Deutsche Konsum Real Estate AG (DKG) Earnings Call Transcript & Summary

Good day, and welcome to the Deutsche Konsum REIT-AG H1 Results 2021/2022 Conference Call. Today's conference is being recorded. And at this time, I would like to turn the conference over to Rolf Elgeti. Please go ahead, sir.

Yes. Thank you. Thank you, and good morning, everyone. Thank you for your time and interest in Deutsche Konsum for the half year figures of the year '21-'22. You have already seen the results as a presentation on our website. I will refer to a few slides here and there and there's also been a press release. So what I suggest is, as per usual, I just run through some of the key highlights in my opinion. And then there's plenty of time to ask any questions and provide comments. So I'll be starting on Page #4 of the presentation. just going through the key highlights of the numbers first. So let's start with the operational business. The operational business was strong as per usual. I mean that's one of the characteristics of our business is that's reasonably predictable, noncyclical, et cetera. So the rental income was up 10% year-on-year. It's noteworthy that the net rental income was up 13% year-on-year, which, of course, is a margin expansion, again, which is somewhat helpful. The FFO was also up 4%. I mean only 4%, one could say, but that's, of course, due to the higher financing costs as we've grown the portfolio. As you know, we have not increased the number of shares for now almost exactly 24 months in spite of the growth. The AFFO per share was stronger, has been growing stronger. It's mainly due because we finished many of the CapEx projects last year. That's something that we flagged in previous calls that the delta between FFO and AFFO will come down. And as of today, we haven't really any big significant redevelopment projects, so that, that should stay for the time being, like-for-like rental growth at 1.4%, again, positive, meaningful, but not huge, as again, you would expect. I will refer later on to the very important point that we increased the proportion of index-linked to inflation-linked contracts and that many of these contracts have hit or are about to hit the various thresholds so that one should really expect higher like-for-like revenue growth in the future. So that's for the operational business to start. Second point, our acquisitions. The key message here is, firstly, we keep acquiring. So we still find good things at good yields. The average yield acquisition has been 8.4%. We've acquired almost EUR 50 million worth of assets, and that's interesting because the assets we sold have had lower rents. So already the capital recycling that we started end of last year has actually led still to increase of the rent level because the assets we've acquired since then are producing more rent than what we've lost from the assets that we have sold. The acquisition pipeline is still strong. We are very close on approximately EUR 100 million of further acquisitions and hopefully can do more transactions there shortly. Thirdly, our sales pipeline looks good. I mean, we've had 2 major by our standard sort of disposals approximately at yields of 5.5%, which we've notarized one of those transactions has closed. The other one has not closed yet, so to also keep rents for that. And we are also opportunistically looking for more disposals, not too many, of course. We don't want to shrink the company, but we want to make really our disposal at the right value if and when those opportunities arrive. So if you look at it, we're buying at yields of north of 8%. So far, we bought at over 10% yield since we started the business, and we are selling at yields of 5.5% and less. So that's not our main business to do this yield arbitrage, but it's worth mentioning that this is working, this is happening and sort of these values have been justified in the market. Fourth point, our balance sheet remained strong. Interest coverage ratio of 5.5x EBITDA, LTV just over 50%, which is where we want to be. Average cost of debt is still below 2%. And it's likely to fall further. I will stress this that in spite of the macro backdrop as far as interest rates are concerned, been changing, our interest costs will very likely decrease from here because we will refinance those that has historically higher coupons. And therefore, we were likely to reduce our cost of debt further from here in spite of the different interest rate environment. We are confirming our guidance, and we're also confirming our dividend guidance for as well. So that sort of in telegram side is sort of what is we in terms of the numbers. If we move to Page #5, we've inserted a page into this presentation, which my colleagues have very kindly prepared, which really summarizes sort of the various value creation drivers for the business. And I find this very interesting and maybe helpful and illustrative because when we get asked, like, are you about rental growth, are you about sales cash flows, are you about recycling, are you about growing? And the answer is, well, we are about all of those, and that was maybe what's sort of deflecting the various value creation drivers. So firstly, what do we do, just to remind ourselves where we're acquiring at a high yield. These cash flows, they are stable. They're very stable, economically stable as in defense, just noncyclical. They are very strong micro locations, they're grocery anchored. They are inflation linked with more than 3 quarters. In fact, we are at [ 79% ] at comfort level and the second also index-linked. And of course, the capital discipline is key to us. So the first building block is an attractive and safe cash flow yield. The second is, of course, we do try to create asset management alpha. We extended the leases, we would use vacancies et cetera. And we occasionally invest CapEx where we can have strong returns from that. Thirdly, all this is sort of accompanied by a very strong balance sheet with all the governance sort of protection of the REIT regime that should lead to low cost of capital I mean it doesn't at the moment as far as equity concerned, but certainly for cost of debt, that's working, and we should therefore be a company that provides reasonably reliable, stable dividends. And of course, the fourth is just the icing on the cake, as I mentioned, is the capital recycling, which is not the reason we set up the business, but it's sort of a very helpful extra return driver. And of course, if we do this, then of course, the proceeds from the sales then feed into more acquisitions at good yields, which, of course, means that we can keep growing without issuing shares, which is, of course, super helpful. So that's just what I wanted to add down, do sort of a very quick page turn on some of the other pages here, forget Page 6 because just to summarize what I just said, on Page 7, you find more details on the last acquisitions. I don't want to go through them. The point is just to say it's good micro locations, everywhere in Germany, it's grocery-anchored and the yield is between 8% and 9%. So that's more of the same. You see the pictures on Page 8, again, more of the same. Here, we look at sort of some of the key metrics. And I just want to highlight that sort of the value of our properties in our books, that's the fourth line here, is still sort of way below EUR 1,000 per square meter, so EUR 960, that has gone down, not because we had devaluation, but that has gone down because we sold some more expensive things and bought more cheap things, which also in turn explains why the kind of the rent per square meter is a little bit less. As I said, like-for-like, it's 1.4% up. But of course, if the pro forma portfolio, we bought cheaper stuff. We also bought more vacancy. So the vacancy going up is not because we sort of lost space. It's because we bought things with higher vacancy. And you can see that the walls in place has been more or less constant as in prior years. And there always stress in these presentations, that's the key thing is that as long as the wall remains reasonably stable, then you know that our team works and our thesis, just to remind ourselves, is that we're getting too well compensated for taking lease extension risk, which, of course, is a brilliant idea only if we manage to extend the leases. But here, you can see the clear evidence that we do, and that's reassuring. Moving on to Page 12, if I may. Here you can see the usual sort of summary of who are our tenants that they're noncyclical grocery-anchored et cetera. You know all that. So I don't want to repeat that. But I just want to make the point that we -- actually, I don't on the next page, I apologize. So I want to make no point on Page 12, I want to make a point on Page 13, which the key point I want to make here is the share of the CPI linked rents, which has been going up significantly from the last quarter where it was at 74%. Now actually 83% of our leases are now CPI-linked. And as I said, this is, I mean, not just helpful, but of course, it's now extra helpful and extra relevant as we start to hit these key kind of CPI thresholds and therefore, do expect sort of good news on the rental growth front, maybe not in the next quarter but in the quarter after next, in particular, as we're hitting the numbers in the quarter now as we speak that will be visible in the quarter thereafter of course. So that's something I want to stress because that's new and that's extremely relevant and the key sort of characteristics of our asset class. Page 14, my favorite chart on the left just showing how often we have the same tenant again and again across the portfolio, that's not a change in principle, but it's always good to see and remind ourselves that this is what we are about is that we have the same tenant again and again across the portfolio and that this is one of the reasons next to our sort of hard work, of course, but this is one of the reasons why we can take these lease extension risks and why we're building a better relationship with the tenant and therefore, actually get a better risk reward on the assets. On Page 15, you can tell how embarrassingly cheap the stock is in terms of the implied yield it does and finally, on Page 17, you see our refinancing structure. Again, nothing has structurally changed here. We're still as diversified as we were before. But I did want to make the point that the debt that expires in this year in 2022, that this is actually a sort of higher-yielding debt than where we can refinance, so we will likely be able to reduce the cost of debt further. So this is where I wanted to stop. There's lots of numbers, lots of things we can answer. So this is where I'd say thank you for now, and please do call for any questions that you may have.

[Operator Instructions] We will now take our first question from Stephan Bonhage from Metzler Capital.

Yes, on the acquisition volume for this year, I mean, we are now in the second half of your fiscal year. And I would assume that you already have some kind of visibility regarding the acquisition pipeline for the remaining year. And in the previous fiscal years, you were able to acquire a triple-digit million amount of properties. Would you say that triple-digit million amount of properties would be also able for this year with regard to the acquisition volume. And my second question would be on the like-for-like rental growth in the coming quarters, the inflation rate in Germany is currently at roughly about 7%. So could we assume -- or can you give a rough indication regarding the like-for-like rental growth, CPI at 6%? Is this realistic?

Well, so on your first question, yes, we are optimistic to be in the triple digits again. We are currently working on approximately EUR 100 million of very concrete acquisitions. But of course, the issue is as per usual, it's only when you've been in front of the lottery and in fact, there's maybe not even then that you can be really sure that it will happen. So the likelihood is high already with the transactions that we know about now to get there. But of course, it's uncertain and binary every single time. So we certainly don't want to promise that, but we think it's extremely likely and we've so far in every year since inception has delivered that. And we do believe that this year will be no different. On your second question on the like-for-like, it's unfortunately much more complicated because the way it works, as I'm sure you know, is that first, we have to hit the various sort of 105% or 110% sort of levels of the CPI. And then you get the full 5% or 10% sort of increase on the rents. And as many of our leases have been sort of recently sort of extended, you need this 5% or 10% push before you have the next sort of hike. And therefore, it will almost certainly not be 5% or 6% sort of in the next quarter. But sort of if you take a view sort of 12 months forward, then it's actually much more likely because we just need to get over the next couple of quarters to all these thresholds to fall. But the truth is that we're not able to guide for this very precisely. I mean, in theory, and intellectually, we should be. So I apologize that we are not because, I mean, we have all the data. It is just sort of even complicated. There's lots of data and lots of work. And we haven't actually precisely calculated sort of when which sort of CPI level will trigger rent increases in which contract precisely. Of course, we do monitor this on a monthly basis and the rents are adjusted on the monthly basis. So it's reasonably in real time, but it's contract by contract with different thresholds. So that's why it will be a messy picture. I think for the next 4 quarters, I would guess, because these thresholds, they're sometimes 5%, they're sometimes 10%. But of course, with inflation at over 7%, it's only a question of time for every threshold has been kicked. And then we'll have a clearer view, but not precisely for the next quarter or 2, I'm afraid.

[Operator Instructions] We will now take the next question from Manuel Martin from ODDO.

Two questions from my side, please. One question is regarding the cash management that you have within your company. Can you give us an update on the loans that you are giving within your cash management come in terms of potential default risks? I mean, we are in an interest rate environment, which becomes a bit unfriendly, cost inflation, et cetera. Maybe you can tell us something about that, please?

Yes, the actual position hasn't changed significantly, and so far, we've had no defaults from that and we are no more expecting any either.

My second question would be on the overall environment. What could be the potential effect on your portfolio in your company when it comes to rising interest rates, supply chain disruptions and the cost inflation. I mean, of course, in terms of inflation-linked rental contracts, that's favorable. But are you going to see some side effects on your portfolio on your business or refinancing situation in general?

Yes. I guess that's 3 aspects to look at. First, sort of our business itself, I mean, no real impact. I mean, the rents are CPI-linked, our costs are low. So the effect of course there is minimal. We don't have any sort of supply disruptions really in grocery retail. And if there were, we're the landlord, not the operator. So I mean, we're quite well protected from that within reason, of course. So operationally, that's not an issue. Secondly, as far as interest rates are concerned and our cost of debt, I think we are in good shape now because we have a granular refinancing strategy where we reach out to the various sort of savings and loans and cooperative banks across Germany. And there the accessibility and also the pricing of senior secured debt still very, very strong. And because we still have some historic debt at higher interest rates, we are in a good position to refinance at the lower cost. So that all looks more challenging. And if anything, that's probably becoming a competitive advantage for us, but we are in a stronger position there than maybe some of the peers. And the third is like what will high inflation, higher interest rates do to property valuations and to stock market ratings. And I think that's up to anybody's guess. I mean, you can make the argument in various directions. I mean, clearly, as of now, the real estate sector has suffered in the listed space. I mean, in the non-listed space not at all. If anything, prices keep rising in the physical market, whilst the stock prices are sliding, which is why you see more and more sort of public to private transactions in, I guess, in real estate in general and the valuation gap clearly supports that, of course. But yes, those will be the 3 things I'd be looking at. And so I see the main impact on sort of investor sentiment valuation, but neither on the debt side and certainly not on the operational side.

Okay. Okay. That's clear. My last question might be actually related to your responses when it comes to property valuations. But could you give us a couple of thoughts on how you see the transaction market right now? Is our buyers a bit more reluctant, due diligence becoming longer or sellers not really willing to sell? Or what do you see there in the market?

The short answer is that there's been no change in recent months. I mean prices are generally still rising, buyers are very keen to get hands on good product, which is why we've been selling opportunistically but there's also a pipeline available for acquisitions for us. I think the asset plant is now more popular and more sought after and people understand the kind of the low risk nature and also the index link, I think, is better understood than 6 months ago. And so all that together means that the prices are rising slightly probably.

We will now take our next question from Andre Remke from Baader Bank.

Basically 2 questions for starting on the CPI-linked rents. How did you manage to increase the share? If I get it correct, it's up within 1 quarter from 75% to 83% for your total contracts. Was it a function of acquisition and disposals or via renewals? So I'm a bit surprised by such a huge step. I assume that existing tenants are not really willing to accept the change in the new contract towards CPI-linked rents.

Well, it's a little bit due to acquisitions and sales to a small degree, but to a larger degree, we did actually renegotiate that. of course, not for existing contracts, but whenever we extended leases, I mean, we have a sort of a 0 tolerance policy for no inflation link. So we will not extend the single contract without introducing inflation link and they're completely nonnegotiable. I think it's very reasonable to have a position like ours on this. And so when we -- it's a little bit like service charges like why is our margin expanding, like that's both has the same reason is that when we buy assets, we often buy it from nonprofessional landlords, and then it takes some -- for service charge it takes 2, sometimes 3 years to fix sort of inefficiencies. But of course, for important clauses like this one, like the index link, we'll just do it whenever we extend the leases. And therefore, we've been increasing the proportion here. And the third element to that is that we also for the very small contracts that we have, not just with the big grocery anchors, but also the smaller tenants, we've increased the proportion here. And most of these contracts are typically shorter-term contracts anyway. And therefore, sort of it's easier to get this done. I mean obviously, don't expect such a jump again, but that's just what has happened in the last quarter.

Excellent. And would you assume that or what could be roughly a ratio which you are targeting for probably not reaching 100% as you acquired also non-CPI-linked contracts, but is it 85% and stop there or 90%. So just to give a rough indication on that.

Look, I think it should be getting closer to 100%, but it will take 6 or 7 years to get there because for every single extension that comes up, we will push for the CPI link in the rents. But of course, some rents are 10 years long. And then, of course, we can only fix them when we come up for renewal. But so this ratio should increase further, but it will be much, much slower going forward.

Okay. Then the second question on financing costs. Could you provide any indication from current point of view, especially when it comes to the maturities this year. So I would guess for new financing, you would focus on bank financing again? Or is it also the type of financing promissory notes, et cetera? Or is this market completely closed at the moment?

No, the market isn't completely closed. And we've done a small transaction there recently. But we will, indeed, as you say, we will focus on classic bank financing. That share will increase going forward to the end.

And could you give a margin or overall financing costs for current contracts?

Yes, well, the current contracts are between sort of 1.3%, 1.8%, depending on the maturity when we refinanced sort of senior secured debt with banks. And the promissory notes would be between 2% and 2.5% probably.

And 1.3% to 1.8%, this is on 5 or 6 years term or...

Yes. This is sort of 1.3% more like 5 and the 1.8% more like 10 years.

Because I'm asking because the 10-year [indiscernible] is currently at 1.7%. So there's virtually no margin for the bank. So I'm a bit surprised that you're telling us...

I'm not saying that I will provide such a loan at that rate, but there are players in Germany who sort of look at -- have their deposits on their liabilities and strangely these [indiscernible], but I agree with you, they shouldn't be. Of course, we will take them where we can get them.

[Operator Instructions] We will take our next question from Mark [indiscernible] from [indiscernible]

At this moment, the LTV level is quite high. How comfortable are you with that? Will you stick to it? Or is there maybe a target to bring it down?

Yes. Our target is 50%. So there is a target to bring it from 53% to 50%. We are not concerned about this because, I mean, really, in theory, the cash flows of the portfolio will be able to carry much higher debt. But to be clear, we do want to reduce it from here. How is that going to happen? Well, mainly via the sales because we've had sales that we've notarized last year, most of them have not closed yet and therefore, on our balance sheet, we still have the properties and the debt. And once these transaction closes, the LTV will fall significantly. Proforma LTV is already lower basically.

Okay. And then a few months ago, you told me that German authorities were working quite slow because of COVID problems, et cetera. And are now working again on normal speed. And will that say that your investment and your sales will now be finalized quickly?

Well, I think it has become a little bit better, but not significantly. I mean the processes are still reasonably slow but not as slow anymore as they were. Like for instance, the sales that we notarized in September last year, they have still not closed, and we are May next year. However, what we notarized in November last year has closed in February this year. So it depends a little bit. And of course, the more parties that are involved in the transaction kind of the longer it takes, but it is getting a little bit better. But at the end of the day, it doesn't really, whether we close sales or acquisitions like a quarter later or not, I mean, on a smart basis it changes the balance sheet numbers a little bit, but in terms of underlying going concern, profitability of the business and cash flow generation, it doesn't really matter in my opinion.

And then a last question. The stock price like a lot of other stocks also was under pressure. Was this more under pressure in South Africa than in Germany or not?

No, I think the reality is that because the shares are interchangeable between South Africa and Europe, if there's a divergence in stock price, it will be very short-lived. But we certainly haven't seen any specific sales pressure out of South Africa, if that's your question.

As there are no further questions in the queue at this time, I would like to turn the call back for any additional or closing remarks.

Thank you. Well, all I have to say is thanks for your time and interest. If there's any more questions, do let us know, we're around and happy to help. And if not, we'll probably speak in 3 months' time. Thanks a lot for your time.

Thank you. That will conclude today's conference call. Thank you for your participation. Ladies and gentlemen, you may now disconnect.