CLS Holdings plc (CLI) Earnings Call Transcript & Summary

Good morning, and welcome to CLS Holdings plc Half Year Results 2023 presentation and Q&A. I'm Fredrik Widlund, Chief Executive; and next to me is Andrew Kirkman, CFO. Today, we will present you with results for the first 6 months of the year and give you an update on the portfolio. As we normally do, I will start with an overview of the period. The period was characterized by inflation concerns and rising interest rates, which created an uncertain business environment that impacted leasing take-up. Nevertheless, CLS delivered strong net rental growth of 5.3% in the period from a combination of 2022 acquisitions, indexation and higher student and hotel income. EPRA EPS, however, was down 10.3% from increasing financing costs, offsetting the healthy growth in rents. This is, in many ways, a timing issue, and the variable part are debt book and immediate increase in financing costs while the rents adjust over time. We have increased activity in the number of leases we signed compared to the same period last year and the new leases were 10% above ERV at year-end. This included a long deal in Essen, Germany. But even if you exclude this transaction, the new leases signed were 4.1% above ERV. Valuations on a like-for-like basis were down 5.5% in local currency, meaning that our portfolio has declined by 10.5% since the peak in June 2022, which is better than the office market. This was driven by yield expansion in all countries, and more on this later. Like-for-like vacancy was flat at 7.4%, but reported vacancy was up to 9.2% from completed developments in the U.K. and France. We also successfully completed on 10 refinancings or extensions for GBP 299 million in H1; in July, a further 2, leaving 1 financing left to do in 2023. Our investment in sustainability is progressing well, and the proposed interim dividend is maintained at 2.6p per share. Finally, on the right-hand side, you can see that our portfolio is now 46% in the U.K. and 54% in Germany and France, with a total portfolio value of GBP 2.2 billion, which gave an NTA of 291.6p per share. I would now like to talk more in detail about the valuations. On a like-for-like basis, the portfolio declined 5.5% in local currency, which is an outperformance against market data. In the U.K., valuations were down 8.5% since year-end, from a 34 bps like-for-like yield shift. We also have shorter lease length left on some of the larger U.K. assets like Spring Gardens, which impacted valuations. The strong performance from student and hotel had a positive impact on valuations for these properties. In Germany, we saw a 3.3% decline from a 15 bps like-for-like yield shift in the period. The launch lease in Essen had a positive valuation impact, and excluding this property, the decrease would have been 4.7%. In France, valuations were down 1.9% from a 28 bps like-for-like yield shift, which was partly offset by strong letting performance. Over the past 12 months, we have seen a 10.5% decline in valuation with yields moving 51 bps and ERVs up 1.5% as shown in the graph in the top right corner. There are also tentative signs that valuations are starting to stabilize as we get closer to peak interest rates. Now moving on to sales on Page 6. As we have previously communicated, we will be a net seller this year. And in the first 6 months, we sold 3 properties. In the U.K., we sold an existing office building in Maidenhead, which had planning permission for a larger office development. The transaction completed in April; and in June, we unconditionally exchanged on the sale of Westminster Tower in London for residential conversion. Closing is planned for later this year. Finally, we also sold a plot of land in Sweden that had planning permission for a logistic development. The plot of land was included within our German portfolio and was our last Swedish property asset. In total, these properties sold for 7.5% above latest valuation. We have also accepted offers or agreed terms for a further 6 sales for GBP 39 million that are in progress and we are working to complete them before year-end. Turning now to the next slide for an update on our larger projects. We have now completed 2 of our 3 launch projects, The Coade in Vauxhall and Park Avenue in Lyon, which are now the 2 best properties in their respective locations. The Coade in Vauxhall, our new 28,400 square feet office building was completed in April this year. That's an EPC A rating, and we are awaiting BREEAM Excellent certification shortly. Viewings have started with excellent feedback on the quality and amenities and we are in discussions to let 2 floors. We expect rent between GBP 50 and GBP 60 a square foot and the total ERV is GBP 1.45 million. At Park Avenue, Lyon, we completed the refurbishment of the entire building in June, including a new facade and an additional 2,300 square feet of space. Existing tenants moved back in March and we have let 2 additional floors with interest in 3 of the 4 remaining vacant floors. We are targeting an average rent of EUR 220 a square foot -- square meter, and the total ERV is EUR 1.8 million. On Slide 8, vacancy is a key driver for our business, and the letting activity in the period increased compared to last year. The top left hand shows that we have signed 69 leases at 10% above ERV at year-end. As you heard earlier, excluding Essen, that was 4.1% above ERV. The average lease size was up compared to last year with a total of GBP 7.8 million signed in the period. On the right-hand side, you can see the movement in our vacancy in 3 different ways. But to summarize, like-for-like vacancy was flat at 7.4% and the completed development added 1.8% for a total of 9.2%. By country, you can see the largest increase of 1.2% was in the U.K. due to the completion of The Coade, followed by 0.5% in France due to the completion of Park Avenue, while Germany was essentially flat. We expect like-for-like vacancy to reduce as return to the office continues to gain momentum and business confidence improves as the macro picture stabilizes. Reported vacancy will increase further in the U.K. when we complete on Prescot Street later this year, while we expect Germany and France to improve. As we have said before, our greatest challenge, but also our greatest opportunity is in the U.K., where we are carrying out the majority of our refurbishments to ensure that we meet the quality demanded by tenants. The short-term situation in the U.K. is still challenging, but medium to long term, there are great opportunities given the low estimated supply of quality office space. I will talk more about that later. I will now hand you over to Andrew to go through the financials.

Thank you, Fredrik, and good morning, both to those in the room and to everyone dialing in. This morning, I'm going to run you through our first half financial results, the considerable progress made with planned 2023 and 2024 refinancings, and our occupiers on our index-linked leases. And on this slide is a picture of our newly refurbished office at CI Tower in New Malden, which shows the increased quality and rental upside in the portfolio. Slide 10 sets out several of the key financial metrics of the business, which I'll run through in more detail over the following slides. In summary, CLS continues to perform well, but again, it's a challenging market. This market has led to reduction in valuations, a strengthening of sterling against the euro, and an expected increase in finance costs. As a result, EPRA NTA was down 11.5%. EPRA EPS was down 10.3%, with a proposed interim dividend maintained at 2.6p per share. Overall, these result in a total accounting return of negative 9.9%. The balance sheet remains strong with almost 80% of debt fixed or capped at an interest cost of 3.32%. And now for some more detail around these numbers and the drivers behind them. The waterfall chart on Slide 11 sets out the main components of the movement in EPRA net tangible assets with NTA decreasing by 11.5% or 38p per share. Going to the components of the movement from opening to closing NTA in order. We have the final 2022 dividend paid in April of 5.35p per share. EPRA earnings of 5.2p. This is broken down in more detail on the next slide. The valuation decrease of 5.5% or 33.4p with decreases in all countries, albeit these were lower than the office market. Sterling strengthened by 3% against the euro in the period, resulting in a 5p decrease. This is the decrease in the value of our properties, the value of our properties in Germany and France, partly offset by the natural hedge of the associated euro debt. And lastly, other of 0.6p is mainly made up of the profit on sales in Cloud Gate and land in Sweden, with more profit on sale expected in the second half, particularly when the Westminster Tower sale completes. Turning to the next slide, we have set out the movement in EPRA earnings per share, which increased by 10.3% or 0.6p per share in the first half. The principal movements, which I highlighted in the graph are as follows: firstly, we've shown a pro forma EPRA EPS number for June 20, 2022, using the same share numbers as for 2023, adjusting for the share buyback carried out in September last year. This is so as to not distort the movement analysis. Net rental income grew by 5.3% or 0.7p per share in the first half as a result of a full year -- half year impact of German acquisitions, indexation and the strong performance of our student and hotel accommodation. There were some offsets from disposals and vacancy. Whilst property and administration expenses were flat, interest expense rose by 1.1p from higher rates on refinance loans and the roughly 20% of floating rate debt. When we bring our vacancy back to our usual levels, this rental increase will more than offset interest rate increases. A 0.2p increase in tax from higher rental income in Germany and France, as well as a slight impact of higher U.K. tax rates on the small amount of our U.K. operations, which are not in the REIT. And finally, a small increase in the FX losses from those movements on U.K.-based euro-denominated bank accounts, which go through the income statement. Slide 13 sets out the movement in CLS' liquid resources during the first half of 2023. Despite ongoing investment into our portfolio, our cash position remained strong with over GBP 90 million of cash and GBP 50 million of undrawn facilities. Our existing GBP 30 million RCF is due to expire in September, and we are advanced on negotiating replacement. Cash went down by GBP 21.4 million in the first half, which is less than the GBP 31.6 million that we spent on capital expenditure. We would expect the cash to increase in the second half as we make further disposals as highlighted by Fredrik earlier. Lastly, cash from operations remained strong and was used to cover the payment of dividends, interest, tax and other costs. Interest cover at 2.4x remained healthy. Slide 14 is an important one, and so I'll dwell on it a bit longer. There are really 3 key points to bring out. Firstly, we've made excellent progress with both our planned 2023 and 2024 refinancings with nearly GBP 300 million across 10 transactions refinanced or extended in the first half. This was a record amount of activity for CLS. As a result of first half activity and the 2 financings excluded in July, we have only 1 loan in Germany for GBP 24.7 million left to refinance this year. For 2024, we've already refinanced nearly half of the amount that was due at the start of 2023. We now have 10 loans with 7 banks for GBP 103.7 million at an LTV of only 46% to refinance. They are also well spread with 4 loans in Germany, 4 in France and 2 in the U.K. Secondly, as flagged at the year-end, we expect our interest costs to increase by about 60 basis points, and in fact, it increased by 63 basis points. This was due to interest rate increases impacting new deals and floating rate debt. Given stubbornly high inflation and thus further Central Bank rate increases, we'd expect our interest cost to increase by further 15 to 25 basis points by the year-end. And lastly, our loan-to-value has increased to 45.1% as a result of valuation declines with net debt remaining flat. This LTV is the top of our targeted range, and we're expecting to make further sales to bring that rate down to 40% in the next year or so. Slide 15 summarizes all the movements that I've already talked about and how they impact the value of our property portfolio. We're continuing to invest in our portfolio to increase its quality to help entice employees back into the office and thus spent GBP 32 million of CapEx. We will spend less in the second half of 2023 as Prescot Street completes, and then CapEx will drop to around GBP 30 million per annum going forward. The disposals reflect the sales of St. Cloud Gate and land in Sweden, and we would expect more in the second half of the year. The valuation decline of 5.5%, together with movement in the lease incentives and depreciation equates to GBP 131.5 million. And finally, the value of our French and German properties has fallen by GBP 37.1 million when translated back in sterling as a result of the 3% strengthening in the period. As regular investors will recognize, this usually swings back and forth for CLS, given that we operate in both the U.K. and Europe. My penultimate slide, Slide 16, is a familiar slide, which illustrates our high-quality and diversified tenant base across our 3 markets. The 3 key points to highlight are our properties remain strongly multi-let with our 718 tenants equating to an average of over 8 tenants per building. A couple of changes in our hit parade of our top 15 tenants with Kantar in at #4 and Frank Hirth at #13. Both of these changes are the result of us negotiating the surrender of the head lease at New Printing House Square from the Secretary of State. This means that we are directly contracting with the tenants as well as receiving increased rental income. And as a consequence of this, our proportion of government tenants has dropped by just over 4% to 21.3%. But these plus major corporations represent well over half of our tenant base, which is reflected in our rent collection of 99%. My final slide summarizes the resilience of our income with over 55% of rent being index-linked. As noted, this indexation was one of the key drivers of the increase in net rental income. The amount of indexation and how it works does vary by country. Most U.K. leases are not index-linked, but benefit from upward-only rent reviews. However, Spring Gardens, CLS' most valuable property, had an 11.4% rent increase midyear 2023 due to the rent being linked to RPIX. In Germany, 65% of our leases are CPI linked, which rose by 7.1%. In addition, a further 20% of our German leases have contractual step increases. And lastly, in France, all leases are index linked. In the first half, we saw an inflation increase of 5.7%, and we expect further increases in the second half. And with that, I'll hand you back to Fredrik.

Thank you, Andrew. On the next few slides, I would like to discuss the bigger projects and give an update on our sustainability program. With The Coade and Park Avenue finished, we only have 1 larger project left to complete in the near term, and that is also why CapEx is expected to revert down to our average spend of around GBP 30 million per year going forward. At the Artesian 9 Prescot Street, we are refurbishing the entire building of 94,500 square feet, great top of the range offices in the original Art Deco building. Practical completion is due for lower ground to third floor in September and for the fourth to sixth floor in October. To increase flexibility and following occupier interest, we have submitted a planning application for dual-use for office and educational purposes. A full marketing launch will take place in November, although viewings have already started. Total investment, GBP 32.2 million, and we are targeting rent of GBP 60 a square foot, giving a total ERV of GBP 4.8 million. Turning to the next slide, I will update you on our sustainability program and the progress we have been making. We have a very clear pathway to achieve our net zero carbon commitments by 2030. And so far in 2023, we have completed on 34 projects across the portfolio, with a further 84 in progress or planned. By the end of 2023, we expect to have invested circa GBP 6 million as part of our overall net zero carbon plan to invest GBP 65 million between 2021 and 2030. We continue to increase our on-site solar power generation. And year-to-date, we have seen a 48% increase compared to 2022. We're also working on the U.K. EPC ratings to be in full compliance by 2030. And overall, we are confident that the portfolio will be in compliance given the quality of our properties and our long-term commitment. On the next couple of slides, I would like to give a market update and outlook. In the U.K., the return to the office is gaining momentum, and we have seen more activity in inquiries as well as rental growth for the right properties, even if many occupiers are still uncertain about how much space they require. Vacancy in the London market has increased above 9%, but with large differences between good and bad stock. In the medium to long term, we see a much better supply and demand balance given the low supply of new offices. The investment market is unlikely to change significantly until there's clarity on when interest rates will peak. In Germany, lettings to government and Mittelstand companies are holding up well, while larger corporate occupiers are more reluctant to commit despite working from home being less of an issue than in the U.K. Vacancy in the top 7 cities has increased to just about 5%. The lowest vacancies in Cologne with only 3%, while Dusseldorf has now reached 8%. The German investment market has started to stabilize, although activity is still low compared to historical numbers. In France, the letting market has been resilient for small to medium-sized floor plates, which has benefited the CLS portfolio. The economy has also benefited from state support, which has helped keep unemployment and consumer spending stable. Vacancy in Paris has increased to 8%, but there are large differences between districts while the vacancy in Lyon fell to 4% due to a strong local economy and a restrictive planning system for new development. The investment market is also down in France with very few international buyers active. Finally, on the last 2 slides, I would like to talk about the opportunities we have in the portfolio. Our main focus continues to be on reducing vacancy to drive rental growth, but since 55% of our portfolio is index linked, this also drives uplifts in the current environment. We're working hard to secure lettings for our recently completed development and there is significant upside from letting The Coade, Park Avenue, and later this year, Prescot Street. There is always a delicate balance between letting early and achieving the highest possible rent. I'd like to walk you through the work that you have at the bottom part of Page 23. So starting on the left-hand side, you can see that we have contracted rent just below GBP 109 million. We have GBP 11.3 million that represents the vacancy we have in the portfolio. And we have GBP 2.7 million of net reversion in the portfolio, it's under rented. So that would take the ERV to GBP 122.7 million. In addition to that, we have another GBP 14 million in ongoing refurbishment and development. So this includes likes of Prescot Street that you heard about earlier, Apex Tower, Gateway House and Bismarckstrasse in Berlin. And that would take the existing ERVs up to GBP 137 million. In addition to that, we also have potential developments like Adlershofer Tor or LichtHof that we have not committed to. And then long term, we have 2 large development opportunities in London, Spring Gardens and New Printing House Square. So overall, it's something like 28% potential upside in the portfolio in terms of driving ERV for the future. On this final slide, I would like to leave you with a few key takeaways. So firstly, we are seeing good rental growth with net rental income up 5.3%. EPRA EPS was down 10.3% as the revenue growth was offset by higher financing costs. As highlighted earlier, the variable part of our debt book had an immediate increase in finance cost, while rents adjust over time. EPRA NTA was down 11.5% from valuation decreases, but there are signs that valuations are bottoming out as yields have adjusted. We've successfully financed GBP 299 million of debt in the first 6 months, leaving only 1 financing to do for 2023, and we are continuing with the 2024 financings. We believe our portfolio and geographical diversity provides resilience despite the macroeconomic headwinds. And recent lettings in Germany also demonstrate our ability to capture opportunities in the market, and we are now focusing on letting up The Coade and Prescot Street in London. Overall, our active asset management and investments in the portfolio continue to position us well for the future. That is the end of today's presentation. Thank you all for listening and attending, and we will now open up for questions.

James Carswell from Peel Hunt. Maybe just on the disposals that you outlined for the second half. I know some -- you've mentioned Westminster Tower, but beyond that, where are you looking to -- which geographies are you looking to sell down from? And then just in terms of disposal, I mean, clearly, the investment markets are pretty quiet, but you have been selling assets. I mean, where you're seeing the best demand? Is it where there's maybe alternative uses and things like that? Or are they more kind of normal standing office assets?

Yes. I mean if we start with where these disposals are, they're actually spread between all 3 countries. So you can't say that something is more in one or the other country. We're looking to exit a few things in each, both U.K., Germany and France. Not all of them are for alternative use, but I think it's fair to say that quite a few of them would be for residential conversions.

And James, the other one, in the notes for the account and assets for disposal, you'll see there's -- assets held for sale, there's GBP 180 million, which coincidentally is the same amount of money that would bring us down from 45% LTV to 40% LTV, which might answer another of your questions as well.

John Mozley, Liberum. Can I just follow up on James' question on disposals? I'm assuming that assuming you complete all of the disposals you've got targeted for this year, that takes out quite a big chunk of income?

It does take out some income, absolutely, John. But as you'll see on the 3 disposals that we've already announced, the yield on those was about 2.5%. So actually, there wasn't significant amounts of income. And the debt on the disposals that we're looking at is floating rate debt. So we've extended some of our leases delivery to avoid any break costs, and obviously, floating-rate debt at the moment is the most expensive debt that we've got. So there's quite a significant offset from that. So yes, there will be a little bit of loss of income but not very significant.

My second question was on the U.K. valuation decline. You're obviously slightly better than the broader market. Just wondering if that was an across-the-board decline or whether there were any specific items in that?

I will say that, in general, it was across the board, but we also have, as I said earlier, a few large leases that are getting shorter and shorter, not least Spring Gardens, our largest asset. And clearly, that had a larger valuation impact on that specific property. But overall, it was fairly evenly spread.

Okay. And do the changes to the government head lease at New Printing House Square, does that make a big difference to valuations? Or does that make a big difference to your long-term views on the building?

We obviously had a discussion with our valuers before we did this transaction, and it has a very small impact on the valuation of the property. It does give us direct control of the property and the tenants and it also adds income for us because, yes, the head lease was slightly lower than ERV.

Okay. And then finally, on The Coade, it sounds like things are going very well now. What's the sort of day-to-day situation?

Yes. I mean, the building is looking absolutely fantastic. We have viewings. And yes, we would hope to be able to start signing up new tenants to come into the building.

Hugh Rich from Panmure. Question for Andrew. On the refinancing this year, some of it is floating, some of it is fixed. What was the sort of logic of that split? And what's the duration of the new loans that you've taken on?

So trying to join those 2 points together. So effectively, there are 3 main reasons why we have done extensions. One is in events of sales. So the sales that we are targeting, we've tried to make sure we've got floating rate debt, because obviously, then we avoid break costs. Secondly, a good example is Bismarckstrasse. You'll see now that is in redevelopment. So we are going to look to redevelop half the building. And then once that's been redeveloped, we will then let that. And so again, floating rate debt for the short term to be done the refurbishment and then let that. And then there's a couple of buildings actually where there's also the letting situation we're trying to improve. And then once that's done, we'll put longer-term debt in. We've been typically taking out 5- to 7-year debt on the new deals where we refinance, whereas extensions are of the order of up to 2 years. We have one question on the web from Simon, but no company listed. He asks, given the ongoing significant share price discount, what would be required for you to launch another tender offer as you did 12 months ago?

I think as we've been pretty clear, our first priority is to reduce loan-to-value to ensure that we have enough capital in the company. Depending on how the sales program goes and the timing of that, any share buybacks will be for the future to decide on. But we have no current plans to do that.

There are no other questions on the line. Does anyone in the room have any more questions? Then I think we'll leave it there today.

Okay. All right. Again, thank you all for attending and for your questions. And that ends today's session.