Derwent London Plc (DLN) Earnings Call Transcript & Summary

Well, good morning, everyone, and welcome to the Derwent London H1 '26 Results Presentation. Today, you will hear from Damian, Emily and me, following which we will be happy to take any questions you may have. Firstly, some key takeaways. We are delivering against the operational and capital allocation targets we outlined in February, including the buyback. The London occupational market is strong with active demand remaining above supply, driving rental growth across our portfolio. Whilst the investment market is more subdued, impacted by the war in the Middle East, we have sold well in accordance with our targets, and we are pushing ahead with selective West End developments where forecast returns are strong, supported by the positive rental outlook. Now turning to the key business highlights. We have delivered a very strong operational performance, securing over GBP 30 million of leasing and asset management transactions since the start of the year, and there is more currently under offer. New leases have been signed more than 5% above ERV. Our asset management activities extended leases in higher rents. Our EPRA vacancy rate remains low at 4.4%, and we expect this to reduce further. We have continued to deliver value through development. Network completed during Q2 with the offices fully pre-let and delivering an ungeared IRR of around 11%. Rents well ahead of our underwrite more than offset the outward movement in market yields during construction. Our next phase of West End development is firmly underway with 4 major projects on site totaling 0.5 million square feet. Supported by rental growth and fixed price construction contracts, we forecast ungeared double-digit IRRs. Looking at the financials, earnings in H1 were ahead of guidance we gave in February, and we're upgrading our guidance for 2026. We also reiterate guidance for '27 and through to 2030. NTA was down through H1, principally due to the small outward movement in yields following the conflict in the Middle East and the provision at Old Street Quarter, which Damian will provide further details on. In February, we laid out our returns-focused capital allocation framework alongside a series of associated targets. I'm pleased to say that we are executing these strongly. This year, we have completed or contracted some GBP 280 million of disposals within 3% of book value and more is under offer or is in discussions. This compares well with our targets of GBP 400 million in 2026 and GBP 1 billion over 3 years. This provided financial capacity, and we launched a GBP 50 million share buyback, which is now over halfway through. Further buybacks will be kept under consideration alongside other reinvestment opportunities that may emerge, including potential acquisitions. On development and building on our success at 25 Baker Street, we committed to 50 Baker Street in Q2, a project we're really excited about given the strength of the occupational market in Maryburn and which we forecast will deliver the highest development return for several years with an ungeared IRR in excess of 12%. I'm confident we have been conservative in our underwriting. Underlying this, our balance sheet is well placed. Leverage remains comfortable and our average interest rate reduced in H1 compared to the second half last year following refinancing activity. I will now hand over to Damian, who will take you through the financial results and the valuation in more detail.

Thank you, Paul, and good morning, everyone. Firstly, some key takeaways from me. As Paul has said, we've made good progress against the strategic targets set out in February. Disposals have enabled us to commence a GBP 50 million share buyback program in May, while also bringing down our LTV and net debt-to-EBITDA ratios over the last 6 months. First half EPRA earnings were slightly ahead of guidance, and we are upgrading our 2026 full year earnings forecast. We've increased the interim dividend again as in every year since the merger in 2007, and it remains well covered by EPRA earnings. In relation to EPRA NTA, 2 points to make. First of all, the valuation saw 6 basis points of outward yield shift in the period, and we've also booked an early provision against the Old Street Quarter site, which we expect to acquire in late 2027. Finally, the balance sheet remains strong. Our credit rating was reaffirmed in May, and we have arranged new or extended bank facilities since June. The financial highlights are shown here, and we'll take a look at each of these over the next few minutes. EPRA NTA at the 30th of June was 31.57 per share. The main reasons for the 2.1% reduction were an overall revaluation deficit after accounting adjustments of 18p per share and the provision booked against Old Street quarter equivalent to 41p. The total accounting return for the period is set out here. The first 3 bars show EPRA earnings, capital growth on the main portfolio, excluding yield movements and development returns seen in the half year. This takes us to a 3.7% total accounting return, indicating how the underlying business performed with neutral yields. On the right-hand side, we show the positive impact of the buyback in H1, our estimate of the outward yield impact and the Old Street quarter provision. This takes us to the reported minus 0.4%. Now looking at the property valuation drivers. Underlying ERV growth was 2.6%, the highest first half increase in a decade with the West End outperforming the East. This was offset by overall outward yield shift of 6 basis points. But if you adjust for the large letting at Network and the sale of Horseferry House, the movement was effectively 15 basis points. As already mentioned, the developments did well, up 10.3% over the period. Network reached practical completion in May and its valuation was up strongly, rent achieved being 5% above December ERV. The value has also tightened the investment yield, and we've been able to release some contingency. Other projects on sites were up just over 5%. The balance of the portfolio was down 1.3% on average with the West End and the higher-quality buildings outperforming. Some of our older properties, which were approaching refurbishment or are earmarked for disposal saw greater declines as leases shortened. In addition, investment yields have moved out a bit to some of the larger lot sizes. The yield adjustment we mentioned also impacted our total property return for the first half. Now on to Old Street. We expect to complete the acquisition of the Old Street site in Q4 2027. The GBP 239 million price was set over 4 years ago in May 2022. And at completion, the site will be valued on a residual value basis and subsequently held at fair value. To date, our balance sheet includes a GBP 3 million deposit paid plus GBP 11.9 million of planning, design and other fees after impairment, all held within prepayments. We regularly consider the expected costs and benefits of the acquisition and the subsequent scheme. At the 30th of June '26, after updating all the inputs and considering additional strategic delivery options for the site, we booked a provision of GBP 45.8 million. We will update this 6 monthly up to the time of acquisition, at which point it will be offset against any valuation adjustment. By December '25, it was determined that no provision was required. Now turning to the income statement. As expected, gross rental income was down slightly compared to H1 '25. The positive impact in the period from Network, 25 Baker Street and other lettings was GBP 12.5 million and Networks annualized rental income of GBP 10.7 million after incentives will come through more clearly in the second half. However, we have a larger-than-usual number of projects on site and saw some additional vacancy earlier in the year, including 1 Page Street, which is being marketed for sale. These combined to bring rental income down by GBP 13.6 million compared to H1 '25. On a like-for-like basis compared to this time last year, gross rent was up 1% and net rent 2.7%. More details in Appendix 3. EPRA earnings for the first half were GBP 54.6 million or 48.7p per share. Actions taken to reduce costs saw property expenditure and admin expenses GBP 1.5 million lower, and we expect admin costs to fall further in the second half. Net finance costs increased due partly to a GBP 2.3 million reduction in capitalized interest. H1 '25 also benefited from convertible bonds with an IFRS rate of 2.3%. These were redeemed in June 2025 and replaced by conventional bonds at 5.25%. Looking ahead, we now expect EPRA earnings per share for 2026 to be between flat and 3% lower than in 2025. That's a 2% to 3% upgrade from the beginning of the year guidance. Our outlook for earnings up to 2030 has also strengthened slightly, but we've maintained guidance. The next slide shows where we're allocating capital, including the share buyback. We spent GBP 60 million on projects in H1 and CapEx is expected to accelerate into the second half as the projects get fully into their stride. Development returns are looking interesting, and Emily will explain our expectations here later. The share buyback continues. And after GBP 18.1 million of purchases up to the 30th of June, we have now completed about GBP 34 million in total. The current program of GBP 50 million should be finished in a few weeks' time with a larger positive impact on NTA and earnings in H2 than in H1. Further buybacks will be considered in the future from surplus capital driven by disposals. The buildup of our portfolio ERV is shown here. This is on a net effective basis. Total rental reversion has increased to GBP 83.3 million from GBP 70.9 million at year-end, but the CapEx required has also increased with the commitment at 50 Baker Street. Moving on to refinancing highlights. In the first half, GBP 230 million of maturing fixed rate debt was repaid, including the GBP 175 million LMS secured bonds at 6.5%. These have been refinanced with cheaper floating rate bank debt. As a result, the weighted average interest rate that we paid in H1 '26 was 3.9%. That's lower than in H2 '25, but above the first half in '25. Allowing for one further base rate increase this year, we expect our average interest rate to be 3.8% in H2. Since the end of June, we've increased total debt facilities by signing a new GBP 100 million 5-year unsecured revolving credit facility with Handelsbanken and have extended our main GBP 450 million group RCF to July 2030. Finally for me, our debt summary. Cash and undrawn facilities at the 30th of June were GBP 481 million, but with the new facility in place on a pro forma basis, that's now up to GBP 581 million. Note also that the sale of 90 Whitfield Street is due to complete in a few weeks' time and will reduce borrowings by a net GBP 107 million. All of our debt is now unsecured and 71% was at fixed rates at the 30th of June. With a strongly inverted interest rate curve, we expect to run higher levels of floating rate debt than usual for the time being. Thank you very much. And now over to Emily.

Thank you, Damon. The fundamentals of the occupier market remains strong. In H1, availability and vacancy reduced with Central London vacancy now below 7% and lower at 5% in the West End. Against this, demand has risen further, now sitting at just under 12 million square feet, supporting strong rental growth, which is now forecast across all London submarkets. Looking a little more closely at demand, it is now at its highest -- second highest level on record with named requirements spanning a broad range of high-quality occupiers across multiple sectors. Professional services and financial occupiers dominate, while tech and AI have become increasingly important, which I will come on to in due course. Turning to supply. Against the backdrop of reducing availability and a constrained development pipeline in the coming years, there is good reason to be confident of rental growth. Current availability is well below the 10-year average for the first time since Q2 2020 and 33% of the 12 million -- 13.2 million square feet under construction is already pre-let or under offer. West End Grade A vacancy is as low as 1.2%. And as ever, we have good visibility on likely completions between now and the end of the decade, supporting our own pipeline, which we'll come on to later. AI has been a standout theme in the market this year. H1 AI take-up reached 700,000 square foot, nearly double 2025's full year total with a further 600,000 square foot of active demand in this sector still to be satisfied. London is a beneficiary of this direct demand. When AI companies choose Europe, they choose London. There is no meaningful challenger on the continent, unrivaled talent, deep venture capital and a mature innovation ecosystem. And we see this as a trend that will continue with CBRE currently projecting significant further growth in the sector over the coming years. Turning now to the investment market on Slide 24, where the picture is much more subdued and volumes are tracking below long-term averages. Q2 sentiment cooled after a strong start to the year, understandable given the global backdrop, but demand for London offices hasn't gone away. Capital is still there, and it's global in nature. GBP 25 billion of equity is targeting London from various geographies. In terms of our own activity across the portfolio, we have been active on sales. We're delivering on the strategy set out in February, GBP 280 million of sales transacted on average 3% below book with a further circa GBP 100 million to come this year. On acquisitions, we remain disciplined, but ready to act on opportunities that can offer strong returns, maybe value-add or core plus and such opportunities will always be considered within that same framework and against other options, including share buybacks where capital may be deployed. Operationally, looking first at our leasing activity, it's been a strong year. GBP 22 million of new income has transacted year-to-date, 5.1% ahead of ERVs, including the pre-let of network to Databricks. In addition, we have a further GBP 5.3 million under offer at half year, setting us up for what's likely to be one of our highest years for new income on record. And in terms of activity with our existing occupiers, we have continued to proactively manage our lease expiry and break profile, and this was reflected in a high level of renewals. Our EPRA vacancy remains low at 4.4% or 3.5% if you exclude 88 to 94 Tottenham Court Road, which is now under offer for sale. Finally, a reminder of how we strategically position our portfolio. We put proactively shape it to meet London's varied demand because we understand what occupiers want, not just from the space itself, but service and amenity around us as well. London is a global HQ city, and that remains our core business, strong and durable WAULT through long-term lettings to large established businesses. And we do Flex too to mirror the market proportionality. Flexible space today sits at around 8.5% of our office portfolio, rising to just over 12% if we include third-party operators such as [ Fora ]. And underpinning all of it, HQ and Flex alike is our DL member offer, which the market now understands and clearly values. In respect to Flex more specifically, we expect this to continue to grow to around 15%. As ever, how we deliver Flex as with everything else, is returns and margins focused. For flex and managed space, that means factoring in operational costs as well as the CapEx. Now moving on to our development pipeline. Just to set the scene on development more broadly. The backdrop has been challenging. outward yield movements combined with a period where construction cost inflation has outweighed rental growth has made some developments harder to justify. Despite that challenging backdrop and not insignificant outward yield shift, we've delivered strong returns on our recent schemes, 25 Baker Street and Network, where rental growth has now been proven. And now the landscape is improving, not necessarily across the board, but for the right developments in the right locations. Our approach remains disciplined and returns focused, always aligned to our wider capital allocation strategy, where developments can make a genuinely positive contribution to total accounting returns through both development returns and earnings in the medium to long term. Add to that the draft London Plan published earlier this quarter, which paints an improved picture for development in London, alongside progress local authorities who are actively engaged with our sector. The complexities of developments remain, but the case for the right development is building for those that know their marketplace. We have a strong pipeline, carefully selected. Our major projects comprise 2 redevelopments and 2 refurbishments, offering attractive returns at a combined IRR of 12%, a profit of cost on 18% and a reverse development yield of around 7%. And I'll briefly talk on each. Following on from our success at 25 Baker Street, we are now on site at 50 Baker Street, delivering unique large office floor plates with strong architectural language and a very special and unique rooftop in a submarket where supply is very thin. We're very confident of strong rental growth here. In terms of the sustainability story as well as the usual top credentials, we are pioneering a U.K. first by transforming concrete from the existing building into structural concrete for the new and are aiming for over 20% of the new building material to be from recycled sources. Holden House is a 133,000 square foot redevelopment behind the retained facade at the southern end of Fitzrovia, bordering Soho and directly opposite the Dean Street entrance to the Elizabeth line at Tottenham Court Road. The scheme includes a beautiful atrium, which supports an innovative servicing strategy, delivering fantastic workspace and again, exemplary green credentials. Greencoat & Gordon gives new life to these character Victorian warehouse buildings in a submarket traditionally dominated by glass and steel. We can offer something genuinely different here, and we expect to deliver a mix of flex and traditional cat space. Finally, Middlesex House, 50,000 square foot within a refurbished 1930s building, complete with a fantastic new terrace and amenity offer, where we'll be looking to provide a self-contained building of flexible workspace. In summary, there's a lot to be excited about across these current schemes. We understand that development doesn't work everywhere, but these projects have been selected specifically because they will make a positive contribution to our overall returns, consistent with our wider capital allocation framework. Looking beyond these schemes alongside any disciplined acquisitions over time and other refurbishments in the portfolio, we have further opportunity to maximize value on a number of sites and potential schemes. We're getting VP of 20 Farringdon next year. This building sits above the Crossrail station at Farringdon, and we are looking to give it a new life, refurbishing the existing building with focus on ground floor and rooftop. Old Street Quarter, you have heard from others on this today, but we have optionality on delivery here, and there will be more to follow on this as we progress through planning. Finally, 230 Black Fries Road, there is scope to get a good planning permission in respect of Bulk and mass with optionality again around delivery. I shall now hand over to Paul to wrap up.

Thank you very much, Emily. As you've heard, we are performing strongly, delivering against the targets we laid out with our capital allocation framework. Operational momentum is continuing. We are capturing the growing reversion and driving income through our leasing asset management activity. We are active in the investment market, executing a decisive plan to further optimize our already high-quality portfolio. And we're making good progress on 4 West End projects, which all deliver attractive returns and which are well located to benefit from the strong rental growth we are seeing. Now before allowing for one-off items, the portfolio is on track to generate returns of 7% to 10% per annum over the medium term. The strength of the occupational market gives us confidence to reiterate our ERV guidance of plus 4% to plus 7% this year following a 2.6% growth in H1. we are upgrading our 2026 earnings guidance with H1 better than forecast. The building blocks are in place to deliver 25% to 30% growth in EPRA earnings by 2030. Earlier this year, I announced my retirement as Chief Executive. And today marks my last set of results after nearly 40 years at Derwent before Jonathan Murphy takes over on the 1st of September. I want to take this opportunity to thank you all for your support and your engagement. I also want to thank the whole of the Derwent team and particularly Damian, Emily and Nigel for their friendship and wise counsel. I know I'm leaving the business in strong hands and look forward to seeing it continue to thrive. Thank you. We're now happy to take questions from the floor, followed by the webcast. Please, Jonny.

Jonny Coubrough from Deutsche Numis. Can I ask firstly, in terms of the strong rental backdrop, are you seeing any indication of a change in incentives in the face of that improvement?

I think incentives have remained fairly stubborn at around 24 months on 10 years. The large reason for that is the construction cost inflation that we've seen over the cycle, which obviously impacts the tenants as much as us. So actually them holding firm, I see as quite a positive rather than having gone out further in that regard.

Second question would be in terms of Old Street Water. If the modeling assumed 100% chance of disposal, how would that impact the provision?

Well, it's very sensitive. As you sell the scheme without going through the development, you obviously give up development profit. So that would increase the provision. I'm not going to give you an actual number because there are so many other moving parts, but it would be substantially higher than the existing.

And then just the last one in terms of new developments. Do you think contractors are going in much larger contingency into their bids where they offer a fixed price now? And is it challenging to get a fixed price of them?

Let me answer that question firstly. I think being associated with D product is seen as very positive for contractors. We've got a very good relationship with Tier 1 contractors. We've just gone through the process of fixing the price for both Holden and for 50 Baker Street. I would like to be fixed price of contractors as we know well. They're obviously a little bit more cautious about the Middle East, but they know that we pay well, we pay well on time, and we're good to work with. So we are able to fix without paying a big premium. And we've got some contingency left within the scheme in case there are further issues. But we feel very positive. We've delivered through some very difficult circumstances, make great profits. And hopefully, our contractors will make some money as well. Any other question? We have Paul.

It's Paul May from Barclays. First one is a bit of a boring one for you, Damian. Can you explain your capitalized interest policy, the rate used? And has anything material changed? How are you going to approach the Old Street quarter? Will you capitalize against the cost or the lower residual value? And will you undertake activities or investment in order to keep capitalized interest artificially high? Or is the plan ultimately that it will reduce as CapEx or development reduces?

That's a very long question. So let me try and answer it. Our policy hasn't changed. And you'll notice that the capitalized interest has actually fallen from H1 '25 to H1 '26 by about GBP 2 million. It's a little higher than we expected when we did the forecast at the beginning of the year, mainly because network completed later. So we capitalized interest for a couple of months longer. We got a little bit less income from network as a result. The net impact was quite small. The policy essentially is unchanged. I think coming back to Old Street Quarter, when we buy the site, that would be a site -- assume we hold it, that would be a site in which we would capitalize interest on the acquisition cost. So initially, the impact on earnings would be very small. But remember, we capitalize at an average rate, not at a marginal rate. So currently, we're capitalizing at about 4%, 4.5%. That's including all the costs on top of the interest cost. And given the marginal rates are a little bit higher, there'd be a small earnings impact, but relatively small. Does that answer most of your questions? I think there were...

That's got all of it, I think. You highlighted larger write-downs in weaker assets. How overvalued are some of your assets, would you say on that basis? And was this focused on specific assets that you're looking to dispose of, i.e., did assets earmarked for disposal see larger write-downs than the others?

You got that one?

Yes. I mean I think the bifurcation in the market still exists. So you're certainly seeing the higher development assets seeing better growth. I think in terms of the read across of the whole portfolio, the volumes have been low. Valuation systems are retrospective. To put a number on how far things are over undervalued, obviously, we can't do. But it is -- the important thing is that tail. And in terms of the assets we're selling, we have third-party valuations. They're valued by Frank, and we look at that with them.

I just make the point, as you get towards the end of a lease, the income drops off, values have to take that into account. So you move towards essentially a vacant possession value. It's quite natural to see things like that falling in value. That's really what we're talking about here when we've seen -- we've got shortening leases, some vacancy, that's got an impact on individual property valuation. That's been driving those falls of the tail.

Some of those are opportunities as well for future refurbishments or for others. And if you look at ourselves today through quite difficult in a macro environment, just 3% below book, I think, is a pretty positive story with a range of different properties. But with a portfolio -- any portfolio, you're always going to have some really good winners and occasional a few losers.

Yes, it's just more on the assets earmarked for disposal. We've seen with others that they write those down quite aggressively, then sell in line with book. So I just wondered if that was something that you were doing as well or looking to do whether the valuers were minded to do that to.

I wouldn't say we've done it like that, but a building like Page Street, for example. So this time last year, it was occupied by Burberry. Currently, it's empty. It's on the market. The value has fallen quite a bit, but that's mainly because it's now vacant. But there we go.

Makes sense. Cool. Last one, you highlighted the increased confidence in your FY '30 EPS targets, I assume, driven by stronger operational performance. Given your comments, is it fair to assume you're now towards the top end of the 25% to 30% range? And what would it take for you to increase that target?

Damian, you can also...

Yes. Well, you know I'm usually quite careful with these things. And 2030 is a way away. So our model has strengthened since we last reported. Well, I didn't think it was right to upgrade guidance 4 years in advance. So we're feeling more confident, but we're maintaining guidance. But if you can say -- I can say I'm a little bit more confident even than I was in February, if that helps.

Thank you Paul. Zach?

Zachary Gauge from UBS. A couple of questions. First one, just to wrap up on the EPRA earnings guidance upgrade for 2026. How much of that is driven by the higher capitalized interest versus organic things that we should be thinking about as a run rate into H2? Because obviously, you're originally guiding a 20% increase in H2. Presumably that's now flattened out largely because of the capitalized interest. But please let me know if there's other things to take into account as a run rate into H2? And the second one is on share buybacks. You did mention that sort of still part of the capital allocation framework going forward. But given the shares are now 2021 versus where they were when you first announced an intention, do you have a level where you think they actually don't make sense given in particular, the P&L you have to sell out for them to make sense is considerably lower than it was 3, 4 months ago?

Do you want to start with the...

Yes, I'll start. On the earnings, I think it's -- there are winners and losers. One of the things that's changed in the second half compared to where we were in February, we were expecting a rate cut later in the year. So our finance costs were a bit lower in H2, which is one of the reasons for the upgrade in February for H2 versus H1. That's gone the other way today. So I'm now expecting in accordance with the market, probably one rate increase. So that has an impact on H2. H1 was quite a bit stronger than we expected. The capitalized interest really is offset by the later rental network pretty closely. It's really other things around the portfolio and a bit of cost reduction that's driven that increase. So it's basically organic growth in the portfolio, but there has been a shift because of the interest rate change. That's the main difference. But the other point is we've got Pay Street on the market. It's vacant currently. The longer we hold it, the more that hits earnings in H2. So that's a little bit difficult to be sure. We've modeled it on the basis we sell at the end of the period. If we were to sell it a bit earlier, we could perhaps be a bit stronger -- but it depends on individual buildings like that. So I hope that helps.