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

Good day, and welcome to the DEMIRE Quarter 3 Results 2020 Conference Call. Today's conference is being recorded. And at this time, I would like to turn the conference over to Ingo Hatlief. Please go ahead, sir.

Good morning, everybody, to our Q3 2020 results call, and thank you for dialing in again. I trust you are all still well and healthy. With me here is, as always, Tim Brückner, DEMIRE's CFO; and Michael Tegeder, the Head of our Investor Relations team. Although corona has influenced as in Q3 as much as in Q2, it remains topic of the year. It has kept us busy over the course of 2020. To cover this important topic first, let me shortly summarize the situation at DEMIRE as of today before I jump into the presentation. The good news is that the impact of corona has been further limited and is manageable for us. And the situation, especially in terms of rental collections has strongly improved or we can say, even normalized since July. The current lockdown light affects only minor groups of our tenants, like some of the hotels and indirect some of the retail, but office only very slightly. Hence, we remain confident to deliver a robust set of 2020 results, which will exceed our very strong fiscal year 2019. In a nutshell, the corona effects in numbers. As of yesterday, 2020 16th November, DEMIRE has outstanding rental charges due to corona from its tenants of EUR 3.6 million, representing approximately 4% of the annualized contractual rents. And while the monthly rental collection in Q2 were on average at 89%, they increased to 97% from July 2020 onwards and are underway to a pre-crisis level again, that our asset management approach paid off is underlined by another number. About EUR 1.75 million of initially outstanding rent has already been repaid so far. More on the impact of corona to follow, but let's look at the bigger picture first. Our REALize Potential strategy, which we have defined and introduced last year and which focuses on the main goals of portfolio growth, financial strength and increased profitability has helped to make DEMIRE more resilient on the current crisis and has proved to be the right action at the right time. For all 4 pillars of our realized potential strategy, remember, asset management, acquisition, financials and processes, we have continued working over the course of the year so far and sharpened our efforts in Q3 2020. And we will proceed going this way. First, in the asset management field, we were able to let almost 110,000 square meter in the first 9 months of the year. And we see a demand, especially for logistics as well as office remains robust. While the EPRA-vacancy keeps trending downwards and improved to 8.4% as of September 30, the WALT of our portfolio remained almost stable at 4.7 years. This applies to the annualized rent of EUR 89 million as well. Second, the optimization of our overall portfolio structure has driven our transaction activities, especially in the third quarter. One obvious result is a further increase of the average size of our assets up to EUR 18.2 million. By closing the disposals of the portfolio we signed in October, we expect the average asset size to further increase. Please allow me 2 sentences on our perception on the German transaction market. In terms of transaction activity, we rather see a nearly normalized year-end rush and no significant corona slowdown. And in terms of prices or values, we do not see or expect an overall decrease. And that is underlined by the fact that we sold all smaller and nonstrategic assets with a premium to our December 2019 book values. Operations-wise, the financial performance in the first 9 months of 2020 was as strong and is exceeding the excellent 2019 results. The successful asset management activities supported with integration of the acquisition in 2019 led to an increase in rental income by 9.5% to EUR 65.8 million and an FFO improvement of about 23% to more than EUR 30 million. LTV, on the other hand, increased mainly due to the payout of the dividend in September and is now at 49.9% to the target range. And the cost of debt further improved at 1.75%. Fourth -- and the fourth pillar of our REALize Potential strategy, processes, operational improvements are taking effect in DEMIRE's organization. After we have implemented the state of the art treasury system and the portfolio management system, earlier this year, we have streamlined our internal organization and adopted a new risk management system, thanks to Tim and his team ahead of time. All that supports us to considerably simplify and improve our workflows, enable more detailed analysis and more targeted measures control. Given DEMIRE's strong liquidity situation with more than EUR 90 million, about EUR 73 million to come from signed disposals and no larger upcoming cash outflows, the company is well prepared for the rest of the fiscal year 2020. And we are looking forward to 2021. Hence, we are happy to confirm our 2020 guidance for rental income and FFO, which will both exceed our 2019 results. So let's take a more detailed look on the numbers and continue with the operational portfolio highlights. Follow me on Page 6, please. You see the development of our annualized contractual rent and our letting performance. The main drivers for the only slightly decreased annualized rents are strong letting performance and rent increases, along with the portfolio additions. While the disposals of the nonstrategic assets partly offset this. As there are some new rental contracts becoming effective over the course of the remaining year and 2021, we expect this development to continue. Strong operational performance offsets part of those losses of rental income due to the signed disposals. After the record-level lapping performance, over the course of 2019, we achieved again an outstanding letting result in the first 9 months of the year, almost 110,000 square meter. Although it looks, and it indeed is below last year's figures, please consider that our half year performance in times of corona is still on the level that significantly exceeds recent 12 month periods. So the first 9 months of 2020 were again strong in terms of letting performance. In figures, we made EUR 10.7 million in rental income in almost 8 years in WALT on a stand-alone basis. In addition, our letting pipeline is well filled, and we expect the letting performance to remain strong despite the challenged market environment. Let us have a look on vacancy and WALT of our portfolio on at Page #7. Both EPRA vacancy as well as WALT developed, very satisfying. And the chart speaks for itself. EPRA vacancy is down to 8.4%, and the WALT remained almost stable at 4.7 years. And the WALT for the positive development is in both cases, twofold. The strong operational performance was the main driver, and the portfolio optimization in terms of disposing nonstrategic assets helps us to improve these portfolio metrics as well. If you consider all these contracts that have been signed already, the WALT would exceed 5 years and the vacancy would fall further down. Many facts that are underpinning strong execution of our REALize Potential approach. Here, ladies and gentlemen, please find the development of our gross asset value on page #8. Our portfolio is not totally unchanged, but there were only 2 larger effects happening in the first 9 months of 2020. The closing of the Roomers in Frankfurt increases our investment property value by about EUR 43 million, while the aforementioned sale of the nonstrategic assets had an adverse effect of almost EUR 100 million, thereof EUR 29 million affecting the direct disposals and EUR 71 million of assets that were classified as assets held for sale after the exchange of sale contracts. Overall, the portfolio value is still -- exceeds EUR 1.5 billion. We will conduct the valuation of our properties for the end of the year in the upcoming weeks. And for now, our disposals confirm the current property values and [ receive a seller ]. Overall, the year 2020 has been challenging so far but also gave us the chance to demonstrate the robustness of our strategy as well as evidence of the right diversification and resilience of our portfolio. We would not have needed the corona pandemic to prove that our strategy works, but we were able to deal with it. Now I would like to hand over to Tim for some insights about our key financial metrics before I will provide you with a more detailed overview of the corona effect on our portfolio. Tim, go ahead, please.

Thank you, Ingo. Good morning, everyone. 3 quick slides on our financials. On Page 10, you see that we have been able to deliver rental growth even in corona times, as Ingo already elaborated. But I guess the good thing is also that we have been able to increase our FFO margin. Our FFO margin has been increased due to the aforementioned acquisitions, our asset management performance. And when you look to our P&L, especially lower financing expenses. With that, our rental growth grew -- is about 10% from EUR 60.1 million to EUR 65.8 million, at the same time, our FFO I grew from EUR 24.5 million by more than 20% to EUR 30.1 million in the first 9 months of 2020. Also in 2020, we have been able to extend our financial debt. We have signed 2 more mortgage loans, and we have extended our cash position to capture corona opportunities. As you know, we have also paid our first ever dividend of EUR 0.54 per share, which impacted our NAV negatively, but this effect has been partially mitigated by our operating results and the share buyback executed in Q3 this year. On page 12, you see that we have now reached our leverage target of roughly 50%. We expect it to go down slightly due to disposals in Q4. But it's also important that -- to maintain our P&L strength is that we continue to deliver on our promise to show best-in-class financing costs. Our financing costs on a nominalized basis, on average, are now at 1.75% and we have no relevant refinancings due until 2024. With this, I hand back to Ingo.

Thank you, Tim. Let me now give you some more details and figures about how our portfolio is affected by the corona pandemic so far. What we said at our last call in August was that direct impact on rental income is very moderate and well manageable. And that's a strong development of DEMIRE over the last years helps us now to deal with the situation. But it does not make us fully resilient but that it helps us to manage the situation and keep our heads up. Seeing the development from August so far until November, I would repeat this statement with slightly more confidence in my voice. In more detail and with latest data, while the rent suspensions from DEMIRE's tenants in context with the corona crisis amounted up to 13% of the target rent during the month of the second quarter, we see a significant recovery on even normalizations since July. Until then, we have been able to collect about 97% and also collected already EUR 1.75 million of outstanding Q2 rents. Rent suspension due to corona currently amounts to EUR 3.6 million. These suspensions do not directly transfer to a loss in the P&L. Lockdown life in November has not had a strong effect on collections so far. The dip in collections for November results rather from rents due to 15s . Again, I'd like to stress that with over EUR 90 million cash on the balance sheet and more than EUR 73 million to come from the disposals of assets, DEMIRE has ample liquidity for any growth opportunity that might arise and for a dividend. Finally, I would like to confirm our 2020 guidance on page 15. Most important, both rental income from FFO, I will exceed the strong 2019 results. We are confident that our rental income will increase by about 5% to EUR 85 million to EUR 87 million. This increase compared to full year 2019 is mainly based on full year effect of acquisitions and strong letting result, mitigated by selective disposals and, of course, corona effects, as mentioned. And the FFO I, I will -- FFO I -- sorry, it will increase as well, probably even stronger by about 7% to EUR 36 million to EUR 38 million. The 2 driving forces for the FFO improvement are rental growth and lower financing costs, hence made operational efforts. To summarize DEMIRE's first 9 months 2020, while we have not been fully spared from the corona crisis, the effects on our portfolio and P&L have proven to be moderate and manageable. The structural and operating improvement of our REALize Potential strategy gives us strength and paid off. We will finish the fiscal year 2020 with both rental income and FFO exceeding last year's figures. And this has created a very solid base for a further promising development in 2021. Thank you very much. We are happy to answer questions.

[Operator Instructions] We'll now move to our first question over the phone, which comes from Andre Remke from Baader Bank.

A couple of questions from my side, please. Starting with your guidance after the strong FFO of EUR 30 million after 9 months. I guess that was also fueled by lower maintenance expenses in the last quarter. We are now at mid of the quarter of the last quarter today. So do you see much higher CapEx in the remaining quarter, i.e., will the NOI margin will be that much lower -- not to exceed the guidance range? This is the first question, please.

It's Ingo here. Andre, I don't know what you're comparing our figures with. In the first 3 quarters of 2020, we have a total expense of EUR 15.6 million so far. This includes maintenance, TIs and CapEx. And this is more than double the first quarters -- the first 3 quarters of 2019. So we -- of course, we gave more in this group of cost and investments than in the last year. So -- and we plan for the full year, the total expenses of EUR 20 million so far. So I think this is manageable. And please keep in mind that 2020 is a corona year. So this means that it was hard to manage all the craftsmen and to fulfill these goals, but we see very good on track with it. So I don't see a backlog or something like that. I see that we are going further in the last quarter as we've done in the first 3 quarters.

And -- but the background for the question is also, there is only, let's say, to your guidance, to reach your guidance only EUR 6 million to EUR 8 million in FFO for the last quarter. What makes you believe that, that put into this stage, this is not easily achievable? So are there any other risks we -- which we consider to be only reaching the lower end of the guidance there, for example.

Andre, it's Tim. I don't think that we are in a position to change our guidance at this stage. I mean you have done the analysis right on our Q3 numbers. And as we all know, we are in a light lockdown now. We don't exactly know what's going to happen next week. When we look abroad, the situation is, at least in part, much more difficult than in Germany. I guess we are not piggybacking, but we remain careful. And well, we are -- we have a positive view on the last 6 months of the weeks. But I guess, a bit of carefulness is right at these challenging times. As soon as we have more clarity on the final numbers, obviously, we will look at our business plan and our model again. We will look at our guidance again. But at this stage and on the back of the October numbers, and the rental income in November, I guess, we are absolutely right and confident that we make our guidance of EUR 36 million to EUR 38 million this year.

Okay. Perfect. That's fair enough. And then the second question on your acquisition strategy, could you provide us an update here? You mentioned the normalization of transaction markets, probably not only for disposals, but also, there are some opportunities. And in the last call, Ingo, I think you mentioned a larger acquisition of -- if I'm correct, EUR 100 million or so. Are you still working on that? Or is it off the table? And in general, what kind of assets you are looking for in terms of asset class locations and type of properties?

Yes. Thank you. Very good files you have. Of course, I mentioned it already, but we are still working on it. The process is a little bit longer than expected. But we are in advanced negotiations now for acquisition of a larger office building in a very good location. And this is, at the moment, our focus for the acquisition, hopefully, we can sign it in 2020 or in the first beginning of '21.

And in addition to that, do you have a further acquisition pipeline, not to go too much into detail but...

Of course, of course, we have a smaller acquisition pipeline, but in this stage, it's only 1 property.

Okay. Then you mentioned the portfolio valuation. From today's perspective, what are your expectations here for the year-end acceleration? Any indications on that would be helpful.

As said in the presentation, our disposals are above the valuations of the last year. And we are talking about more than 20 properties at overall to be seen. This gives us a lot of confidence that our valuation is absolutely right, even due to the crisis. Of course, we see some pressure in the retail market or in the hotel market, and this will affect our portfolio as well. But we have already a conservative view on retail also in December 2019 in our last valuation. This is due to the fact that the retail was at least discussed, the retail market was discussed ahead of corona already. So this gives us some confidence that we are stable. And on the other hand, we told about our operational improvements. We see some of the properties with better contracts, with a better position than in the last year. For example, whether Telekom moved out in Flensburg or other properties. Where we expect more an uplift in valuation and then decrease. So overall, we expect this slightly stable valuation over the whole portfolio.

Excellent. Then a very last question on your strong letting result after 9 months. Could you provide us a figure with -- for the like-for-like rental growth, i.e. what comes from vacancy reduction and what from rent increases? And what were the terms for the relettings in comparison to previous conditions? That's the last question, please.

Of course, and if you look at the like-for-like rental growth, this hurts a little bit. It's a weak 0. It's 0.3 minus. What is the reason for that? It was a step down in rent in 1 of our properties rented to the Telekom, our biggest tenant, it was gone. And if you take this effect out, we have a like-for-like rental growth of 1.2%. And this comes, of course, due to indexations by EUR 165,000. And of course, a vacancy decrease of EUR 1.38 million. This is the main reason for the like-for-like rental growth, if you take 1 out of 1.2%.

[Operator Instructions] We'll now move to our next question over the phone, which comes from Julius Stinauer from Hauck.