Citycon Oyj (CTY1S) Earnings Call Transcript & Summary

Good morning, everyone, and welcome to Citycon's First Half Year Results Audiocast. Last night, we published our second quarter 2023 interim report which you will find alongside all other results materials in the Investors section of our website. My name is Sakari Jarvela, and I'm the Vice President for Investor Relations at Citycon, and I will 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 will start the presentation by Scott going through a summary of our business and operational highlights for the second quarter and the first half year. Following that, Bret will go through our financial results and financial guidance for the full year 2023. After the presentations, there will be a separate Q&A session, and we will be opening the line for questions from the audience. With that, I will pass on to you, Scott. Please go ahead.

Thank you, Sakari. Good morning, everyone. We continue to see strong performance in our business fundamentals in the first half of the year as like-for-like tenant sales were 4.1% above 2022 and 9.7% above prepandemic levels. We're also seeing more customers in our centers as like-for-like footfall increased 3.1% compared to the previous year. Retail occupancy is now at 95.5%, up 50 bps versus the same quarter last year. At the same time, average rent per square meter with comparable FX increased by 7% to EUR 24 per square meter. We continue to benefit from a low occupancy cost ratio of 9.4% which, together with increasing tenant sales, positions Citycon for continued compounding rent growth and service charge increases. Sales keeping pace with inflation were evident in our continued high collection rates of 97% in Q2 and Q1 collection improving to 99%. In the first half of the year, these metrics supported our underlying asset values where we recorded a net fair value gain of EUR 69.4 million, reflecting the impact of compounding rent growth due to 93% of our leases being indexed for inflation. The net effect of these strong KPIs is that like-for-like NRI grew nearly 8% when excluding onetime items and comparable FX. This is on top of 9% growth for Q2 2022. On a sequential basis, Q2 NRI grew 2% over the first quarter. In the first half of this year, there has been adverse volatility of currencies, which is outside of our control. Specifically, the NOK and the SEK were at 20-year lows. Each quarter, we translate these currencies back to euro for reporting purposes. These currencies will likely rebound and, in fact, have partially since the end of the quarter. More details on the impact of currency will be discussed by Bret later. There are several factors which explain the strong KPIs: our terrific assets, our strong local teams, the strength of our markets throughout the Nordics and continued strength of consumers, as evidenced by the high level of foot traffic in our assets and the corresponding sales being reported by our tenants. This is due in part to our business model, which focuses on necessity-based retail and essential services addressing the everyday needs of our communities. This type of retail promotes daily traffic to our properties, which is only enhanced by locations in central urban areas adjacent to public rail and bus transportation hubs. Another driver of the consumer strength phenomenon is the wage growth of 5.5%, which has occurred in our markets due to inflation. As is typical in an inflationary environment, price increases work throughout the entire chain. Wages translates to cost of goods services translates to higher sales and, ultimately for Citycon, higher rents. As noted in our interim report, we refinanced and expanded our credit facility in April from EUR 500 million to EUR 650 million, consisting of a EUR 400 million revolver and a EUR 250 million term loan. Following this refinancing, Bret and the team continued their disciplined capital allocation by using the proceeds to execute a EUR 138 million tender for our bonds maturing in 2024, taking advantage of discounts and dislocation in secondary trading. In addition to the tender, we continue repurchasing bonds in the open market at a significant discount during the second quarter, and we'll continue to act opportunistically to repurchase debt. Through these actions, we continue to mitigate the earnings impact of higher current market interest rates while also improving our overall balance sheet. In addition to the new credit facility and term loan, we have disposed of EUR 266 million of noncore assets at approximately book value over the past 20 months, including EUR 120 million in December of 2022. All of this is part of our planned EUR 500 million asset sale target. With the additional flexibility of the new credit facility, we can be patient as Nordic transaction markets stabilize and we continue our asset management initiatives to maximize values for further sales transactions. Given the reports of significant amounts of investment capital waiting to be invested, we remain confident that we will meet our previously disclosed divestment target by the end of 2024. As mentioned, the tenant mix of Citycon's assets, which consists of municipal and grocery tenants, anchored by public transportation with index-linked leases sets us apart from our peer group. This long-stated strategy has already demonstrated its strength and resilience through a variety of market conditions, and we continue to push our properties in this direction. The most recent example of our active asset management is Myyrmanni in Finland, where we have further improved the tenant mix to increase the share of necessity-based tenants by signing several new leases, including a new Lidl grocer and a 7,300 square meter Prisma hypermarket opening this fall. This will result in groceries representing over 50% of the GLA of this property. This is consistent with what we have achieved in many of our properties, including Columbus which we sold in '21, and we'll continue to accomplish across the portfolio. These actions not only provide stability to revenue growth, it has the added benefit of improving the average credit profile of our tenant [ bids ] and creating cap rate compression. These asset management decisions remain aligned with, but separate from, the zoning work we are doing to achieve substantial additional building rights across the portfolio. Our business is really not that complicated. We own quality real estate, provide the consumer the goods and services they require and provide an environment that's convenient to access. When you layer on the dramatic impact of compounding rent growth, you have the recipe for success. The bottom line is that our business fundamentals are strong and our assets continue to perform very well. There is a scarcity of the type of high-quality retail assets we own. We have a proven business model and all of the important metrics, sales, footfall, rents, occupancy, collections, continued to show sustained and compounding growth. For all of these reasons, we remain bullish on the prospects of the business moving forward. Now Bret will walk you through the financial results for the first half of the year. Bret, over to you.

Thanks, Scott. And good morning, everyone. As Scott said, while there was certainly some noise in the quarter in the first half of the year, the main takeaway should be that the underlying performance of our assets are strong and performing as we anticipated in constant currency. Looking at the details of our direct EPRA results for the quarter on Slide 9, in constant currency, standing net rental income growth increased 2.6%. Our standing portfolio excludes dispositions and includes Lippulaiva and Torvbyen. Lippulaiva is, of course, our recently opened asset, which continues to grow with the addition of the new metro and residential buildings and will provide increasing NRI as it stabilizes over the next few years. Torvbyen is the Norwegian asset we closed due to structural issues at the end of Q1 2023. Like-for-like growth in the quarter was up 4.5% over Q2 2022. However, this does not reflect the underlying performance of the portfolio as we benefited from several onetime items in Q2 2022 where we recorded 9.1% NRI growth over Q2 2021. These skew the comparison. These onetime benefits were a result of parking income reconciliations and recategorizations of approximately EUR 1.1 million from 2021 in Norway and Sweden that were recorded in the second quarter of last year, resulting in again, the difficult year-over-year comps. Excluding these onetime benefits, like-for-like growth in Q2 2023 would have been 7.5%. In constant currency, standing direct operating profit increased 1.6% as admin costs increased EUR 1.1 million in the quarter versus last year, primarily due to the reduction of IT-related capitalization benefits as we transition to a new ERP system in the second quarter of last year as well as higher consulting and legal fees. I would point out that versus Q1 2023, our admin costs declined approximately 40% and are in line with the quarterly run rate we anticipate for the remainder of the year. Standing EPRA EPS and adjusted EPRA EPS both declined by 6% in the second quarter versus the same period last year, mainly driven by direct share of results in JVs, which declined by EUR 1.3 million, a result of Kista's financing costs increasing as the interest expense on the 25% unhedged portion of that loan rose alongside the sharp rise in STIBOR. During the quarter, our strongest markets were Denmark and Estonia followed by Finland. The onetime benefits from Q2 2022 that I mentioned, impacted both Norway and Sweden where, if excluded, like-for-like growth for both in Q2 2022 would have been 5.9% for Norway and 3.5% for Sweden. Moving to the year-to-date standing results on Slide 10. The story is generally the same as the second quarter with a few exceptions. In constant currency, standing net rental income growth increased 5.5% for the standing portfolio and like-for-like growth in the quarter was up 6.9% over the same period last year. Again, excluding the onetime benefits we received in Q2 2022, like-for-like growth for the first half of 2023 would have been 7.8% and in line with our expectations at this point in the year. In constant currency, standing direct operating profit increased 4.3% as admin costs increased EUR 2.2 million year-to-date, a result of the combination of the increases I mentioned in Q2 and the higher bonuses related to 2022 performance recorded in the first quarter of '23. Year-to-date, standing EPRA EPS in constant currency declined by 0.7%, driven by the rising financing costs at Kista and direct net financial expenses which increased EUR 2.4 million year-to-date over the same time last year, mainly due to lower capitalized expenses due to Lippulaiva remaining categorized as a construction project in the first quarter of 2022. Standing adjusted EPRA EPS improved by 50 basis points, primarily a result of hybrid bond repurchases and the correlating decrease in hybrid interest expense. In addition to providing our normal NRI and EPRA earnings bridges, we wanted to include some additional detail and transparency on the individual and cumulative impact of the 3 major items that impacted the quarter and the first half of 2023: FX, Torvbyen and onetime benefits that we received in Q2 of 2022. The impact of these items is highlighted on Slide 11. As you can see, FX had the largest impact on our standing results, costing us 670 basis points of growth in Q2 and 580 basis points year-to-date. However, you can also see that the other 2 items are meaningful with Torvbyen costing us 210 and 150 basis points in the quarter and year-to-date, respectively. In addition, the onetime benefits mentioned primarily in Norway, had a large impact of 250 basis points and 80 basis points on Q2 and year-to-date growth. Excluding these 3 items, standing NRI growth, which includes all our existing assets, regardless of development or redevelopment status, was 7.2% and 7.9% for the quarter and half year, respectively. On Slides 12 and 13, we've provided detailed bridges for both NRI and EPRA earnings. While I have already described many of the main drivers of change relative to last year, it is clear that FX had the largest impact, costing us approximately EUR 5.8 million and EUR 3.9 million in year-to-date NRI and EPRA earnings, respectively, again, compared to last year. We continue to see improvements in valuations in Q2 '23, which were up EUR 24.7 million, excluding Kista. In total, net fair values were up nearly EUR 70 million year-to-date or approximately 1.7%. The improvements come from simply updating our rents that were improved via indexation as well as matching the current forward inflation outlook. Yields remained stable at 5.5%. These changes to fair value improvements were offset by continued NOK and SEK weakness, resulting in an EPRA NRV per share of EUR 10.71 versus Q1 2023 of EUR 10.78. As noted, EPRA NRV per share would have been EUR 11.29 in constant currency. The good news is that subsequent to Q2, both the SEK and the NOK have had a sharp rebound which, if measuring the rates as of last Friday, would have translated to meaningful improvements in LTV, EPRA NRV per share and IFRS equity. This can be observed on Slide 15, where the recent movements alone would have increased IFRS equity by EUR 32.4 million translating to EPRA NRV per share of EUR 10.93, an LTV of 42.6%. If FX rates from year-end 2022 are applied to these metrics, we would see an increase in equity of EUR 86.2 million, an LTV of 42% and an EPRA NRV per share of EUR 11.29, as I mentioned. Taking it one step further, if year-end 2021 rates are applied, we would see an increase in equity of EUR 131.9 million, an LTV of 41.1% and an EPRA NRV per share of EUR 11.60. As discussed on our first quarter call and highlighted on Slide 16, we are very pleased with the refinancing and extension of our credit facility, which increases our liquidity and improves our maturity profile significantly. As noted, the total facility is EUR 650 million, an increase in capacity of EUR 150 million over the prior facility and includes both a EUR 400 million revolver and EUR 250 million term loan. During the second quarter, we put the term loan proceeds to work with the successful tendering of our 2024 bonds and additional open market bond purchases for a total debt repurchase amount of approximately EUR 155 million. Year-to-date, we have repurchased EUR 235 million of debt for EUR 215 million of cash. The credit facility refinancing and subsequent debt repayments have provided ample room and time for us to complete our remaining asset sales target of EUR 380 million by the end of 2024. The success of our credit facility refinancing underlines the strength, liquidity and flexibility of our balance sheet, as noted on Slide 17. We have no significant maturities until October of 2024, total available liquidity of EUR 443 million and over 85% of our assets remain unencumbered. All debt maturities through 2024 are covered, and we have improved our well-laddered maturity schedule with the Q2 refinancing of the credit facility and term loan. I would also point out that both the RCF and term loan have a 1-year extension option to 2027, further solidifying that maturity schedule. We remain investment grade with S&P, and they reaffirmed our BBB- stable outlook in April of this year. As noted on Slide 18, our credit metrics are stable. Weighted average interest rates ticked up slightly to 2.83%, reflecting the rate on the new term loan we drew in Q2 2023, and correspondingly, interest coverage came down slightly. As mentioned, FX impacted IFRS LTV in the quarter, and excluding the impact of currency changes, our LTV would have been lower by approximately 100 basis points or 42%. Again, assuming similar exchange rates to year-end 2021, our LTV would have been 41.1%, close to the low point for the company since 2019. Moving to our guidance on Slide 19. We have reaffirmed our current operational guidance and midpoints based on the fact that our underlying portfolio is performing well as expected. That said, given the extreme volatility in the NOK and SEK currencies in the first half of 2023, we have introduced additional information to provide transparency and clarity around the potential full year negative impact of weaker FX rates. While we cannot predict where either of these currencies will end up, we have noted that if exchange rates for the NOK and the SEK were to remain at today's levels, the approximate full year impact to direct operating profit, EPRA EPS and adjusted EPRA EPS would be EUR 10 million, EUR 0.08 and EUR 0.08, respectively. This accounts for the fact that in the first half of the year, we have recognized nearly EUR 6 million in direct operating profit impact from FX. So it would imply an additional EUR 4 million in impact if rates were to remain at today's levels. As noted, we have seen a marked improvement in both the NOK and the SEK since the quarter ended so that trend continues. The full year impact of FX would obviously be less than what we have outlined here today. That concludes our prepared remarks, and we are now happy to take your questions.

[Operator Instructions] The next question comes from Neeraj Kumar from Barclays.

So my first question is regarding your term loan. If I remember correctly, there was a step-up based on the rating. Was it linked to your Moody's rating or S&P rating? And if there has been any step-up on -- based on Moody's downgrade on that?

Yes. Correct. There's a step-up, and it's only related to having 1 -- we need to have 1 rating. So with no Moody's rating, we're just relying on S&P. And so there's been no step-up in the rating as we remain investment-grade with them.

Okay. That's helpful. And my second question is regarding your valuations. I noticed that you switched from external valuation to internal valuations in H1. Can you please help with the rationality on that side of things?

So we've made a policy change in the first quarter of this year where we're doing an annual valuation, annual external valuation. So previously, in the interim Q1 and Q3, we had requested yield movement changes from our independent appraisers JLL and CBRE. We had done a full appraisal in the first half or in Q2 and a full appraisal at year-end. We've switched to where we just do it once a year, which we think is more reasonable and more in line with the market. We still go to CBRE and JLL to get comments on any yield changes, which are reflected in our current valuations.

The next question comes from Simen Mortensen from DNB.

This is Simen from DNB. My line has some background noise here. The divestment program, you say you're comfortable with that. On what kind of things need to fall in place for that to come through? Are you already in discussions on these asset sales? And how firm are you that you are able to divest these assets [indiscernible] in the current market given where liquidity is in the property market?

Yes. Thanks for the question, Simen. I would say that it varies market to market. We're seeing a fair amount of liquidity in Norway at this point. Sweden, probably less so. And in Finland, it's somewhere in between. We are in a variety of conversations on a number of different assets. I think the good news, as we noted in our comments, is that we don't have a gun to our head. We do not have to sell anything, which means that we can remain patient as it relates to pricing. But as we said in our comments, we're -- we believe that we won't have any issues meeting the target that we've outlined previously. Yes. Do you want to add anything?