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

Ladies and gentlemen, good morning, everybody, and a warm welcome to our results presentation for the first half year of '22. Thank you for dialing in. I trust you are all well and healthy. Joining me for this call is our CFO, Tim Bruckner; and Darek Gruttle, Investor Relations. Before I start to dive into our results and provide you with the latest figures, let me briefly touch upon the omnipresent topics to determine the current overall economic sentiment, and how they affect the operations of the mirror. The first aspect to mention here is the war in Ukraine, which is sadly still ongoing. As for DEMIRE, we have not been directly affected since the vast majority of our tenant base does not have close ties to Ukraine or to Russia. Closely connected to this conflict is the rapid increase of the inflation over the last couple of months, while especially the increased energy costs impact our P&L negatively, the largest part of the price jump can be passed on to our tenants. Positively, almost 70% of our annualized rent is indexed and the index clause of many of our rental contracts have been triggered recently, which raises our rental income. I will elaborate on this a bit more later. On the other hand, we are, of course, aware that our tenants are doubly burdened by the rising rents and the rising ancillary costs. So far, no defaults have resulted from this, but we have continued the well-established and intense tenant landlord dialogue. The last topic I would like to mention at this point is a still tense corona situation, which has not impacted DEMIRE notably in the first half year of '22. Assuming we do not see any strict lockdown measures or like over the rest of the year, we are confident that the impact will keep being manageable. To summarize, the company has again shown a high level of resilience towards the current economic challenges and demonstrated the robustness of our business model. Let me illustrate this now by walking you through our most important KPIs and their development in the first half year '22. We follow our realized potential strategy for 3 years now, and the results are still satisfying. All 4 pillars of our strategy have again contributed to a solid first half year. Some of the KPIs appears weaker, but this is caused by the disposal of 11 assets in '21. Hence, the reference figures were based on more assets and don't include Cielo anyway. The first strategic pillar, asset management, contributed to a new all-time high of square meters let around 145,000 square meters. This helped to achieve a like-for-like rental growth of almost 1% and to increase our annualized contract rents to EUR 80.6 million. We were also able to reduce vacancy significantly to below 10%, while the WALT remained fairly stable at 4.6 years. Secondly, the acquisitions are, let's call it, transactions. Since we implemented our strategy back in 2019, we have acquired 12 assets overall with a value of around EUR 631 million and 33 assets were sold on average with a premium to market value of 12.5%. Despite the challenging market in 2022, we have also made some progress in terms of the institutionalization of our portfolio by selling a smaller property in Bremen, again, 6% above book value. We expect the closing to be in September. Pro forma sale and in accordance with our strategy, the average asset value of our portfolio continues to improve further. It is time to speed up our portfolio dynamization efforts. Recently, the board upon approval of the supervisory board, has decided to intensify the focus on portfolio denomination with disposals to create a liquidity caution for refinancing purposes or growth opportunities. This should further improve our already comfortable liquidity position. If you look at our P&L, you will notice the lower profit from the rental of real estate, which is a consequence of the before mentioned lower number of assets, of course. Currently, we count 64 assets. The positive effect of our latest acquisition, Cielo, is due to its joint venture structure reflected below this P&L item in the financial result. Here we were able to improve the FFO in the first half year. Tim will elaborate on the financial results in a minute. And processes, we have published our first sustainability report in June, which we aim to expand and enrich with further information in the near future. Besides that, we have again been able to lower our G&A expenses. All that makes us confident for the future development of DEMIRE. And I am happy to confirm our '22 guidance and on rental income and on FFO. Let's have a more detailed look at our KPIs and follow me to Slide #6. Showing the leasing performance, after an already strong number of square meters let in half year '21, we have been able to improve further in the first half year of '22 up to a new record level of almost 145,000 square meters. While prolongations of rental contracts account for 72% of the leasing performance, new lettings make up for 28%. We were able to conclude a 3-year contract extension with Imotex in Neuss, which represents the largest prolongation and secured EUR 5.4 million of annual rent going forward. Further, we have also seen a jump in our annualized rents, up by EUR 2.5 million to EUR 80.6 million, representing attractive 5.7% gross yield on our EUR 1.4 billion portfolio. The main drivers of this development were new lettings in LogPark Leipzig and rent increase due to the indexation clauses having been triggered in various rental contracts. These factors helped achieving a like-for-like rental growth of 0.9% compared to 30th June of last year. Next slide shows vacancy and WALT. The pleasant development of our portfolio KPIs continues with EPRA vacancy, which has been reduced to 9.5%, mainly driven by a ramp-up in occupancy in the asset in Leipzig, but further and due to an interim leasing in Kassel that will be replaced by a new long-term hotel contract afterwards. Our WALT remains practically unchanged at 4.6 years. So Tim, please go along with details about the financial performance.

Thank you, Ingo. Let me quickly go through our P&L on Page 9 of the presentation. As Ingo already elaborated, we have slightly declining rental income driven by the disposal of assets in the previous year. You see that the operating expenses and income from utility and service charges are substantially higher given the accelerated inflation and specifically as widely discussed in the press, and as you may feel it personally as well, rising energy expenses. This adds up to an NOI driven by the disposals in 2021 that is lower than in the previous year period. together with a slightly and only slightly declining NOI margin. When we walk further through the P&L, we see that we had no disposals this year in the first half. Further down the impairment of receivables, we see for the first time for years 0 in this line. This is a net position as various tenants paid on previously written off receivables during the corona period. For the remainder of the year, we still expect some impairments, but significantly lower than in the previous year. And as Ingo said, hopefully, and most likely not driven by the corona situation. General and administrative expenses are further down slightly. I think we have worked as part of our realized potential strategy, quite strict on the tightening of our cost base, and we have now reached cost margin in line with our listed peers. The financial income, which is note number 4, has increased, mainly driven by the Cielo transaction that is now in our financial income position, which was what not last year. Together, this adds up to earnings before taxes and minority interest of roughly EUR 20 million, slightly lower than last year. But after FFO adjustments, which are, for example, the fair value adjustment of investment properties and its total proceeds, we see that our FFO has increased. Our FFO margin has increased predominantly given our strong letting performance the tight cost management and tenant relationships and the positive full year impact of the Cielo transaction. On Page 10 of our presentation, you see the balance sheet, which basically has no surprises at all. As you might remember, we have paid a dividend in May slightly reducing our cash position and the reserve position in the equity part of our balance sheet. Otherwise, I believe there are no surprises. We have not conducted any external valuation of our investment portfolio. What we will do at the end of the year again. But the discussions with value so far -- and together with our strong operating performance, give us a good feeling that our investment property valuation is still in line with the market. So we think we post very stable numbers here. On Page 11 of the presentation, you see the net LTV. The net LTV moderately increased due to the dividend payout. We still have comfortable headroom to our bond covenants 60%. And -- and the average cost of debt given that we had no refinancing in the period remained about stable at 1.67%. Obviously, you are fully aware, we are fully aware of the refinancing requirements of the company in 2024. We all know that capital markets, backed markets and financial markets overall are in, let's say, difficult shape. We prepare ourselves for the upcoming refinancing. As Ingo already elaborated on we will work on an extended liquidity position, and you can be certain that we will start discussions with our lenders, bondholders as early as possible. And as some of you may be dialed in, you all know that we are in regular contact with you. We are always available for discussion, and we obviously stay fully committed to full transparency when it comes to refinancing and the financing environment. Ingo, your words on guidance.

Absolutely. Thank you, Tim. After all, and to conclude, we delivered solid results in the first half year '22, and we are not only looking forward to the second half of the year, but also are convinced to be well prepared. Consequently, we can confirm our rental income guidance of EUR 78 million to EUR 80 million and funds from operations of EUR 38.5 million to EUR 40.5 million. Thank you very much for listening so far. We are now happy to answer questions you may have. Emma can take over.

We will now take our first question from Philipp Häßler from Pareto.

Philip Häßler from Pareto Securities. I have a few questions. Firstly, you are mentioning your bond, which will mature in 2 years time. And maybe you could elaborate a little bit on what tools you have to soften somewhat the impact from a higher coupon, which is very likely as of today. I mean, capital market mean change again. But as of today, it seems to be very likely that you will have to pay a much higher coupon. Maybe you can give us an idea what levers you have to fight against the higher funding costs? Then on the rents, which are indexed, have I heard it correctly that 70% of the rents are indexed? And is there a big difference between office and retail? And then on Cielo, if I'm not mistaken, I think the Q1 and Q2 equity -- the contribution from an equity consolidation was different? Is it not always the same each quarter? And maybe you could give an outlook for H2.

Yes. Thanks for your question, Philip. It's Tim, the CFO. Maybe first on the potential future financing costs. Well, first of all, we have no upcoming maturities until the bond materials and in the same year, some mortgage financing, which was always intended that we pushed that all to 2024 in today's market. Obviously, it would be very difficult to issue a comparable product. So of course, we will look at alternative financing sources. Today, I guess it is too early because we have secured those preferable rates for another more than 24 months. But you can be certain that given our plan to increase the liquidity position and prepare ourselves for the refinancing, we will obviously start right in time next year with financing discussions with our bank partners, with capital markets service providers and so on. And apart from capital market financing, there is obviously always the opportunity to enter more into the mortgage financing market, which is, at the moment, at least coming in at significantly lower rates, but still, I guess, it is a bit too early because I think nobody knows exactly how banks will behave in 24 or 48 months, also the capital markets, which is at least my personal belief will stabilize and will provide, I guess, more realistic rates. And if you look at the forecast of leading banks, you will see that most of them, at least expect that the credit curve will soften again. And I guess we are well prepared, and we will start the process right in time next year. I would continue with the Cielo question. I think there are 2 components of the Cielo -- of the income from the Cielo joint venture, which is the first financing income, which is basically interest income. This interest income is basically fixed. It can vary slightly over the quarter, given certain effects in the agreements with the joint venture partner, but it will be more or less stable. The equity income might vary a bit more because, obviously, it is in this yellow joint venture, you have certain costs, which are relating to the operation of the business, and that might go up and down in various quarters and effect equity earnings of the joint venture and therefore, our equity income. Maybe Ingo...

So for the indexation question, what share of our contract rent is linked to CPI was the question. You heard it right. 70% is indexed, 22% approximately is fixed and 8% is step-up. And yes, there is a difference between the contracts in office properties and in property, mainly usually office properties, the indexation is between 90% and 100% and in retail between 60% and 80%. So you see here a slight difference between the asset classes. In total, the effect in our P&L is EUR 1.9 billion due to indexations this year. Hope this answers your question.

We will now take our next question from Peter Wild from Muzinich.

I just wanted to carry on the discussion about refinancing the 2024 bonds. And kind of 2 interrelated questions, which is now that you've been downgraded yet again to single B, is it really realistic that you can refinance in capital markets at a level that is acceptable versus what it would cost you to do this in the mortgage market? And if so -- if that is not the case, then does it not make sense to start the process of refinancing using the mortgage market. And kind of the second question which is related is, I was hoping for some kind of an update on the sales process of which there's no mention in any of the stuff you've published today. So I was just wondering if you could give us any indication of whether that's moved ahead at all, whether that's now been delayed given the general financing conditions attitude towards real estate any information you can give us there would be helpful. And is that delay in the sales process having an impact on your refinancing decisions.

Okay. I'll start with the second question first, Ingo here. It's uncertain time. So the process takes some time. It's ongoing. But we can't speak for our shareholders to give some information about the results so far. So Tim will elaborate on the financial question.

But Peter was it realistic that we can refinance ourselves for the capital markets in 2 years' time? From today's perspective, given the recent move downgrade, the capital market environment, I would probably agree with you that it is very difficult or potentially impossible to refinance ourselves. But in 2 years' time, I think both of us don't know how capital markets will behave. And obviously, we, as a business, need do something to stabilize our earnings to decrease loan-to-value. And this is, I think, what we do and what we have just said that we increased our liquidity position and so on. And so we are certainly getting prepared to refinance ourselves ideally in a dual track environment starting in about 12 months' time. And then we will see what capital sources require the best opportunities for the mirror that might still be capital markets refinancing with lower LTV and potentially a fresh view on the rating. If not, I think there is the mortgage market available, and we will certainly increase our discussions with bank partners. But as you know, we have already a substantial portion of our debt book with banks, about EUR 300 million in total. And that is certainly something that we are looking at to expand to give the company a good future given the most likely increasing financing costs.

Okay. And then just to the final part of the question then. If you can't give any information about the sales process, is it fair to say that the delay in the sales process is having some impact on your financing decision? Or is that not a fair comment?

Yes. Obviously, and that is maybe the cause of your question is that there is a change of control clause in the bond documentation, so obviously beneficial for bondholders if there is a change of control event, given where our bond trades and what the COC clause means. But in effect, it has no direct effect on what we are planning for the refinancing of the company because we always, as part of the sales process, prepared ourselves for, let's say, going concern environment. And it is obviously in focus of the management to work for the company and make sure that we enable the company to refinance itself successfully.

[Operator Instructions] We will now take our next question from Jeff [ Sena ] from Miguel.

We have been shareholders in DEMIRE for a number of years now, long-term shareholders, and my question is just regarding the sales process. I understand there's so much you can say you can elaborate on the sales process. I certainly understand and appreciate that. But at the same time, I mean, I understand, I mean this process has been going on, I don't know, take almost 8 or 9 months now. So I was just wondering, and I understand the uncertainty in the market is not helping the sales process. I fully appreciate that. But at the same time, I was just wondering at what point will you draw the line and just say, this is happening? Or this is not happening? I mean this -- or is it possible that this could go on, I don't know, for full year? Or is there some sort of indication in your estimates as to when you could just draw line in the sand.

Yes, thanks for your question. Obviously, we as a management team are not the sellers of the company, the potential sellers are our majority shareholders, Apollo and basically the vacant family. We cannot speak for them. I guess they have entered into the process because they were planning to sell their stakes in the business. As you said, the market environment is difficult. The financing market environment makes it even more difficult. But still, I guess, the interest is still there to sell their stakes and if there is an opportunity to do so. pretty sure that they will consider this option. But we cannot give you any dates or timing on a potential withdrawal from the process or a conclusion of the process.

Understood. I mean -- and again, I fully appreciate that just -- as I said, there's so much you can say about the process. But I mean initially, our understanding was before the market just became volatile. Our understanding was that the company was talking to or in some sort of engagement with maybe a handful or maybe multiple parties may be strategic and as well as financial potential parties. I'm just wondering, I mean, obviously, we don't need to know the full detail here, but I'm just wondering, are these parties still in the data room, or they put the project on hold? Or is it just -- or has it just become, I don't know, some exclusive talks with 1 party. I mean, if you could give us a little bit more detail because as I said, I mean -- I fully understand the process was initiated by the largest shareholder in the company. But at the same time, as I said, I'm a shareholders of this company for a while now. I think we also need to understand a little bit more, a little bit more and because we've been completely in the dark about this, a little bit more about the nature of the discussions, negotiations or anything basically that would be very useful.

Yes. Well, we said end of last year that we have mandated JPMorgan to help us conducting a sales process. JPMorgan is still working on it. We are still in discussion with potential buyers, but we are not able to provide any more information on the process.

We will now take our next question from Sanford [indiscernible] from Blue Baird.