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

Hello, and welcome to Deutsche Konsum REIT-AG Financial Year Results 2021-2022. My name is Sara, and I will be your coordinator for today's event. Please note this conference is being recorded. [Operator Instructions] I will now hand you over to your host, Mr. Rolf Elgeti, to begin today's conference. Thank you.

Hi, good morning, everyone. It's Rolf here from Deutsche Konsum. Welcome to our earnings call, and thank you for your interest. What we would do is, as per usual, we will run very briefly through 2 or 3 slides of the presentation literally, touching on the highlights, and then there'll be ample time for any questions and comments you may have. So I'll just start maybe on Page 4, where we summarize the highlights for the last fiscal year which ended in September 2022. In short, the numbers were in line. Our rental income was up 7% year-on-year, so going to just over EUR 74 million. That has led to an FFO of just over EUR 41 million, in line with our forecast range. As we have not changed the number of shares, of course, the FFO per share at EUR 1.17 has also been exactly sort of in line. Why has the FFO not risen faster than the rental income? Well, the main reason is that we, of course, have sold some properties and we also have spent a little bit more on maintenance for 1 or 2 as we are repositioning some, and I'll talk about this more. And second, in particular this is true for Stralsund and Ueckermünde and in particular, in the last quarter, and therefore the aFFO, i.e., the FFO post-CapEx, was down very slightly. But of course, at EUR 0.64, the share is still very strong. It's worth noting that most of our leases are CPI-linked, as you know, and that has led to rent increases by 3.5% alone over the last year, which, of course, is the highest rental growth we've ever had. So that's the operations. Strong, solid, but basically in line. Then second point we'll talk about is the portfolio revaluation here. That's changed the prior years. We've actually had to value or value the properties twice in the last year. As you know, we normally value our asset once a year for the fiscal Q3, i.e., calendar Q2, so by the end of June, and then use this valuation for the end of September final accounts to kind of de-stress the entire process. This year, we've had the asset revaluation by -- as of end of June that we published in the last quarter. However, due to the change in interest rates and discount rates being affected, for the fair value models and all that, together with our auditors, we decided to revalue the properties again, so just a quarter later. And obviously, we've devalued them slightly relative to the June number. But year-on-year, they're still up some 4.9%, which is not too far away from the rental increase. So I guess that somehow makes sense. And that leads us to a current portfolio valuation of about 14.1 or 14.2x the annual rent depending on how you round or, give or take, about 7.0% yield on the book value. So that's where we stand on the valuations. Third point, again, no change in the last quarter but just worth highlighting here for the annual numbers that we have acquired and we have sold. It's important that -- sort of which is -- we always refer to this as a bit of icing on the cake of our business model, that we can occasionally sell at tighter yields than we acquire. So we sold in the financial year 8 properties for a total yield of 5.2%. In fact, some of these were vacant. So the yield was actually tighter than the 5.2% as a result. And we acquired at 8.2%, give or take, well, the same amount. So we acquired for just under EUR 100 million, sold for about EUR 100 million. So that's not huge. But of course, it still moves the needle in terms of redeploying capital at a higher yield than where we can sell. And of course, it won't surprise you to hear that given the current market environment, our acquisition pipeline is strong at even more attractive yields. At the same time, that may surprise you to hear, at the same time, the sales pipeline is also intact and we are negotiating exits at still about the same yields, sort of 5 points a little bit basically, that we see here. So that is unchanged and is a very attractive environment for us because we can make accretive transactions both in terms of acquiring and disposing assets, which is not very standard, I guess. Then let's move on to the balance sheet. Our balance sheet remains very solid, you could say boring. Our LTV is at 49.7%. Our target LTV is 50% so we are more or less there. And we are at this level of LTV even after the dividend payment of EUR 0.40 a share earlier this year and even after the minor devaluation in the last quarter. So still more or less exactly where we want to be in terms of the LTV ratio. Our interest cover is over 5x EBITDA, so that's very solid, too. And we show you here that we have refinanced some loans earlier this year at interest rates of way below 2%, fortunately. And that brings us to a weighted average debt cost of 1.98% still. But of course, this will go up gradually going forward. Moving to the dividend. We announced on the dividend a few days ago, we -- I mean, it feels a bit awkward to apologize, that we increased the dividend by only 20% in this environment. But we increased -- or the dividend proposal, I guess, it is for now, we suggest we increase the dividend by less than we previously guided purely out of considerations for the current market environment and everything that's going on there. And of course, the way to get there is to reduce the profit on the German GAAP. You know as a REIT, we have to distribute at least 90% of the German GAAP profits. And we therefore have booked a few sort of precautionary items in our German GAAP accounts, devaluing some properties, making -- booking provisions and also booking a provision for a minor tax dispute we're having for the very early years of the foundation of Deutsche Konsum. And that has reduced the German GAAP profit to a degree that the dividend is therefore only growing by 20%. So those are the highlights. I'd like to just point you to a very few other slides. Let's maybe start with Page 12. In flicking through, you would see the various acquisitions that we've done. It's basically more of the same so not really worth mentioning. But I'd like to point you to this table here a couple of numbers. First, and most importantly, the lowest line where we show you the WALT, the weighted average lease term. This is still -- and I say this at every earnings call, but I'll say it again because I think it's more relevant now than in normal times. The weighted average lease term is still more or less stable, always oscillating just over the 5-year mark. And that's just to underscore that still we are able to extend the leases at more or less the same terms, I mean higher rents, of course, but at still about the same lease durations. Don't forget, this is post -- so this is not like-for-like. This is post us having sold kind of more mature assets where we have reduced vacancies and extended leases and post us having acquired assets with higher vacancies and shorter lease terms. So this is still completely intact. You see that our valuation, we're getting on the books now, is just under EUR 1,000 per square meter. You also know that just building our kind of product cost at least EUR 2,000, plus the cost of land. So it's fair to say that our book value is less than half of replacement cost, whatever that means. But I think it's an interesting data point. And also, our rent in place is currently at EUR 6.65. I mentioned this, I think, for 2 reasons. I think, first, it's worth reminding ourselves that this number is so low that it doesn't justify new construction. I mean, in particular, not in this interest rate environment anymore and, in particular, with the current cost of production, well, for any sort of building stock. And as a result, I think at this rent level, we can conclude that there is simply no supply function. So either rents will have to go up or there will be supply. And I think that, that's sort of a very comforting position to be in terms of just the microeconomic supply and demand balance or should I say imbalance in this case. So that's reassuring. And the second reason I just bore you with this number is that we often get asked the question, well, leases are index-linked, but are tenants actually able to pay this? Are they happy with this? Of course, they're not happy with this. But it's very clear that at EUR 6.65, that may then become EUR 6.80 or EUR 6.90. I mean, no one is really going to complain plausibly because these rent levels are simply affordable and very low in comparison with the European peer group. That's unchanged to prior quarters but I wanted to highlight this given what's going on. And again, many things haven't changed, but I want to highlight Page 15 briefly. It's a bit rather simple chart but important in message, which is that 84% of our rents are CPI-linked. And also just to remind you that contrary to some other European countries, there's no cap on these CPI links, like in the U.K., for instance. And also, if you've been a regular follower of our calls, then you will have seen that the number, 84%, has also grown over the last quarter. So the percentage of our CPI-linked leases has grown over the last quarters, which I think shows you something. I mean, most importantly, it shows you not only that we're looking at this, but also it shows you that the market simply accepts us because there is really no plausible counterargument against that. And I think that's probably where I'd like to stop. Obviously, if you have detailed questions on the P&L and balance sheet, we're happy to answer them. My 2 colleagues are with me. So I'll stop here. And please, please let us know if you have any questions that we can answer.

[Operator Instructions] The first question comes from the line of Kai Klose from Berenberg.

Maybe I can ask 3, 4 questions. The first one, could you remind us of the total vacancy rate, how much it contributes to the move out of Real in this year or the previous year? And what are your plans there? And if and by how much you would like to expect to reduce that in the current fiscal year? Second question, could you give us an indication on maintenance and particularly CapEx investments for the current fiscal year? And the last question would be on Page 19, regarding the debt expiry profile. Just to clarify, 2022 means the current fiscal year 2022? Or is it the calendar year, what you have to renew -- that was up for renewal, this EUR 58.4 million?

Yes. Thank you, Kai. I'll start with a few. So the debt on Page 29, that's the calendar year, so i.e., the next 10 days. And the reason it's stated there is that we've literally have to sign the documents that are on our desk, of which we signed 2 loans, 1 we signed yesterday and the other we have on our desk now as we speak. So this is being extended, these 2 loans. In terms of maintenance and CapEx, I think there's no reason to assume that maintenance will change materially for the next year. Maybe, of course, there's some cost inflation clearly. But that cost inflation is going down compared to earlier this calendar year. For the CapEx, we expect a reduction in CapEx because the big repositioning projects are more or less done so this is very likely to be significantly less in the coming year. And as for the Real vacancy, we are in the process of selling this asset, is the short answer. And my colleagues laughed, I don't know why. But in terms of the -- another super colleague basically tells me that the Real vacancy is 1.1 percentage points, I guess, that is of our vacancy.

Okay. And maybe 2 very last ones. You mentioned that according to German GAAP, you did some precautionary adjustments. Could you quantify or specify the total amount, including the impairments or the provisions for the taxes? The last one from my side would be, there was a request from the BaFin, if I remember correctly. Could you maybe give us an update, what's the status there?

Yes. So we have had basically 3 key items in the German GAAP where we reduced the profits. The biggest one was over EUR 10 million, is we have written down properties. Now that sounds very strange because we actually have massive hidden reserves in the German GAAP accounts. But as you may know, these, you cannot sort of counterbalance at the various valuations. So out of the almost 200 properties that we've got, we have valued down, I think, 5 or 3. So basically, the way this works is you have the German GAAP sort of book value and then we do the market valuation or what is called market valuation or fair value for the IFRS accounts. And then, of course, for the entire balance sheet, you simply see the total sum when it goes up, and it has gone up and will likely to keep going up. But in the accounts, we also have a sort of fair value check for every single property. And sort of as and when sort of leases sort of shorten, the fair value sometimes go down year-on-year. And in particular, for those properties where we sort of are in a big sort of repositioning exercise, like where someone moved out, the vacancy has gone up as a result, now there's CapEx and later on, it will be relet. Like the spot mark-to-market valuation will or can, in those circumstances, go down so that we have occasionally -- we also had this in the prior years, by the way, that we occasionally have to write down the German GAAP book value because very rarely, but of course, for 200 properties it happens occasionally, very rarely the IFRS have used lower than the historic sort of cost-accounted German GAAP book value, in particular for those repositioned assets. And then we simply write them down to the lower value, thereby sort of in total, of course, increasing the hidden reserves. But on an individual basis, this would use up the German GAAP profits because you have those write-downs. And of the hundreds of millions of sort of higher values that go the other way, they -- of course, they are not booked on a German GAAP. So that's just a just over EUR 10 million. And then we have a tax dispute, where basically the tax authorities claim that we were not a REIT initially, and therefore, we should pay a corporation tax. We think that's, of course, totally wrong and ridiculous. But under German GAAP, we provisioned for this with, I think, EUR 3.7 million, which is the potential tax damage for those years. And under IFRS, if you read the accounts capital, you will see that because we think it's so unlikely that this will happen, we have a sort of a claim sort of on the asset side of the balance sheet to counterbalance. But again, on a German GAAP, it's just it's more sort of quarter bookings. So we booked the provision only and no counterbalancing claims for that. So that's EUR 3.7 million. And then we have booked higher receivables -- sorry, higher depreciations on receivables, that includes the loans. And that also brings me to your BaFin question. Sort of we still don't know what BaFin actually wants. We have provided them with the information they've asked for. We are waiting to hear back from them. But we have -- in any case, we have decided to sort of book those loans more -- sort of more cautiously, and therefore, have taken these kind of noncash devaluations for those loans, again, also to reduce the German GAAP profits. And those are the 3 key items. And re BaFin, that's one news we're expecting to hear from them some time.

Okay, okay. And very last one, when you had -- after you've done these adjustments according to German GAAP, will that materially impact your future dividend payment or ability to pay out of the hidden reserves after you've taken these adjustments materially?

That's a very good question. The answer is it does not because if in future years and realistically next year when the sort of revitalizations have been affected, and if that's then reflected in the new market value, you can then, even on a German GAAP, sort of revalue the property back to the historic cost value. So we'll effectively be able to catch up with that. And therefore, this will increase the dividend capacity for the next year. In fact, that's true for all of these items that I mentioned because -- yes, I mean, it's self-explanatory.

The next question comes from the line of Manuel Martin from ODDO BHF.

Four questions, if I may. The first one, unfortunately, I tried to use a crystal ball, maybe you can help me. But when it comes to valuation, I mean, in the fourth quarter, there was a correction of valuations in your portfolio as far as I can see. Do you have any feeling or indications from appraisers what could happen next year in terms of valuations? Many competitors are very cautious on valuations, indicating for valuation losses. Is there anything what you could indicate to us?

Yes. I think that's a good question, actually. There's 2 things we can say. I think the first is that I think the discount rate damage to the operations in the third quarter was, of course, quite severe. And that has been -- has partly gone the other way in Q4. So just purely in terms of cost of capital and discount rate, you should actually expect a minor sort of improvement to valuations sort of quarter-on-quarter, I mean, if it was that strict. But of course, it isn't because everyone, the valuers included, sort of tried to smooth this process a little bit. But very technically speaking, the discount rate has sort of improved a little bit. And what it would do in the next couple of quarters is anybody's guess, and we also don't have the crystal ball. But if rates stay where they are, then you should actually see from the end of September level, a minor improvement from that. And -- but much more importantly for us, contrary to many other peers and other market niches, we, of course, have the indexation of the rents. So the rents will very likely keep growing strongly. In fact, it's very likely they will grow even faster than in the last quarter. I mean, it's purely how these indexations work. So we will have, whatever, a percentage of rental growth. And if there's no change to yields and discount rates, then obviously, then it's very clear that everything else being equal that the valuations should sort of grow in line with that, so in line with rental growth. And that's before we talk sort of our asset management alpha that we hope to achieve. And that alone should give us sort of revaluations of 5% to 6%, everything else being equal, and who knows when it will be equal. But I think that would give us a rough indication in terms of the methodology. If we look at the market, then obviously -- I'm just looking at my colleagues, but I can't think of any property we would sell at 14x rent. No, yes, they're shaking their heads, too. So I mean -- so clearly, I mean -- but we said this in prior calls, that is a very low valuation. And all our historic sales, and there have been now quite a few that you can't really say there were flukes, they have happened at significantly higher valuations. And as I mentioned earlier, we are still in talks to potential buyers of our assets at significantly higher valuations than the book values.

Okay. That brings me to my second question, the transactions. Apparently, you are very confident to conduct transactions either on the acquisition and on the disposal side. What is the reason for being so confident? Because transaction market for a lot of people has dried up. But don't you experience any problems or delays or buyers shying away or sellers not wanting, whatever?

Yes. Look, I mean, what can I say? I mean, we've experienced problems and difficulties and delays and people being painful for the last 3 years. And so that -- this is nothing new. I think in terms of -- let's start with the acquisitions first. In terms of the acquisitions, what helps us, of course, is that we don't need bank debt before we acquire because we always buy out of cash and then refinance later, and that gives us a significant sort of timing advantage and speed advantage. So that's very clear. And that's now even more relevant than before. And I wouldn't say that there's distress out there, but that's maybe a little bit sort of semi stress in 1 or 2 sort of subsegments, I think, in particular, for slightly bigger assets. And -- which is actually great because we would like to own a few more bigger assets, everything else being equal. And so our positioning vis-a-vis sort of potential sellers has improved as a result. And then also, let's not forget, I mean, we are a tiny player. We are a really small player in a huge market, and therefore, we don't need to buy big portfolios and we don't need lots of transactions. We just need to be successful a few times. And we have a very strong team that can actually deliver that. And therefore, the acquisitions have always been strong. And if anything, I guess, it's probably clear that in this environment, the acquisition pipeline is stronger than before. If we're looking at the disposals, I think that was probably more surprising or less intuitive why there's a disposals pipeline. But there are still sort of many -- there's property developers, there's, in some cases, the tenants themselves that are happy to acquire these locations at very tight yields. There's still the odd funds out there that are looking for things. And we're effectively benefiting from the fact that the market is so heterogeneous and so fragmented and intransparent. And when you have 200 properties, there's always someone who likes a particular property for a particular reason. And therefore -- I'm not saying we're selling the entire portfolio tomorrow, but we constantly get approached. And often, people think they can make a bargain and then we clarify the situation. But it happens and it's -- this market isn't dead. I mean, we're not talking billion-dollar portfolios, we're talking individual assets. And that market is not dead at all. And so therefore, we're not promising anything, but we are reasonably confident on achieving both acquisitions and disposals at a very attractive yield gap.

Okay, okay. Very useful. And just the other 2 questions, which are rather short from my side. The first one is on your financing. Given the high interest rate environment that we see, your marginal cost might have gone up. Can you share with us where your marginal cost is right now?

Manuel, this is Christian. Yes, so we are also in talks with the banks, obviously. And at the moment, we get offered rates for short-term refinancings, the range between 3.25% to 4.5%. Our strategy is that we try to sign shorter durations for the moment, assuming that interest rates will come down a little bit in the future. So we don't want to lock in now 5-year durations at the moment, and yes.

Okay. Yes, makes sense. Okay. And final question is on the other side, so your interest income. Is your interest income going to increase as well with the high interest rate environment? And how do you see the default risk in your interest income part?

Yes, the interest income will come down because this is basically the short-term lendings that we have done. And as we communicated before, we are sort of in the wind-down mode of that and want to actually bring this down to 0 over the course of the current fiscal year. It will come down -- due to smaller volumes, that will come down, yes.

Okay. I see. And any news on potential defaults or problems in the lending portfolio?

Well, there's no actual ones. I mean, we have booked a few provisions but there's no actual defaults.

The next question comes from the line of [ Mark Eckhartd ] from [indiscernible].

A question. A few quarters ago, you did a survey regarding the strategy. It was, first question, to keep the strategy buying and selling or to grow the portfolio. It seems to me that you maintained the actual strategy, buying and selling.

Yes. In short, yes. I mean, I remember that discussion we had, and it's a very tricky one. But we have bought and sold. And ultimately, we are driven by the total return per share, and therefore, if we can sell at yields that are accretive, which given the low valuation of the shares, this is now actually quite easy. And if at the same time, we can buy accretively, which amazingly is also still possible, then both make sense. And therefore, we currently do both without a clear direction in terms of portfolio size. And until we have a better idea, we'll just do that. But we're very open to hear views from you on how you see that because you could -- of course, in this environment, they look -- the shares look so cheap that let's just sell and buy back shares or delist the companies. And I'm sure there's people around [ Berkeley Square ] that have their Excel spreadsheets open and do those maths. But -- which, of course, from a pure sort of corporate finance one-on-one logic would make a lot of sense. But we are here, we're managing the company and we're trying to optimize the total return per share. And for that, it's sort of employing capital at higher yields is always sensible, and that's what we're doing.

Okay. Is it also because maybe you're between a rock and a stone because LTV is at almost 50 and the stock price is much lower than the NTA or enough? So you cannot create new shares and then you are blocked?

That's true. I mean, fortunately, it doesn't matter yet because we have the disposals at those very tight yields that allow us to acquire. And size-wise, that has been just perfect to fit to our acquisition pipeline. And therefore, we didn't actually need to raise equity. But you're totally right. I mean, it's out of the question of raising equity at this level.

-- It seems to me you are quite happy with the figures and confident. But if you look to the stock price, and we know what also happened to the interest rates, but it seems to me that the market doesn't understand quite well how good you are working. What can you do against that? More communication, more putting the company into the picture?

Well, the short answer is, if only we knew. I mean, I would think that the transparency we give is actually quite good. If you go to our website, you can download the entire property portfolio, we show you all the numbers, we do this quarterly call, we go to investor conferences. We have a very good sell-side coverage for a company of our size. So it's good in terms of number, but also good in terms of quality, if I may say so, vis-a-vis the analysts on the call. So all that, I think, is green boxes that are ticked. I think we have the problem that we are bit small. We're borrowing -- we're a real estate in a time when interest rates go up, so we're unpopular there. But I think that's only one thing we can do, and this is sort of deliver on our strategy and on our operational performance as well as we can. And that's what we're trying to do. I mean, we -- I don't think we should sort of put the company in any shop windows or anything. We'll do our work, we'll try to deliver the numbers, we present them, and then the rest is up for Mr. Market to decide.

[Operator Instructions] It seems that we have no further questions. I will now hand you back to your host for closing remarks.

All right. Well, thank you. So thank you again for your time and interest in Deutsche Konsum. Thank you for your questions. If you have any more questions, please do let us know, very happy to help with anything off-line and after the call. And if we don't speak, very happy holidays to you and your families, and all the best for the new year. Thanks a lot.

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