us as we look at each of the assets, there may be some opportunities if there -- if the building rights are for, let's say, condos, which is a onetime kind of purchase price benefit, we may opt to sell those building rights or JV them. If the building rights are for an ongoing rental stream, we would probably in a lot of instances, develop those, again, either ourselves are worth the JV. But again, we have, as you mentioned at the beginning of your question, we have a lot of flexibility in terms of how we realize those, not only in terms of methodology, but also in terms of timing.

And I think going back to your original question on after the next 2 years, a lot of those building rights will be coming on and fully realized plus 2 years. So it gives us a lot of value optionality, right, [ Vince ], as you look beyond the next 2 years, which we talked about, this measured sales process to have value in our assets that we can utilize in multiple ways. So I agree with Scott.

[Operator Instructions] There are no more questions at this time. So I hand the conference back to the speakers for any closing comments.

Okay. Thank you for everyone attending and for the great questions. It goes without saying that if you have any more questions, please reach out, we're always happy to help and talk about our business. But with that, I thank you a lot for today and wish you a great day.