DEMIRE Deutsche Mittelstand Real Estate AG (DMRE) Earnings Call Transcript & Summary

Good morning, everybody, to our 2019 Full Year Results Call. Thank you for dialing in today. With me here in this call is Tim Brückner, CFO; and Michael Tegeder, Investor Relations. I will open the company presentation with the highlight of DEMIRE's strategy and portfolio achievements. Tim will elaborate on the financials and our new guidance thereafter. Finally, we will open today's Q&A, however, let me start with some personal words. 2019 has been an extremely positive year for DEMIRE. So it is a pleasure to give you some good news in these turbulent times. Due to our REALize Potential program, DEMIRE is currently in a better shape than ever before, portfolio-wise and financially. The future development of all markets is unpredictable in these dynamic times. Nevertheless, we give our best efforts to bring the positive momentum of the last year across into the current situation, to monitor the risk closely, but also to keep in mind that the cycle is alive and that chances can occur as well. After we implemented our REALize Potential strategy in early 2019, the consequent execution of this program led us to take a fundamental step towards achieving our priority goals. Portfolio growth, financial strength and an increased profitability. In all of our areas of our REALize Potential program, remember management, acquisition, financials and processes, we were able to meet or exceed our targets. First, in the asset management area, we were able to let more than 170,000 square meters. The EPRA vacancy rate of 9.4% is well below the peak in mid-2019, which emerged from the acquisition of properties with potential. The world of our portfolio increased from 4.5 years to 4.8 years. At the end of 2019, and the annualized rent amounts EUR 90 million. Second, in the acquisition area, we were able to increase the size of the portfolio from EUR 1.1 billion to EUR 1.5 billion at the end of 2019 by purchasing 11 properties, totaling an investment volume of EUR 356 million, 9 of them as portfolio transaction and 2 as single-asset deals. In addition, as part of the portfolio streamlining, we sold 8 properties very successfully with a total volume of EUR 46 million. The sales proceeds were roughly 46% higher than the latest valuation. Third, in the area of financial, we were able to repay higher interest financing ahead of schedule through secured property financing with a volume of EUR 97 million and the issue of a corporate bond with a volume of EUR 600 million. That reduced our average nominal financing cost from 3% to 1.84%. The LTV is now at 46.7%, leaving room for further growth. In the fourth area, processes, operational improvements are taking effect in DEMIRE's organization: the use of economies of scale, the outsourcing of property management processes that are more efficient, less complex company structure, increase efficiency of our administration. As a result, administration costs came down significantly by EUR 9.4 million. All of these 4 measures have had a positive effect, which enabled us to significantly exceed our 2019 KPI target. The forecast for FFO -- the FFO I after taxes and before minorities was increased twice in 2019, most recently, to a level of EUR 33 million to EUR 34.5 million. With FFO of EUR 34.5 million, we reached the upper end of that range, recording a significant increase of nearly 48% compared to the previous year. Rental income reached with EUR 81.8 million, the upper half of our latest expectations, which was EUR 80.5 million to EUR 82.5 million. This is a rise of 11%. Let me continue with operational portfolio highlights. On Page #6, you see our outstanding leasing performance underlined by the growth of annualized rent and the 2019 letting results. The annualized rent increased by more than 23% to EUR 90 million, up from EUR 72.9 million end of last year. This was mainly driven by the acquisitions we executed over the course of 2019, only a slightly mitigation effect from the disposal of nonstrategic assets as they were small and sold towards the end of 2019. In addition, strong driver was a strong letting performance, with an increase of 110% to 172,000 square meters or almost 15% of our total portfolio. We delivered an absolute record performance in signing lease contracts, which will secure as much as the total of EUR 11 million in rental income. Some of the new contracts have started in 2020 or will start later in the year. So a further decrease in vacancy will like-for-like come along over the course of 2020. A strong example as well as a highlight in terms of letting performance is a property in Bad Vilbel, close to Frankfurt, which I will demonstrate in a case study just in a minute. The property, Bad Vilbel, is a nice changeover to Page 7, which describes the vacancy on the left. Indeed, the EPRA vacancy, which was at a very solid level of 7.5% end of last year, increased over the course of 2019, with a peak -- with 11% in the middle of the year. Reason is as simple as obvious, we acquired a portfolio with high vacancy in May 2019. Our strong letting performance here as well as all over the portfolio and the country helped to bring down the vacancy to 9.4% again at year-end, with further decrease to come in 2020, when some of the already-signed letting contracts will become effective. To conclude that, the development of the vacancy 2019 is better than it appears, and our target range remains at less than 8% vacancy. Another key performance indicator is the development of the WALT, the weighted average lease term. It was improved from 4.5 years to the end of 2018 to 4.8 years at the end of '19. The result coming from a slight dip in mid-2019 demonstrates again our very strong letting performance, enhanced by accretive acquisitions we made. When you consider all these contracts that have been signed already, the WALT would exceed 5 years, many words describing the execution of our REALize Potential approach. Here, ladies and gentlemen, please turn over to Page 8 for a bridge to reach EUR 1.5 billion portfolio size. As you know, we started the year with assets worth EUR 1.14 billion. Revaluation gains of about EUR 84.7 million underlying our strong operational performance. But we have recognized the moderate yield compression as well, summed up by about EUR 5.0 million in CapEx. This bar contributed about EUR 90 million. More significant price-wise are the contribution from acquisitions, with about EUR 300 million in this year. I will not describe each deal or asset in detail here but please understand that especially the overall pool of assets acquired has enhanced KPIs and quality of the DEMIRE portfolio and brought a fundamental step in size. The EUR 34 million book value of the disposal demonstrates that we are able to monetize valuation gains, but more important to improve our overall portfolio quality. If you add these assets, held-for-sale, the portfolio sums up to EUR 1.5 billion. This is a strong evidence of high-quality portfolio growth and brings us closer to our target, the portfolio value of at least EUR 2 billion. Let me conclude again, our operational results -- before I will present REALize examples. 2019 was a year of strong performance, leading to very satisfying results. And more important, the performance is the result of structural strength that will enable us to remain the pace high and improve the performance further in the upcoming months and years. Please turn to Page 9 to see our first case study. To continue with the lively example of our execution of REALize Potential program, let me come back on our office building in Bad Vilbel. I elaborated on that already in our Q3 call, but the success story continues and the optimization is almost completed. Bad Vilbel was part of a portfolio transaction, which was closed in May '19, the 26,000 square meter, single-tenant office building joined our portfolio with a high vacancy and just EUR 1.1 million GRI. The purchase price was EUR 31 million. Between signing and closing of this transaction, we already worked on a repositioning concept and executed it immediately. Key was the transformation from a single-tenant property to a multi-tenant property, with ongoing investments of roughly EUR 4 million. We established a tenant-related asset management, moved tenant within the building to optimize a second plan, installed the canteen and started a marketing campaign. After having acquired the State of Hesse as a tenant with 5,000 square meters in the last year, the newest tenant is now Brother with another 5,500 square meter. Both move in mid-2020 and reduce the economic vacancy to a low 5%, with a positive effect on the whole portfolio. So what are the achievement in figures? Pro forma annualized and increased value was more than EUR 44 million. The Brother contract is yet not reflected here to mention that. The GRI is up by 164% to nearly EUR 3 million a year, and the WALT is 7.5 years now. That's how we REALize Potential on an example, but another example is coming across. Please join me on the next Slide #10. The property in Essen was part of the same portfolio transaction: 45,000 square meters, 30% vacancy and a purchase price of EUR 81.5 million. The key here was the marketing concept and the focus on existing tenant relation. Our good relation to a state tenant leads to an early prolongation and to a significant increase in GRI. At the moment, we are in negotiation with the same tenant for more contracts in other properties of our portfolio. Please note the achievements for Essen on the right part of the slide. A valuation uplift by 20% to EUR 97.6 million, a vacancy reduction and a GRI increase of 24%, and the WALT is 4.5 years now. I could move on with examples, but for you, it is more important to combine this operative success and real estate examples with the overall financial. Tim will pass you through that part of the presentation.

Ladies and gentlemen, it's a pleasure to speak about some really strong financials this year. And I will go over to Page 12, where I give you a brief insight about our profit and loss statement for the financial year 2019. As you had already figured out and heard from Ingo, we have posted higher rental income, lower administrative costs. We have experienced higher one-off financial expenses, but a significantly improved FFO. First, the income from the rental of real estate has been driven by acquisitions in 2019 and some positive like-for-like performance of our portfolio. Together with the outsourcing of our property management, we have been enabled to increase our NOI margin to 80%. When you go further down our P&L, you see our general and administrative expenses significantly improved. Now ratio-wise, alongside our main peers in the office, our commercial property sector in Germany, it has been improved by measures we implemented over the year 2019, but also by lower advisory fees and consultancy fees than in the year before. As we have already elaborated on in the last year, we have refinanced our bond. We have refinanced promissory note, such that we have higher one-off financial expenses that's roughly EUR 50 million now, but I will stick to that a bit deeper on the following pages to give you an idea what the positive effect will be going forward. Finally, on that slide, you see the FFO and the FFO bridge. More details can be found on Page 24 of the presentation. And you see our funds from operations improving from EUR 23.4 million for 2018 to EUR 34.5 million for 2019, which really demonstrates our ability not only to grow our revenues but also to have a strong grip on our cost side. Switching over to Page 13. We'll talk about our balance sheet. Obviously, as you have already figured out, the balance sheet has been extended on the asset side by some property acquisitions and the improved valuation of our portfolio. On the equity and liability side, we have increased our debt book from EUR 640 million to roughly EUR 810 million. And our equity has improved by more than 13% to -- from EUR 580 million to EUR 660 million. Together, this result in an EPRA-NAV uplift per share on a diluted basis, which is now EUR 0.82 up to EUR 6.32 from the year-end 2018. On the following slide, I will come back to our refinancing of the bond program that is something we conducted in Q3, Q4 2019 after -- in summer. We did a mortgage loan of EUR 97 million, which also helped us lowering our interest expense. For us, looking back into 2019, the bond refinancing was exactly the right thing that we could do. We issued senior unsecured EUR 600 million note with a coupon of 1.875% and a maturity of 5 years. The result of that program, you really see on the right-hand side under the key benefits of the refinancing column. It shows that the refinancing of the bond and alongside the refinancing of the Schuldscheindarlehen helped us to lower our financing expense only due to that refinancing measure by 91 basis points, and it helped us to extend the duration of our liabilities by 1.4 years. In that uncomfortable times we experience these days, this is a strong benefit for our company. Also, interestingly, these days, obviously, are the bond covenants. We have comfortable headroom. We have one maintenance covenant, the interest coverage ratio, where we have more than 100 basis points headroom. The net LTV, according to the bond definition, which is a bit wider than the general net LTV definition, is 60% where we stand at roughly 45%, and the net LTV -- net secured LTV covenant is about 40% where we are currently at 7.3%. Over the year 2019, we experienced very strong trading of the bonds, so the investor universe liked the product, liked our company. Obviously, these days, our bond performance is in line with peers. And at yesterday's closing, the bond was trading at 85%. I personally believe this is a strong experience for our investors to invest into DEMIRE. On the next Slide 15, we talk about our key financial KPIs. As you see from 2016 to 2019, we have delevered the company, and now we are approaching our target 50% net LTV level from below and stand at 46.7% at the end of 2019, which I believe is a comfortable leverage situation. At the same time, also when you look on the right-hand side, 2016, we come from an average nominal cost of debt from more than 4% to now 1.84% at the year-end 2019. If you put that into numbers, this is 120 basis points lower than at the year-end of 2018. Putting that in relation to our debt volume of EUR 800 million that has a positive effect of close to EUR 10 million in higher profits before taxes every year. Switching over to the following slide. You will see our share price performance in 2019. You see our increasing NAV. Last year, EUR 5.50; now we are at EUR 6.32. We see a significant gap and a significant NAV discount over the year, it was roughly 15% on average. These days, it's more than 30% NAV discount. I guess this reflects a strong opportunity when looking at DEMIRE. Looking further and jumping to our outlook, the guidance 2020. I'm sure you have questions for us later, but let me talk about the guidance first. The guidance 2020 has not yet been affected by the coronavirus impact. We look at stable trading over the first 2 months of the year. We have put time and efforts to work on our business plan for 2020. And when we put together our operational trading performance, the acquisitions that we have done last year, the financing measures we have put into place, we expect rental income of EUR 90 million to EUR 92 million for 2020. We also expect an increase of the funds from Operations I from EUR 35.4 million (sic) [ EUR 34.5 million ] to EUR 40 million to EUR 42 million. In summary, we remain confident that our REALize Potential strategy will continue to help us to grow DEMIRE further and make it even more profitable than today. With this, I will hand back to the moderator and open the floor for questions.

We will take our first question from Andre Remke, Baader Bank.

Well, a couple questions. I know that it's difficult in the current environment to provide clear answers or even calculations because all is moving and changing. But some questions on your current discussions with, let's say, tenants, partners, et cetera. So first on the tenant demand. Do you already experience some existing -- with existing or potential tenants becoming less responsible for, let's say, base expansion or even lease extensions at higher rents. So how confident are you that the value-add approach for the higher vacancy properties could be a WALT in these days? This is the first question, please.

Andre, coming back on this to a single, the current situation, as you said, is moving really fast. If we look at our figures until February, we don't see any impact on the rent collection so far. Currently, some discussions occur, especially from branches that are hidden by this crisis, like hotels, and like some of the retailers. At the moment, we are just in discussions with them. There is not a concrete resolution on that, but we are dealing on it and having -- putting in place our risk measurement systems. To get your overview of what we're talking about, just looking at the hotels, I think this is part that is mostly impacted by this crisis today. We have 5 hotels in our portfolio with a monthly rental collection of EUR 300,000 roughly. You see this is not really a big proportion regarding our whole portfolio. So with 5% to 6% portion on our portfolio, we are relatively stable on that. And now we start the discussions with them and see what we can do and bring to the table to help them with the situation.

And how many of your retail portfolio with, I think, 27% or so is affected by closures?

So far none. So far none to answer it right away.

Okay, okay. And secondly, on the transaction market, what is your current pipeline here and you're already -- also here, same question, experienced any delays in negotiations, what is the situation or your best guess expectation also for the upcoming months?

We have 1 portfolio and 3 single property in our pipeline that we are in negotiation with. This is totaling EUR 0.5 billion roughly, a little bit more. We see that the market is flooded with money at the moment. So we don't see any impact on the transaction market so far. So we move on with negotiations, but we will see and watch the situation every day from another angle.

And how comfortable, in general, do you feel with your acquisition path towards the EUR 2 billion, even some could emerge from higher values of the portfolio and operating performance. But your target for further acquisitions and given an LTV closer to your target of 50% these days, the most asked question from investors is on the liquidity side, so will you become more cautious also here from your angle, even if there are opportunities?

Obviously, we'll remain cautious, and we monitor the situation closely, but we have, as you see from our numbers, we have some liquidity on our balance sheet. Some of that will be certainly retained, and we have recurring credit facility that we could draw, if required, a smaller one. But I mean we are looking into the future, and we want to make sure that we manage the firm responsibly, but we want to remain on the growth path, and we do everything to keep that in line. And to be quite honest, when you see the time line of events in China that is certain that this is a major shock to the economy, but it's not the end of the world. And we are positive that the wheel will keep on spinning, and we want to be there to capture opportunities.

Ladies and gentlemen, we will take our next question from Ash Heatwole from Shenkman Capital.

I hope you all are well and in good health. A few questions for me. Firstly, just on crisis management within your internal operations. Can you remind us of the number of employed staff you have and how you're set up internally to have your employees largely working remote? Is there any friction costs that would be associated with that? That would be my first question. And then secondly, it's just -- can you remind us if you have any required debt amortization in 2020? And I guess I want to tap on to that as well, you mentioned for your current liquidity you have an RCF. Could you quantify the level of committed funding you have there?

Sure. Let me first tackle the coronavirus impact question. We have roughly 30 employees on the ground. And obviously, from a corporate perspective, we need to have measures in place to enable us to continue working, and that is what we currently do. So we have put in place advanced health and safety measures. We offer home office solutions for individuals at this stage with children or any specific health risks. We have some IT systems in place, specifically including our treasury systems that we can work on remotely. As you see from this conference, we have telephone systems in place that allow to work from home. We do video conferencing a lot. I'm not saying that this is all ideal, but I guess, when you're asking for frictional cost or additional expenses because of working from home at this stage, I don't see additional costs from working from home. We try to be and work as efficient as possible, and I'm really confident that we continue working like this. And let me add something on this. I mean furthermore, and I personally believe this is something every one of us should do: we have also offered support to our local community, well, to help not only us as a corporate entity and U.S. shareholders and stakeholders that we altogether come good through this difficult time. Back on your second question, the financial, the credit line I was talking is comparably small and gives us liquidity for a few months. Upcoming maturities this year are not material and could be fully fulfilled from the existing liquidity, even if we do not retain any euro in rent this year. So until year-end, I believe we are absolutely secure.

[Operator Instructions] And our next question comes from Stefan Scharff, SRC Research.

Stefan here from SRC Research. One question regarding Slide 6. It's about your letting performance. You stated that you more than doubled your letting performance from the year before to 173,000 square meters. That's nice. Can you give us a split here? What is prolongations and what is new lettings? And regarding to the prolongations, can you say if the square meter prices were stable or you could even get a little hike here?

Just give me a second, looking for the numbers to give you some more details on that. We have prolongations with 93,000 square meters, and the rest are new lettings. Mostly, we look at Leipzig items through CASM. This was -- this is our logistics center, as you know, with huge space. This counts a lot on this 170,000 square meters, but we succeeded well in other properties, like Bad Kreuznach, Kempten and for example, also Essen assets before Bad Vilbel. So this spreads all across the portfolio.

And the square meter prices were more or less the same? Or did you manage a hike here?

The rent is up, especially in Bad Vilbel and Essen. We realized above-expected rents in these properties. Also, in Leipzig, we could improve the rent we already had. So this is the main reason -- or it's one of the main reasons why the valuations went up that much in the last year. It was coming more from operational results than from yield compression as we see it.

Yes, yes, you have shown it in the Bad Vilbel property, the good success. Are there some talks underway in Bad Vilbel for the remaining vacancy? And can you feel if there might be a delay for further lettings of free space in Bad Vilbel or other locations or...

If you look at the vacancy in Bad Vilbel, it looks more than it is. The economic vacancy in this property is roughly 5%. So we are close to a full letting, and for the remaining space, we are in discussions with existing tenants who wants to enlarge their footprint in the property. So we are hopeful to give you more good numbers in this year -- in the course of this year.

Okay, okay. And for your FFO guidance, it was -- I would say, it was okay, but it was not very, very optimistic. But it might happen if we get over the crisis, over the corona crisis, and you get some more lettings in at an earlier stage or you can expand your portfolio at a more early stage that you might even increase your FFO forecast in the course of the year or in the second half of the year? Or you think this is too early to think about such a positive scenario.

Well, we -- Stefan, it's Tim. We discussed our business plan for 2020 in great detail, internally, and also with our Supervisory Board. I mean as you follow our company now for a few years, you know that in the past, not in every year, all the maintenance and CapEx has been invested in our portfolio. As Ingo elaborated on, we want to lower our vacancy, so there might be some TI costs that will run through the P&L. So I guess our business plan assumes some strong operational performance, some investments into our portfolio. If you don't invest the money, I guess, the portfolio or the FFO could be a bit higher, but I guess, we have put together a really strong scenario for 2020, which will not only increase the FFO significantly but will also see some proper investment in the portfolio.

Okay. Okay. I see. So yes, all the best for this year. It's a challenging year, but you have a good portfolio so you can work on it.

[Operator Instructions] As we have no further questions, I will now hand back to the speakers for any additional or closing remarks.

Yes. Thank you for joining in our call today. I hope to hear you again in our next call, and please stay healthy. Goodbye for now.