CLS Holdings plc (CLI) Earnings Call Transcript & Summary

Good morning, and welcome to this live video presentation of CLS Holdings plc Half Year Results 2020. I'm Fredrik Widlund, Chief Executive; and to my right is Andrew Kirkman, our CFO; and to my left is Simon Wigzell, Head of Group Property. Today, we will present you with the results for the first 6 months and give you an update on our performance and how CLS and our tenants have adopted (sic) [ adapted ] to the new situation that we have all been experiencing since March. I will start with an overview on the next page to set the scene before we go into more details. So if we turn to Page 3. Overall, CLS has performed well, and it has been a busy period with rental negotiations, acquisitions and sales against what has been a challenging market for both individuals and organizations. Despite this backdrop, I'm happy to report that all our properties, after modifications to ensure they are safe and in compliance with rules in each of our countries, have remained open and operational throughout this period. This has not just benefited us, but it has also been necessary since many of our tenants perform vital services given our large proportion of government tenants in the portfolio. It's also worth mentioning that the lockdown restrictions were different in each country, with, for example, German offices never really closing. EPRA NAV was up 3.2% to 339.6p per share, which was primarily driven by operational earnings, foreign exchange gains and EPRA metrics change from 1st of January 2020, but Andrew will talk a bit more about that in his section. On the operations side, our net rental income was up 5% to GBP 56.5 million from net addition, operational efficiency and other property income. Our rent collections were strong, with 99% collected for the first 6 months and similarly high numbers for the third quarter. Valuations were overall relatively flat, down 0.1%, with Germany and France showing increases, while the U.K. was down slightly. Our vacancy levels were up in all countries from 4% to 5.2%. This was due to a few different reasons. We acquired vacancy in the early part of the year and also completed refurbishments. But the main driver has unsurprisingly been less demand in combination with lockdown restrictions, that means new viewings were not possible. Our EPRA EPS was 7p per share, which is up 16.7% against the same period last year. We also intend to maintain our dividend and for the interim dividend, we will pay the same as last year. On the next slide, I would like to talk to you more about our collection and tenant base. So if we turn to Page 4. In the table to the left, you can see that we have strong collection metrics in all countries. And for the first 6 months, we have collected 99% of contractual rent due. For the third quarter, we are today at 95%. If we include tenants that are now paying monthly, that increases to 97%. By contracted rent, we have agreed with circa 7% of tenants to switch from quarterly to monthly rent to support them through this period. Now some key points on the portfolio in relation to this. Firstly, we have a very diversified portfolio with roughly half of the rent coming from government and major corporations. On the right-hand side, you can see the industries for our tenants, which is well spread between the different sectors. We also only have 3% exposure to retail, leisure and travel, sectors that have all been hard hit by the pandemic. The credit quality is strong, and we have seen very few bankruptcies to date, although we do expect to see some increases later in the year as the full impact of the pandemic is taking effect. And we have provided for that in these results. We also have well-defined internal controls. And given that our property management is all in-house, we are close to our tenants and can work together early, should there be any problems. Now moving onto valuations on Page 5. So overall group valuations were essentially flat, down 0.1% in local currency, with Germany and France showing uplift, while the U.K. was down. Starting with the U.K. where overall valuations dropped 2% as an effect of a slight hardening of yields to 5.3%, being offset by increasing vacancy. ERVs were largely flat across the portfolio. Excluding recent acquisition disposals, the like-for-like decline was 1.8%. The largest decline was in our only hotel property, part of Spring Mews in Vauxhall, while offices, in general, held up much better. In Germany, we saw an uplift of 2.6% for the 6 months. The increase was driven by active asset management that increased our average lease terms in Germany from 4.6 to 5 years in combination with net initial yields hardening 29 bps to 4.7%. ERVs were unchanged here as well. The French portfolio was up 0.4%, and there was little valuation movement for the majority of the properties. We saw a slight sharpening of yields to 5%. And like in Germany, ERVs were unchanged for the period. Next, I'd like to go into more detail about the acquisitions and sales in the periods. If we turn to Slide 6. CLS has a well-defined investment criteria. And as a long-term investor, we will continue to acquire properties when we see the right opportunities, even in more volatile times. In the first quarter, we completed 2 acquisitions in London, one in Harrow and one in Staines, which had exchanged in late 2019. And in early June, we acquired a property in Nuremberg in Germany. This was our first acquisition in Nuremberg, the second largest city in Bavaria, and the building is in a growing area between the city center and the airport. In total, these properties was acquired for GBP 49.3 million at a net initial yield of 6.2%, and they added GBP 3 million to contracted rent. We also have clear criteria for when capital can be redeployed into other opportunities. And sold or agreed to sell a total of 5 properties during the period. 2 of the disposals, in Salford and Norwich, were the remaining part of the U.K. regional portfolio, which largely completed in December 2019. We also sold 2 smaller properties, one in Sidcup in the U.K. and one in Paris. In July, we announced the disposal of Albert-Einstein-Ring in Hamburg, Hamburg is one of our key markets, but with the price 38% above year-end valuation and a low current yield, we decided to sell with intention to reinvest elsewhere. In total, the 5 disposals sold for GBP 42.2 million with a net addition of 3.3% and contracted rent of GBP 1.5 million. I will now hand over to Andrew, who will take you through the financials in more detail.

Thank you, Fredrik, and good morning to everyone tuning in. This morning, I want to run you through the financial results for the first half of 2020, which demonstrate the resilience of our business model, and the robustness of our balance sheet. Turning to the financial highlights on Slide 8. This slide sets out a number of key financial metrics of the business. Firstly, new EPRA net asset measures came into force at the start of 2020. We have decided to adopt EPRA net tangible assets or EPRA NTA as our lead net assets key performance indicator as it most closely aligns with our business model. Although for this year, we will also refer at times, to EPRA NAV as it remains familiar to stakeholders. For the first 6 months of 2020, EPRA NTA was up 3.1% to 336.4p, with EPRA NAV up 3.1%, driven by currency movements and earnings. Those earnings were up 16.6% to 7p, driven by increased net rental income and foreign exchange. More detail on net assets and earnings are on the next slide. Cost of debt fell to 2.35%, a new record low for the group, with strong interest cover of 3.5x. Finally, regarding dividends, it is worth reiterating that we proceeded with the payment of the final 2019 dividend in April. And we'll be maintaining the interim dividend at 2.35p, the same level as 2019. The rise in EPRA NTA plus the final 2019 dividend paid in April results in a total accounting return of 4.6%. Over the next few slides, I'll look at some of these numbers in more detail and the drivers behind them. The waterfall chart on Slide 9 sets out the main components of the movement in EPRA net tangible assets, with a 3.1% increase, largely driven by EPRA earnings and foreign exchange movements. However, the graph first starts by reconciling EPRA NAV to EPRA NTA as at the start of the year. As is shown and reflecting the long-term nature of our strategy, the difference between EPRA NAV and EPRA NTA is minimal as we expect few asset sales in the medium term. Going through the movements from opening to closing NTA, we have the final 2019 dividend paid in April of GBP 20.6 million or 5.05p per share, EPRA earnings of 7p, which are a 1p increase from 2019 and broken down in more detail on the next slide. Reflecting earlier comments, the valuation movement on the portfolio was essentially flat, demonstrating again the benefits of diversification. The valuation movement is in 2 parts: investment property valuations were up 0.7p from gains in Germany and France, somewhat offset by a reduction in U.K. property values and the valuation reduction in our property, plant and equipment, of 1.2p per share, which was almost wholly down to a reduction in the value of our hotel, which has experienced tougher trading conditions as a result of COVID-19, but still managed a breakeven in the first half. Lastly, sterling weakened by 6.6% against the euro in the period, resulting in a 9p increase, being an increase in the value of our properties in Germany and France, partly offset by the natural hedge of the associated euro debt. On Slide 10, we have set out the movement in EPRA earnings per share, which grew by 16.6%. The principle movements are highlighted in the graph. Firstly, a 0.7p per share or GBP 2.9 million improvement in net rental income as a result of 3 things: net additions to the portfolio, improved service charge recovery and a high level of other income. As highlighted, our rent collections remain very high. However, we have taken an appropriate increase in our bad debt charge. But even then, this has been partly offset by some cost-saving measures, which resulted in a 0.2p reduction. Finance income has dropped from the sales in the second half of 2019 of our stake in Catena and our bond portfolio. Some of those proceeds, though, have been invested in acquisitions, leading to the improvement in net rental income. Whilst most foreign exchange movements go through other comprehensive income, movements on U.K.-based euro-denominated bank accounts go through the income statement. The weakening of sterling by 6.6% against the euro resulted in 0.7p per share increase. And finally, it was a positive tax movement as a result of lower French tax rate and a change in the mix of profits, with greater profits at a lower tax rate in Germany compared to the U.K. Slide 11 sets out the movement in CLS' liquid resources during the first half of 2020. Our cash position remains strong, nearly GBP 200 million of cash and GBP 50 million of undrawn resources. Cash went down by GBP 64 million in the first half as a result of investment in the business with net additions of nearly GBP 50 million and GBP 9 million of CapEx as part of our ongoing refurbishment program. Increased cash from operations of GBP 30 million more than covered last year's final dividend and interest and tax payments to help drive the growth in net asset value. And finally, we financed our acquisition in Nuremberg, but this was more than offset by a regular loan amortization payments, resulting in net outflow. On Slide 12, we have set out our active debt activity so far this year. We have strong relationships with many different lenders and keeping regular contact with them. This has been particularly helpful with regard to the finance activity in 2020 with 9 loans that mature or have matured for GBP 115 million. Given current uncertainty, we've maintained a flexible approach with a balance between refinancing if the rates offered are competitive or extending loans until conditions improve. 3 loans have been extended for between 6 and 18 months. 2 loans have been refinanced or have refinancing terms agreed. And 1 loan for GBP 5 million has been repaid as we're refurbishing the building in Lyon. We are in advanced discussions on the remaining 3 loans. The total amount remained to be refinanced at GBP 29 million is shown in the chart on the bottom right, and we expect positive news on these refinancings before the end of the year. We have also financed our acquisition in Nuremberg for 7 years with an LTV of 70% at a fixed rate of 0.9%, a testament to the skills and track record of our treasury and asset management teams. It also demonstrates our ability to make good acquisitions and strong returns with a building bought in at 5.8% net initial yield, almost 500 basis points ahead of the cost of debt. The cost of debt fell by 7 basis points to 2.35%. The majority of the fall was a result of the weakening of sterling and thus, the increase in the relative proportion of cheaper debt in Germany and France. There was also a smaller benefit from reduction in LIBOR on the U.K. cost of debt. My penultimate slide summarizes our debt position, showing that we're well positioned with good interest cover, over 3 quarters of our debt is fixed, strong banking relationships with loans from 28 different lenders, and a record low cost debt, which we expect to fall slightly further in the second half given the reduction in LIBOR. Balance sheet loan-to-value has increased marginally to 33.7% as a result of net property acquisitions. We anticipate that we'll remain in the 30% to 40% range for the time being. As an example, with cash of GBP 195 million, we have GBP 95 million of available liquid resources above say an assumed buffer of GBP 100 million. Geared at 50%, this GBP 95 million would give us GBP 190 million for acquisitions. Additionally, we will receive over GBP 30 million from the sale of Albert-Einstein-Ring at the end of September, which geared would provide a further GBP 60 million, giving a total of GBP 250 million for acquisitions. However, we will continue to appraise acquisitions cautiously and maintain our strict pricing discipline. Finally, we continue to explore options for our U.K. financing strategy to extend the maturity and flexibility of our debt, particularly through portfolio loans, encompassing loans, which are about to mature and some unencumbered properties in completing recent acquisitions. My last slide, Slide 14, shows the growth in our property portfolio during the first half of 2020, with a portfolio valued at over GBP 2.1 billion by the end of the period. The 2 big drivers of the movement were the 6.6% weakening of sterling against the euro, which increased the value of the portfolio by GBP 69.2 million. And net additions to the portfolio of just over GBP 50 million from the 3 acquisitions in Harrow and Staines in the U.K. and Nuremberg in Germany, with CapEx almost exactly offsetting the 4 small disposals made. The GBP 33 million disposal of Albert-Einstein-Ring will complete in the second half. As highlighted, there was limited net movement on the revaluation of the portfolio. And with that, I will hand you over to Simon to give you further information on our property portfolio.

Thank you, Andrew, and a very warm good morning to everybody. If we turn to Slide 16, I'll just take you through some of the property highlights. With 99% rent collection at half year, we clearly have high quality tenants. 767 across 3 countries, also makes them well diversified. The contracted rent is GBP 113.5 million per annum. You can see on the chart there, approximately 24% of our rents are coming from government and 25% from major corporates. Looking at the bottom left, 1/3 of our contracted rent comes from 15 tenants, all strong covenants, and we have a new entrant in 15th place, which is T-Mobile, and that was following our most recent acquisition in Nuremberg, Germany. Across the group, the average rent at GBP 18.93 per square foot is tracking upwards nicely. And on average over the last -- since 2016, 5%. Whilst this can be influenced by new investments and disposals, much relates to securing new lettings at above ERV, which I'll come on to. 91% of our properties are office use, with the remainder spread across student and hotel accommodation here in Vauxhall; and 2% food retailing, providing important amenities for our office occupiers. Let's turn to the next slide now and just look at what we've been doing. So Slide 17. Our in-house asset management team continued to add value. We completed 52 transactions securing GBP 7.8 million of annual rent, which is up on the same period last year where we secured GBP 6.9 million. So on average, these deals were 4% above year-end ERVs. You can see there that most of the deal activity came from lease extensions accounting for 72% by value, with the largest transaction coming from Germany following the 10-year lease extension agreement with the City of Bochum. New letting activity at 28% was going to be lower due to the market conditions. As frankly, as you heard from Fredrik, we had a period of 3 to 4 months when viewings simply couldn't take place. They are, however, now picking up, perhaps more quickly in Germany and France. Our weighted average unexpired lease term has increased to 4.91 years from 4.75 years. You would expect this, given the higher volume of lease renewals and extensions that we've completed. The top right of the chart, you can see that we have a gap between contracted rent and ERV. And this is actually an opportunity for CLS. It plays to our core strength, which is letting activity and gearing -- regearing existing leases, which allow us to capture that reversionary rent. At the bottom right of the chart, you can see our vacancy has crept up to 5.2% from 4%. And most of this uptick has come from the U.K., which is a combination of tenant expiries and fundamentally, the U.K. has been slower at getting back to work than Germany and France. And there have been very few new lettings. If we turn to Slide 18, talk about sustainability. At CLS, our overreaching -- arching purpose, sorry, is to transform office properties into sustainable modern spaces that help our tenants' business. On the left of the slide, you can see some of our key targets, covering carbon, building certifications, smart metering, recycling water, energy efficiency and a focus on reducing fossil fuel use. Well, the sun has certainly been shining on our larger photovoltaic array, with generation up 11% compared to the same time last year. We're making good progress, carrying out BREEAM, which is green building certifications on all managed assets across the group, and we've completed the French portfolio, and the U.K. and German portfolios will be done by the end of the year. Overall, 78% of our assets now have smart meters. Our German teams have just secured 100% renewable electricity and carbon neutral gas contracts for their entire portfolio. We continue to focus on EPCs, and the U.K. assets are all D rated or better. And the image of the orange pump is our latest electric vehicle charging station at Great West House in Brentford. If we turn to the next slide, I'll just summarize the development activity. Lockdown has not hindered progressing the development projects in any way. And at Vauxhall, we secured planning at Lambeth's first virtual planning committee for our 10-storey office development. We're progressing section 106 negotiations, detailed design, branding and aim to tender the contract to the construction market in Q1 next year. At Vor Dem Lauch in Stuttgart, we also received planning consent for our 140,000 square foot building. Again, we're progressing detailed design, branding, and we'll shortly be going to the market to identify an anchor tenant. Maidenhead, we've submitted a reduced height scheme, providing 43,000 square feet overground and 6 upper floors. We expect to get -- go to planning committee in October this year. In the next couple of slides, I just want to talk a bit more about the workplace and how that's changing. And I'm sure you're all aware, there's been much published on how the work place could change in light of the current pandemic. And no doubt, there will be many more ideas coming forward. And this slide really just highlights some of the key ones being discussed in our industry today. Firstly, I'm pleased to say that many of these ideas, we were coincidentally already working on, and that was really driven by our focus on sustainability and health and well-being. For example, all our new developments will have openable windows, providing the opportunity for natural ventilation. And hopefully, it won't be long before our streets are filled with electric cars, which will improve noise and improve air quality. Sensor taps on basins and loos are more sustainable. But of course, they also reduce touch points. Well-designed receptions can cater for social distancing by discrete patterns on the floors. Reception desks designed being wider and actually lower, softly stop visitors from resting their hand on the surface. The use of copper alloys for door handles are very attractive material and also naturally antiviral and bacterial properties. So rethinking the shape of occupation does not have to mean plastic screens and floor stickers. After the lockdown announcement in each country, I was delighted that our operational teams responded so quickly integrating one-way systems, social distancing measures, and of course, briefing our occupiers so that all our office buildings remained open. This brings me on to my last slide, where I want to just talk about the typical facilities and arguably, how a CLS building is more resilient to the current pandemic. At the beginning of lockdown, it was clear to me that tall offices were going to be more impacted because generally, they are much more reliant on lift access and they typically do not have openable windows and usually have little or no private parking. Our portfolio is much more resilient because 70% have access to private outdoor space, 78% have private bike storage, 82% have openable windows and good parking ratios and offering a viable alternative to public transport. On average, a CLS building is only 5 stories. And as you can see on the diagram on the right, most buildings are only between 2 and 7 floors. So in summary, a typical CLS building offers tenants, easy car access as well as public transport, low lift reliance, openable windows, private outdoor space and cost-effective rents. The group average is just under GBP 19 a square foot. So our tenants won't have to break the piggy bank to give their employees more elbowroom. Thank you. With that, I'll hand you back to Fredrik.

Thank you, Simon. And before we move on, I would just like to mention that a picture you can see on Page 22, is our latest acquisition in Nuremberg occupied, as you can see, by T-Mobile. Moving on to Page 23. In the current market, there are more views, speculation and volatility than we have seen since the last financial crisis. That is not unexpected given the threat to economic growth and changing working patterns. On this slide, I would like to give our house view and what we have seen recently in our own portfolio. So in the U.K. which has been severely impacted by the pandemic, the subsequent lockdown with larger cities like London at the forefront, given its reliance on public transport. Despite this or perhaps due to this, the longer-term fundamentals for non-prime offices located outside the city center looks attractive. This limited development activity, attractive yields and any long-term shift in working patterns should also benefit these locations. The current sentiment has also created acquisition opportunities that well-capitalized investors taking a longer-term view will benefit from. However, shorter term, we expect that leasing activity and demand will be more challenging as we're only seeing a gradual return to economic activity compared to our other 2 markets. In Germany, the resilient economy and the more decentralized political structure have, in our view, meant that a quicker return to work and economic activity has taken place. The underlying office market also have strong fundamentals with low vacancy and supply in the larger cities. The downturn will not change this in any material way. Lending conditions are also favorable, and we will continue to look for acquisitions even if competition is high given Germany's safe haven investment status. In our portfolio, we have recently seen an uptick in leasing activity, as economic activity resumes, and we expect this to continue into the second half of the year. The French economy has a large proportion dependent on the domestic market. And although we have seen vacancies increase in Paris, both Lille and Lyon have been very resilient. In Paris, we are monitoring La Défense and its exposure to financial services and a spill out effect on neighboring areas. On a positive note, the large infrastructure project, Grand Paris Express, is progressing well and will have a positive impact on several of our Paris properties. We have recently seen inquiries increase and a key objective for the French team is to convert these into new leases in the second half of the year. Moving on to Page 24. On my last slide, I would like to summarize the first 6 months of 2020 for CLS. Our assets performed well, with EPRA NAV up 3.2% to 336p per share. Valuations was down 0.1% in local currency, with Germany up 2.6%, France 0.4% and the U.K. down 2%. I think these numbers also pretty much summarizes our current short-term outlook for these countries. We had strong collection metrics with 99% collected for H1 and 95% of Q3 collected. This was due to a diversified portfolio with a large part of the rent coming from government and major corporations and the low exposure to sectors hard hit by the pandemic. This meant that EPRA earnings per share was up 16.7% in the period to 7p per share. Vacancy increased to 5.2% for various reasons, but there's no doubt that the short-term demand and lockdown measures have had a negative impact. The type and location of our properties should benefit from changes to working practices and with increasing demand for easy to reach, well-located and affordable offices. The current market also offers opportunities for long-term investors to acquire properties. And we expect to continue to grow our portfolio through acquisitions. And as I said before, in terms of countries, the U.K. and Germany is looking particularly interesting. Finally, and in reflection of the above numbers and our cash flow in the first 6 months, the Board has decided to maintain our dividend, and we will pay an interim dividend on the 25th of September of 2.35p per share the same as the interim dividend in 2019. So in summary, we are in a comparatively good place, and I expect to continue to deliver long-term value for our investors. With that, I'd like to conclude today's presentation and open up for questions.

[Operator Instructions] First question is from Kieran Lee of Berenberg.

Thank you very much for the presentation. Just a few from me. You mentioned some cautiousness regarding acquisitions. What are you actually looking for before pressing the button on acquired properties? And is the near-term outlook by geography influencing the decision-making here?

Can I just -- so I could fully understand the question, is the question around what criteria we have for acquiring properties?

Exactly and whether that varies by geography, given the short-term outlook.

Sorry, what...

Does it vary by geography given the outlook?

Yes. No, I mean, if we start by just looking at the basic criteria that we have for acquiring properties, I mean, we are a cash flow driven business. So we'd like to look at cash flow. So we're not someone that would look at gains coming at a late-stage in the business plan. We like that. We do like that they are located close to good, well-connected public and car access. So we like that, that people can get to them easily. That's absolutely key for us. If you look at the more macro picture, yes, clearly, you want to be in a growing area, and that is what we have been looking for in the major cities in Germany, in France and in London here in the U.K. So I would say that the criteria across the board is fairly similar. But yes, you might have different timings in terms of when is the right time to buy. And as I said, right now, Germany and the U.K. is looking specifically interesting for us.

And then just on -- you mentioned some of the pace of return to the office being differentiated in say, Germany versus the U.K. Would you be able to talk a little bit more on building utilization and how quickly the [Technical Difficulty] come back in U.K., especially? And when do you expect it to get back?

Certainly. I mean, if you look at our own portfolio at the moment, the physical occupancy is between 15% and 20% for the U.K. portfolio. While if you go to Germany and France, it's closer to 50% -- 5-0. What we have seen is that office occupation, returning to work pretty much goes lockstep with economic activity. So we have seen much more transactions returning and much more activity. I mean all of the 3 countries have different characteristics. So clearly, the U.K. is much more urbanized and more dependent on public transport than perhaps Germany and France are. So we're going to have to wait and see until that changes. And one thing that's absolutely imperative that the schools are reopened, et cetera, so people can start returning to work. But yes, we have seen a quicker recovery in our German and French portfolio than we have seen so far in the U.K.

Somewhat related to that, when you are having these new increasing discussions of tenants around renewals and new leases, have you seen any change in trends, be it shorter lease lengths being agreed or a scale down of space taken, so less expansion space, et cetera?

No. I mean, I think across the industry, as a whole, yes, leases are on a trend becoming more flexible. Our model has always been -- we like flexible leases. We prefer to give flexible leases. It generates asset management opportunities. It allows us to regear and typically, as I think I probably said before, you give less tenant incentive, less rent free if you're giving shorter leases. So it's better for the cash flow, provided, like us, you've got the in-house sort of asset management scales to make the most of it.

[Operator Instructions]

So we'll now take some questions from the webcast. The first is from Chris Spearing at Liberum. Data is showing that U.K. office workers have been slower to return to their desk than in France and Germany with only 1/3 back in the office versus almost 3/4 in Europe. Has this been your experience? And where are current occupation levels across the group? The next question, having put new purchases on hold until there's greater ability, have you seen an increase in acquisition opportunities in recent weeks? And do you expect to be a net investor in the remainder of 2020? And which markets do you expect to offer the best opportunities?

Yes. I think we might have answered some of that already in terms of the occupational levels in the portfolio. But just to say, yes, we have seen an increase in transaction levels in the last couple of months as most of you will know; it reduced dramatically in the beginning of the first 6 months, but it is picking up. And yes, I would expect us to be a net acquirer this year. And in terms of geographies, yes, we are focusing on Greater London and the big cities in Germany, and that's where the acquisitions are likely to be. Right. There are no more questions. So I would like to thank everyone for attending, and we look forward to meet in person when the time allows. Thank you all. Goodbye.