Diös Fastigheter AB (publ) (DIOS) Earnings Call Transcript & Summary

Good morning, and welcome to this presentation of Dios' results for the first quarter of 2023. My name is Knut Rost. I'm the CEO of Dios. With me is our CFO, Rolf Larsson, and we will take you through the results of the first quarter, major events and highlights and end this presentation with an outlook. If you have any questions, there will be a Q&A session after the presentation. You can always reach out to us with your questions afterwards. Contact details are available on the last slide on our website. The highlights for Q1 2023 can be summarized in 4 parts. To start with, we present a very strong operational outcome. Rental income has increased by 17% compared to the same period last year. The occupancy rate was 92%, the highest in our company's history and the surplus ratio was 64%. With that said, I can state that we continue to deliver a very good operating result. Net letting amounted to SEK 3 million. On the financial side, our interest costs are increasing due to rising market interest rates. During the quarter, we have restructured the derivatives portfolio and extended our fixed interest rate to protect from even higher interest rates. On a positive note, we see that the capital market is more functional today compared to mid-February. On the back of higher financing rates in the market, we have adjusted the valuation yield in the portfolio on average by 11 basis points. This leads to unrealized value changes of minus SEK 564 million, which corresponds to 1.8% of the total property value. The eyes of the world continue to be directly towards our market and the green transition led by the Swedish sustainable industries in and around our cities. Our properties are in attractive locations in the right cities to receive new establishments and develop our rent levels. The inflation rate has been rising in 2022 up until now, but my belief is that inflation peak is behind us. We have received higher price levels in society, but also higher rental levels as a result of the index adjustments in our lease agreements. When the rate of inflation falls back, I believe we will see a higher activity in the transaction market and that new lettings will increase. Going into the results in more detail by looking at the income statement, we can confirm the total income is up by 14% and rental income is up 17%. The difference is explained by compensation from early termination in Q1 2022. Occupancy rate is at a record high 92%. Like-for-like growth is strong, 10.6%. However, bear in mind that we have not included CPI indexation from residential by end of Q1 due to the negotiation was not finalized at the end of March. The average indexation for residential in our portfolio will approximately be 4% adding SEK 2 million per quarter. On the cost side, we had more snow this year compared to last year, which adds SEK 5 million to the property cost. All in all, we have satisfying cost control, although there is inflationary pressure. Surplus ratio is at 64%. Net financial is up mainly due to higher market interest rates. Net debt is up SEK 2 billion compared to Q1 2022. I touch up on value changes on the previous line. We have increased the valuation yield by 11 basis points to reflect the rise in market rates, which has led to a negative unrealized value change of SEK 564 million. As you can see, our property portfolio is well diversified in terms of both segment and geography. We have also 29% of our rental income from public-related tenants and 9% from residential, which means that we have a low risk in our cash flow. Looking at the rental growth on offices, as you can see on the slide, it has had a stable trend upwards, but it's still a relatively low krona per square meter. For 2023, we have more of a hockey stick development with the indexation and a good development in new letting and renegotiations kicking in. We repeat that the CPI indexation for 2023 was 10.9%, which corresponds to the increased rent of around SEK 170 million on an annual basis. Unpaid rents for the first and second quarter are at the same level as previous year, which means that our tenants have accepted their new rental levels. Our net letting continues to be strong, SEK 3 million for the quarter. It has been positive 18 out of 21 last quarters. Demand is still very good for high quality and modern offices in locations close to urban services and commuting centers. However, we see that the current market environment with inflation, higher interest rates and the banking turmoil have made the time to get the ink on paper a little bit longer. This has improved already, and we are now seeing higher pace in new signed lease contracts. Our 10 largest tenants, of which 6 are tax financed, account for 18% of our total rental income with an average lease term of 6.3 years. This means very low single tenant risk. I will now hand over to Rolf, who will go into the portfolio and our financing. Rolf?

Thank you, Knut. I will begin by looking at the market value of our properties, which amounted to SEK 30.9 billion. The decrease since Q4 is explained by negative changes in value for the quarter. The average yield was 5.85%, which is 11 basis points higher since last quarter. All segments and cities have been affected in the range of 8 to 13 basis points, which shows that the yield change is primarily driven by higher market rates. The increase in yield is partly offset by positive net letting, renegotiated leases and higher cash flow. And we only have minor changes in the inflation assumption for 2023. With an average yield of 5.85% and an average interest rate at the end of the period of 4.1%, we still have a yield gap of 1.8% and thus a continued strong cash flow. On a yearly basis, we are currently investing just over SEK 1.3 billion in tenant improvement, property improvement and new builds. All our ongoing projects are proceeding according to plan. And before we start the projects, except residential, we always have 100% signed leases. Most of the rental income in these projects comes from tax finance operations and all projects will be certified according to BREEAM very good or excellent. We currently have around 90,000 square meters under construction with a total investment volume of SEK 2.5 billion, with remaining investment amount to SEK 760 million. In addition, we have another 200,000 square meters in existing or possible building rights in central locations, which we either develop ourselves or sell to other developers. The demand for new modern premises and housing remains high, but prevailing market conditions may mean that we will postpone certain project starts, especially regarding housing. We have refinanced all bank debt maturing in the first half of 2023 with margins 20 to 40 basis points higher than last year. Over the next 12 months, we have loan maturities, commercial papers excluded of SEK 6.6 billion, which corresponds to 40% of interest-bearing liabilities, 30% related to bank loans, 2% to secured bonds and the remaining 8% of unsecured bonds. We have very good relationships with all our banks. We feel that they are confident in how we run our business and they are willing to be on our journey and offer us competitive terms. We have initiated discussions regarding all loan maturities within the next 12 months. The discussions are positive, and our goal is to refinance all loans within 6 to 9 months before maturity. We also have 2 maturities of unsecured bonds maturing in June and September, a total of SEK 1.4 billion. And as Knut said earlier, we feel that the capital market is working better and better with several completed issues in the near term. Our goal is to refinance all or part of our maturing bonds on the capital market. If this is not possible at reasonable levels, we have credit facilities available. We currently have 83% of our outstanding loans with banks, 3% in covered bonds and 3% in commercial paper, and the remaining 11% consists of unsecured bonds. Our loan-to-value ratio was 53.7%, which is under our target of 55% and far below our covenant of 65%. Our debt maturity is at the same level as before and amounts to 2.3 years. We have extended our fixed interest rate during the quarter by restructuring parts of the derivative portfolio and signing new derivatives. The fixed interest period now amounts to 1.5 years, and the interest coverage ratio amounts to 2.5x. The average interest rate at the end of the period was 4.1%, which is 0.9% higher compared with last quarter. The increase is due to rising market rates and slightly higher margins. We have 83% of our financing in banks, SEK 1.1 billion in unused credit facilities and a secured loan-to-value ratio of 46%. We will also add additional borrowing capacity during the year through completed projects. This, together with good relationships with our banks, makes us feel comfortable about future refinancing. As you can see in the graph, the yellow bar, we have gradually reduced our share of commercial paper over the past year in favor of bank financing. Our ambition is to be a recurring issuer of both green unsecured bonds and commercial papers. Today, we have 16% green financing and 37% sustainability-linked loans. And we're actively working to increase the proportion of green assets, and our goal is to have at least 55% green assets by 2025. We also see in the graph, our net debt to EBITDA is stable between 11 and 12x where net debt has grown in pace with the EBITDA over the last years. Yet again, I feel comfortable with our current financial position. Our strong cash flow will serve operating expenses, committed CapEx and proposed dividend. And I would now leave the word back to Knut.

Thank you, Rolf. I'll talk a little bit about the market. As previously stated, I think Sweden is the fastest-growing market in whole of Europe right now, thanks to all the new investments in the transition towards a greener industrial production. We have mentioned the battery factory in Northvolt, which is only one of many ongoing initiatives. Other examples of the steel production companies, SSAB and H2 Green Steel and investments into the power grid, forestry and electrofuel. Now latest, we've gotten announcement of a major investment in Ostersund. This investment will create 1,000 new jobs in a town with 60,000 people. It is a unique electricity-intensive circular initiative consisting of a data center that will be powered by renewable energy, and at the same time, supply heat to a large-scale food farm. The total investment amounts to SEK 18 billion, and the first stage will be finalized in 2026, and in whole will be ready by 2033. We also have positive news on the migration to the northern part of Sweden. According to the company MindDig, 50 families per month are willing to move to our cities. In total to meet the employment needs of over 100,000 new employees, this space needs to accelerate. The municipalities and government still have great challenges supplying these families with residential opportunities. The current financial situation makes it harder for us to get acceptable returns on constructing new residential. The approval process is today way too long and the waiting times unacceptable. To meet the need from the industries and investments in our cities, this must change. We are now taking a more active part in the lobbying towards the regulators. The transaction market continues to be relatively slow with few transactions hitting the wire. However, I see some light in the tunnel in the last month where buyers and sellers are finding each other. We keep a close eye on the market and have several ongoing dialogues and I'm positive on finalizing 1 or 2 transactions in Q2. The ongoing major projects are proceeding according to initial plans, both in terms of cost and time. The cost of a new police station we finalized recently, even got under calculated budget, which is a success in current inflationary environment. I see that we will release the start of some new major projects this year. We have a constructive dialogue with several tenants that require new production or major renovation. These new projects will have a marginal effect on CapEx for 2023. For tenant adaptions, the pace is still good. And yield on cost remains at around 8%. We can see that some negotiations are taking longer due to market uncertainty. I believe the pace to pick up of the summer is spiking its hiking cycle. To summarize in short, we are presenting a strong quarter on operating level. This is a proof of high activity and a strong underlying market. And at the same time, we manage the cost pressure very well. CPI indexation on rental agreement is going through, taking rental income higher with very little pushback from tenants. I believe the inflation spike is behind us and looking forward to having a more stable market. Financial cost is up due to higher market rates. We have acted to secure ICR at acceptable levels by restructure and new derivatives. The green transformation is happening for real in Northern Sweden. The economic activity continues to be high and the optimistic outlook has not faded. I am convinced that we have only seen the beginning of what reflects an interesting market in our geography, and I look forward to an intense and exciting journey ahead. Together with other players in Northern Sweden, we are creating new businesses in the biggest green growth revolution of our time. With my employees, our secure and stable owners and a very interesting investor market, we will deliver continued shareholder value. It takes us to the end of this presentation. Thank you for listening. We are now ready for questions.

[Operator Instructions] Our first question comes from Markus Henriksson from ABG.

Rolf and Knut, a few questions from me. First off, you mentioned that you see a bit more activity on the transaction market. But could you state any transactions that you see that is representative of your portfolio?

Knut here. No, not really. What I mean with that sentence is that we see that more -- both buyers and sellers contact us and want to act in the transaction market. We haven't so far seen any real transaction in our market. We see that, for instance, more interest for our building rights in our central location in our cities. So we don't actually have any proof of any values and so forth concerning the transaction market. But I think it will come into Q2.

Very clear. And that was my next question. You mentioned that you might see a transaction or 2 in Q2. Was that acquisitions or divestments potentially?

For us, it can actually be both. It's very easy to say just now that we have net sellers. So we have been, for the last 10 years, net buyers, but we always work as we can be buyers. So if the right transaction occurs, we will be ready to act. And I think not many, but I think a few transactions will occur in the near future, and so we can do great business and act. So I think in Q2, maybe Q3, we will see approval of that.

Then a question on interest maturity. It's now the highest since 2017, 2018 after the restructuring. Do you foresee that you will further increase the interest maturity into 2023?

Rolf here. Yes, if the conditions are right, I think now we have acted, as Knut said, in the presentation, to secure the ICR level. But we will look into our derivatives and our portfolio. And if we feel it's the right levels, we will continue to prolong our loan maturities.

And then you mentioned, Rolf, a minor change in the inflation assumption for 2023. What is the change? And what was the figure last quarter?

The inflation assumption for 2023 last quarter was 4.5%, and it's now 5% and then 2% long term.

Our next question comes from Albin Sandberg from Kepler.

A couple of questions from my side as well. And while I don't envy you having to come up with the market value of our portfolio when there are no transactions, I fully understand the difficulties in doing that, but sure I appreciate you coming as close as you can. But if you look at the LTV now and you compare it to your maximum target, there is not a great deal of headroom. I just wonder if that's a stress factor for you or does it impact the way you plan to run the business going forward and also maybe taking into account the fact that it doesn't seem that Riksbank is fully done with its rate hikes as of yet. So maybe there is some further downside risk to values as we move through 2023. That was my first question basically if you feel that your LTV target is at risk.

Not at the moment. But of course, we have close eyes on this, and we're ready to act if we see a risk on the LTV target. We will follow it closely, but we don't see the risk so clear just now.

But let's say, if you were to end up above it, would it impact your financing conditions, terms or anything else?

Well, it could and it's a possibility for us, as we said in the report, to postpone some investments and also use our liquidity to amortization of debt instead.

And on the project side, it seemed to me like you indicated actually a little bit better than expected, which is good, if I understood that correct. And I just wonder the outlook for the ongoing developments. And maybe if you could clarify a little bit more how is it that you have been such successful also in these terms of cost inflation, escalation? And is it because you have fixed prices with the contractors or you have been able to raise rents more than you thought initially? Maybe give some more color on that and how you see the potential risk during completion of the project portfolio?

Thank you for that question. Knut here. I'll get -- this question is, I think the most common question just now. And we work like this. We work with the contractors that we know. For instance, I can take an example. The hotel we finalized earlier this year -- or last year in Umeå, that was a construction company called [indiscernible] . That's a company that we have a great confidence in and it goes both ways. So the same people, the same managers from that company went over to build Vale that we're building for offices and some residential. So we work with target price, contracting target price and our lease agreement with the tenant are flexible. So in the end, it can differ about 10% up and 10% down. So if it gets more expensive, then the contracting sum, we can adjust the lease. So we work in another way now, and we are securing the target price, so to speak, both with the tenant, with the contractor and ourselves. And that's a very efficient method. I worked with that for 30 years when it comes to this sort of time, and we don't always work like that. But in these sort of times with the high inflation and so forth, it's a very good way of handling things in the contract. And concerning the lease, the level of the lease, we see that nearly every new contract concerning with new construction are above or around SEK 3,000 per square meter. That's a trend, and that's very good for us, of course. And we see that when we -- before inflation, what's going up so far, 1.5, 2 years ago, we had a sort of yield on cost on those construction about 5% to 5.5%. And now we are going towards 7%. So that makes those sort of investments still very profitable for us.

And my final question is a follow-up on Markus and maybe the whole financing strategy of Dios. I mean I think at least in a peer comparison, you have been rather short both on the interest rate and the credit maturity side. And maybe that's a good strategy over time. But do you see any changes to that? Or should we assume Dios operating the way you have done in the past? Or do you take any other active bets in one way or another?

I think our strategy in the long term is to prolong both debt maturity and the interest rate maturity and to have a more, let's say, stable and predictable cash flow in the years to come.

So should I take Knut that you would be ready to pay up a little bit in order to achieve that versus what you have done in the past, that is?

Yes, that's right.

We currently have no further questions. So I would like to hand the floor back to Johan for final remarks. Please go ahead.

Thank you very much for listening. And as always, please reach out to us if you have any further questions after this call. Have a great day. Thanks.

Thank you very much.

Ladies and gentlemen, this concludes today's call. You may now disconnect your lines. Thank you.