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

Good morning, and a warm welcome to this presentation of the Dios Q3 Report 2023. My name is Knut Rost, I'm the CEO of Dios. And together with me today is our CFO, Rolf Larsson. The heading of this report is, a historical strong operational result in a challenging environment. We will give you a summary of the report, and we will guide you through how we navigate in short-term perspective and how we take advantage of opportunities for long-term growth. If you have any questions, there will be a Q&A session after the presentation. Also, you can always reach out to us with your questions afterwards. You can find our contact details on the last slide and on our website, too. I want to start off with a few words on our market in Northern Sweden. We are experiencing a unique growth situation that started a few years ago and has really taken off the last year. Investments of this kind are remarkable and have not been seen in our market, and we are only in the beginning of the green growth revolution. Having that said, we as the largest property owner in our cities on our market work every day to take advantage of the opportunities we see, especially going forward. I will get back to this later in this presentation. The operational performance continues to be very strong with all-time high occupancy ratio, good cost control and improved energy metrics. Financing costs have, however, continued to increase due to higher market rates. For the quarter, the occupancy rate was 92%. It's up 1 percentage point from last year. The surplus ratio was 73%, up from 71%, which shows a good and solid development. Regarding net letting figure of SEK 0 for the quarter, it can be referred to our increased yield requirements on new investments and that it takes somewhat longer to reach business conclusions with our tenants. We aim to increase the return on our investments, which will lead to reduced CapEx. Interest costs are increasing due to rising market interest rates. The Swedish Riksbank raised another 25 basis points in September. That means they have implemented an interest rate increase from 0% to 4% in just 18 months. Refinancing has been a hot topic during the year for the Nordic real estate. We have successfully managed to refinance both bonds and bank loans during the year at relatively good margins. We find ourselves in a good position with only bank maturities coming 12 months. Interest rates have continued to affect property yields. We have adjusted the average valuation yield to 10 basis points to 6.01%, which has resulted in a negative unrealized value change corresponding to 0.6% of total portfolio value. Looking forward, on a short-term basis, we have and will take action to manage the effects of higher interest rates and yield expansion have on financial KPIs. Simultaneously, we continue to position ourselves to capitalize on the green transition led by the Swedish sustainable industries in our market. The rental market shows good resilience, which gives us a sense of comfort. We are prioritizing CapEx by higher return on investment requirements to manage the effect of higher interest rates. Going into results in more detail by looking at the income statement, we can confirm the total income is up by 11% to SEK 621 million. Like-for-like rental growth was 10% in the quarter and is explained by mainly CPI indexation. On the cost side, we have managed to keep costs at the same level as previous year, thus a longer property portfolio. All in all, we have satisfying cost control despite the inflationary pressure. We continue to invest in our properties to be more proactive and future-proof when it comes to sustainability and energy efficiency. Our goal is to reduce our carbon footprint by 50% through 2030 to be carbon-neutral by 2050 at latest. It is satisfying to see that our day-to-day optimization gives us an increased energy efficiency by 2.9% by end of Q3. The unrealized value changes of properties amounted to SEK 206 million and comprised capitalized interest of SEK 10 million. The increased interest cost is a function of higher market rates. On the opposite side of the effect of higher market rates, unrealized changes on derivatives gives a positive effect of SEK 97 million for Q3. We run a well-diversified portfolio in terms of both segments and geography. We also have 30% of our rental income from public-related tenants and 9% from residential. This means that we have a low risk in our cash flow. Looking at the rental growth on offices, it has had a stable trend upwards with further potential as it is a relatively low krone per square meter rent for 2023, we have more of a hockey stick development with the indexation and a good development in new letting and renegotiations kicking in. The CPI indexation for 2023 was 10.9%, which corresponds to increased rent of around SEK 170 million on an annual basis. For 2024, CPI indexation will be disclosed in mid-November and macro economists forecast a print around 6%. With a relatively low absolute rental levels in average, we believe that our tenants are in good position to manage upcoming adjustments. Net letting has been positive 19 out of the last 23 quarters. The net letting for the third quarter amounted to 0 and are explained by 2 parts. First, we have actively chosen to increase the yield requirements on our investments, which has affected a number of new investment decisions and the net letting. We do this, as stated earlier, to manage the effect of higher interest rates. Second, we see signs of our tenants' decision-making is taking longer. The current macro environment and ongoing conflicts are not leaving anyone unaffected. I will now hand over to Rolf, who will go into the portfolio and our financing. Rolf?

Turn to Page 6. Thank you, Knut. I will begin by looking at the market value of our properties which amounted to SEK 31.2 billion. Profit evaluations in the third quarter has resulted in negative value changes of SEK 204 million, corresponding to 0.6% of the property value. The average yield was 6.01% which is 10 basis points higher since last quarter and 60 basis points higher since the lowest level in Q2 last year. The yield expansion in the quarter is largely offset by rental growth. The inflation assumption for 2023 is still 6%. And with an average yield of 6% and an average interest rate at the end of the period of 4.8%, we still have a yield gap of 1.2 and thus a continued strong cash flow. Year-to-date, we have invested SEK 1.1 billion in tenant improvements, profit improvements and new builds. We have increased yield on cost requirements, which will result in lower short-term CapEx volume. All our ongoing major projects are proceeding according to plan, both in terms of cost and time. And before we start the projects, except residential, we always have 100% signed leases. Both of the rental income in these major projects come from tax-financed operations. All new builds and major renovation will be certified according to BREEAM at least level very good. And we currently have around 90,000 square meters under construction with a total investment volume of SEK 2.5 billion, The remaining investments amount to SEK 500 million. In addition, we have another 200,000 square meters in existing or possible building rights in central locations, which we'll either develop ourselves or sell to other developers. And we aim to create at least 30,000 square meters of new building rights per annum. We feel the demand for new modern premises and housing remains high, but prevailing market conditions means that we will be more cautious on starting large projects in the coming quarters and we will postpone the start of our housing projects. During the quarter, we have successfully refinanced both unsecured bonds and bank debt, taking away the refinancing risk for 2023. We have also acted to secure ICR at acceptable levels by restructuring existing derivatives as well as signing new ones. Over the next 12 months, we have additional loan maturities, commercial papers excluded of SEK 5.3 billion, which corresponds to 31% of interest-bearing liabilities. All upcoming maturities relate to bank loans. We have ongoing negotiations regarding all maturities during Q1 next year with a total volume of SEK 4 billion. We have high confidence in refinancing these before year-end as banks have already provided soft commitment to roll over. We have also started discussions regarding the loan maturities during Q2 next year. Our goal is to refinance these during Q1 at the latest. Our good banking relationships and available liquidity makes us feel secure in the face of future debt maturities, and we currently have 83% of our outstanding loans with banks, 3% in covered bonds, 3% in commercial papers and the remaining 11% consists of unsecured bonds. Our loan-to-value ratio was 54.2%, which is under our target of 55% and far below our covenant of 65%. The interest coverage ratio amounts to 2.2x. Now our target is that ICR should not fall below 2x. To manage the balance sheet and secure ICR about 2x, we are in several discussions to dispose assets. We will use the net proceeds to reduce debt and thus lowering our financial costs and, at the same time, improve our loan-to-value and strengthen the balance sheet. And as Knut said earlier, we are also limiting low yielding CapEx to further strengthen the balance sheet. Our debt maturity amounts to 2.4 years and a fixed rate maturity to 2.6 years. The average interest rate at the end of the period was 4.8%, which is 0.2% higher compared with last quarter. The increase is due to rising market rates and slightly higher margins. We have, as I said, 83% of our financing in banks. SEK 800 million 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 bars, we have gradually reduced our share of commercial paper over the past year in favor of bank financing. Our ambition is built to be a recurring issue of both green unsecured bonds and commercial papers. And today, 51% of our total debt consists of green or sustainability-linked loan. We're actively working to increase the proportion of green assets. Our long-term target is to have 100% green financing. Net debt to EBITDA improved to 10.9x compared to 11.2x in Q2, and net debt has grown in pace with EBITDA over the last years. Yet again, I feel comfortable with our current financial position and action taken. Our strong cash flow will serve operating expenses, committed CapEx and proposed dividend. I will now leave the word back to Knut.

Thank you, Rolf. What is happening in the Northern part of Sweden is a long-term growth story, as I said earlier. We have probably the fastest-growing market in the whole of Europe, thanks to all new investments in the transition towards a greener industrial production. Over EUR 100 billion will be invested in the region coming 10 to 20 years. This is important not only to businesses that are active in the region, but it is also important to Sweden as a country and for the CO2 net zero target. Will all those investments take place? Yes, I believe so, because of all the fundamentals they are built upon. What do I mean by that? There are natural resources like minerals and forests, the access to clean green electricity through hydropower and wind power, the cold climate and available land to develop. These fundamentals are not movable and will not go away. To take these investments into reality, we need to cooperate across public and private sectors. Today, residential's newbuilds is challenging with current economic environment, not profitable to start new production just now. Of course, it is our greatest interest that economic growth is created. We are lobbying towards politicians and the government, and we seek cooperation with other companies to accelerate this growth. As the market-leading real estate owner in the regional cities, we are in a sweet spot to capitalize on the increasing demand for new offices and urban services. Sweden as a country need to come together and act on this opportunity. We are in the beginning of something huge regarding the green transition. It is within offices and with our office tenants that we see the strongest development and the greatest potential for growth. In the 2023, office report from the industry organization, [Foreign Language], where our market is specifically addressed. The office is described as the city's engine and social hub. It also shows that the majority of employees choose to be in the office most of their working hours. The report is completely in line with our perception of our tenants, and we see no sign of them wanting to scale down. Instead, the office has become increasingly important for building corporate culture and attracting employees, and we see a high demand for attractive offices in the right locations. Rather than to scale down, we experienced more demand for design and flexibility between workplace and meeting possibilities. Attractive workplaces in our cities provide increased flows of people and conditions for more tenants in other segments as well. The transaction market shows small signs of picking up in activity. During Q3 and so far in Q4, we have seen deals being announced. However, the Swedish market is down by 60% in the transaction volume compared to last year. We have taken and will take more action in a short-term perspective to manage the balance sheet and secure ICR above 2x. We are in several discussions to dispose assets, as Rolf said, we will use the proceeds to reduce debt and lowering financial costs and at the same time, improve LTV and strengthen the balance sheet. The ongoing major projects are proceeding according to our initial plans both in terms of cost and time. We are actively lowering our CapEx by postponing some low-yielding investments because of higher interest rate costs. Regarding tenant improvements, the pace is still good and the yield to cost remains at around 8%. We will balance our investments with our financial covenants and cash flow. By near-term management of CapEx, we are positioning ourselves to be in a better position when interest rates turns. We have, like stated earlier, a very positive outlook on our market. To summarize, in short, we are presenting a strong quarter on operating level. The occupancy ratio of 92% is retained, and we managed to keep the property management effective resulting in a surplus ratio of 73%. Financing costs are up due to higher market rates. We have acted to manage ICR by restructuring and adding new derivatives, and we are looking on additional actions to cope with even higher interest rates. We are more cautious on putting on more CapEx in the near term. We have successfully managed to refinance both unsecured bonds and bank debt during the quarter, taking away the refinancing risk for 2023. I am confident that with our current maturity profile and the relationship we have with both banks and investors for upcoming financing. I'm 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 stakeholders such as the industry sectors, municipalities, investors and others in the Northern Sweden, we are creating new businesses in the biggest green growth revolution of our time. With my employees, I'm convinced that we will deliver great long-term shareholder value. This takes us to the end of this presentation. Thank you for listening. We are now ready for questions.

[Operator Instructions] And our first question today is from the line of Albin Sandberg from Kepler.

I had a few questions. And starting off on the financing side and the comments you are making, Knut, in the CEO statement and you're taking actions to safeguard your interest cover ratio. Could you clarify a little bit more what is that in addition to what you normally do?

Thank you, Albin. Let's say that we are in specific times with high interest rates, but still we have a better operating result than ever. So let's say that we work a lot with our costs. We work every day to lower our cost, that's one thing. We are, of course, looking at disposals of properties and we have long gone negotiations going on. So of course, we are doing that and, of course, a lot of other things. But the main thing is that we are very active in working with the ICR margin, of course.

And then obviously, you have refinanced both banks and bonds during Q3. I just wonder, and I guess I'm coming into the next question and why that may be subject to the Board and so on, but the key question is when you have refinanced and you say that maybe on the bank side, you see a little bit lower activity, do you feel that there are any sort of expectations from your creditors to hold back on your dividends or anything like that because of the situation? Or do you feel that your renegotiation and refinancing basically in the same terms as you did before? Are there any changes, so to speak?

Albin, Rolf here. No, we don't hear anything about future dividend or anything. We feel that it's the same discussions as before. So we are very confident and we have very good relationships and we have very good discussions with our banks. So we're confident in refinancing the debt that's coming up next year.

And just confirm, your target is to be above 2x and then you have covenants at 1.8. Is that still valid?

Yes.

Great. And then my final question is just on the back of this, and maybe this kind of competing targets for how to use your available funds. On the one hand, as you point out, Knut, high NOI, high rents, I guess, rather positive market outlook for Northern Sweden in general. But with the balance sheet you have, do you think you can capitalize good enough on these opportunities? Or would you have needed a stronger balance sheet in order to fully take advantage of what you're seeing out in the market?

Well, that's a very good question. And I'm convinced that we can do that. But in the same way, we are a little cautious with no yielding investments and we are very focused on sort of high-yielding investments. And when we make decisions in new investments for tenants, we prioritize the high yield, of course. And so we are a little more cautious with the low-yielding investments. And yes, I'm convinced that we can do a lot more. But of course, in just now, we are a little, of course, cautious with buying new properties, for instance. We have to be very careful with the balance sheet. And that's our strongest concern right now. But in the same way, we have a strong market that we have to sort of work in. So it's double handed. On one hand, we are very cautious with our balance sheet. And on the other hand, we want -- of course, we want to take the opportunity to see and act on all the possibilities we can see. So that's how we do and how we work just now. We are very active.