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

Good morning, and warm welcome to the Diös Presentation of the Half Year Result of 2024. My name is Johan Dernmar. I'm Chief Investor Relations Officer at Diös. Main speakers for today's call are Knut Rost, our CEO; and Rolf Larsson, our CFO. They will mark the turning point of the balance sheet management now to focus more on accretive earnings and growth. They will also, of course, review the results, major events and give an update on the market. As always, we encourage your participation. Feel free to ask questions during the Q&A session following the presentation. Thank you for being here. I now leave the word to Knut.

Thank you, Johan. The Swedish real estate market has been improving each month from the turn of the year. The investor willingness to take on real estate exposure has gradually improved. Inflation is going down in line with forecasts. The message from the last Riksbank meeting in June came in softer than previous, which gives great hope that we will have another 2 to 3 more rate cuts this year. Looking on the progress in our business, I'm proud to say that it's going well. At an operating level, the revenues have increased by 2% by Q2, despite we have disposed properties for SEK 1.4 billion this year. Occupancy rate has been decreased to 91%, which is totally in line with our strategy of divesting properties with limited potential. I will come back to that. Surplus ratio is stable at 71%. The bond market has been active, and margins have been improving. We successfully took a good market window to buy back part of our November maturity and issued a new 2.5-year bond. We now see stable yields like-for-like and property values are flat and maybe a little positive. We have continued to successfully dispose non-core properties in line with our portfolio strategy to focus on more offices and high-yielding properties with potential. The government has established a green acceleration office to handle decision-making processes in Sweden, facilitating business investments. We welcome this initiative and hope this will speed up growth even further. We are, as stated before, the market-leading real estate company in Europe's most thriving market, which gives us great confidence in our ability to create shareholder value and accretive growth. The total income for the quarter is up by 2% to SEK 634 million, and like-for-like rental growth is up 6.3%. The operating surplus ratio for the quarter is up 3% to SEK 446 million. We show increased absolute figures, although we have disposed assets for SEK 1.4 billion, resulting in SEK 35 million lower rental income for the quarter compared to Q2 2023. It is very satisfying to see that our day-to-day optimization of how we run our properties leads to increased energy efficiency as we continue to invest in our properties to be more proactive and future proof. We collect more evidence that properties with higher sustainability score, lower EPD environmental certificate, et cetera, are achieving increased demand, higher rents and higher value. Asset disposals resulting in 3 basis points yield change to 6.16%. Unrealized value changes were positive by SEK 10 million, whereas realized value changes amount to minus SEK 34 million. That was due to usual deduction for latent tax, transactions costs and DD findings. Our well-diversified portfolio has generated resilience in our top line. 31% of our rental income comes from public-related tenants, which creates a solid ground for passing on CPI. We have increased the share of offices in our portfolio by disposing mainly residentials, which is in line with our long-term strategy. Like-for-like rental growth continues to be strong, primarily explained by CPI indexation for 2024 of 6.5% for commercial lease agreements. 97% of all commercial lease agreements have indexation clauses, of which 94% have CPI indexation. But not to forget, both CapEx and achieved rent reversion have boosted rental growth. I see great potential in our rental growth, but when it comes to rent reversion, continued increased occupancy rate and modern newbuilds, we are seeing an increase in peak rent levels in our new leases, which in some cases, approaches SEK 3,500 per square meter. These rent levels are being reached in our stronger cities, which are being heavily impacted by investments in the green transition. Part of our value creation is taken in vacant premises, refurbish or let out. And as the market leader with local management and a company with strong cash flow, we have a competitive advantage to many other real estate companies in our cities. Net letting has been positive 20 of the last 22 quarters with SEK 11 million in the last quarter. With the economic outlook improving and interest rates decreasing, I believe activity will pick up. The underlying market is incredibly strong and the need for the right premises in the right location in Northern Sweden is significant. I will now leave the word to Rolf, who will go into valuation, CapEx and our financing. Rolf?

Thank you, Knut. I will begin by looking at the market value of our properties, which amounted to SEK 30.4 billion. Investments during the quarter amounted to SEK 249 million and we have divested 23 properties with a book value of just over SEK 500 million. 80% of the property portfolio has been externally valued in Q2, which has resulted in slightly positive unrealized value changes. During the end of last year and the beginning of this year, we have seen an increase in investment activity. We also see that property deal and market values have stabilized, and our assessment is that yield adjustments have reached their peak. The average yield was 6.16%, which is 3 basis points higher since last quarter. The change is explained by the fact that we have sold low-yielding residential properties and with an average yield of 6.2% and an interest rate of 4.4%, we still have a yield gap of 1.6%, and thus, a continued strong cash flow. As I said earlier, we have invested SEK 249 million in tenant improvements, property improvements and new builds. During the quarter, we have completed 1 major project in Luleå, with a total investment volume of SEK 206 million and an annual rental income of SEK 14 million. In the third quarter, we will also complete a project in Borlänge with the University of Dalarna as a tenant, which will add another SEK 38 million in annual rental income. And we currently have around 40,000 square meters under construction with a total investment volume of SEK 1.3 billion, where remaining investment amounts to SEK 250 million. And all our ongoing major projects are proceeding according to plan, both in terms of cost and time. And there's low risk in our major projects, where pre-let is a requirement and most of the rental income comes from tax-financed operations. And all our new projects are built according to BREEAM, at least level Very Good. And in addition, we have around 200,000 square meters of existing or possible building rights where we see great potential for further value creation. These will be used for both our own development and disposal. And 50% of building rights refers to commercial premises and the remaining 50% to residentials. During the quarter and in the beginning of July, we have issued bonds corresponding to SEK 830 million and at the same time, redeemed bond maturities in the coming 12 months, corresponding to SEK 545 million. This means that in the next 12 months, we have additional loan maturities, commercial papers excluded, of SEK 1.8 billion, which corresponds to 11% of interest-bearing liabilities. The loan maturities refer to both bank loans and bonds, where SEK 900 million are due at the end of this year and the remaining SEK 900 million in March and May next year. And we're actively working for a more prudent maturity profile with lower -- longer debt maturities. Bank financing is and will be our most important source of financing, and we currently have around 72% of our outstanding loan with banks. Proportion of bank financing has decreased somewhat since the turn of the year in favor of commercial papers and bonds. During the last couple of months, we have seen a very active Swedish bond market with high volume and lower margins for both secured and unsecured financing as a result. This puts pressure on banks' lending margins, which provides good conditions for lower financial costs. The average interest rate at the end of the period was 4.4%, which is 10 basis points lower compared to last quarter. Our average cost of debt is in line with the marginal cost of debt, meaning we have absorbed the increased interest rate. This will have a positive impact on our income from property management when rates are decreasing. The message from the last Riksbank meeting in June was more dovish than previous, which gives great hope that we'll have 3 more rate cuts this year. In recent quarters, we have acted to secure ICR at acceptable levels by signing new derivatives. With the measures we have taken and the continued strong cash flow, we're convinced that the interest coverage ratio will continue to exceed 2x. We have disposed low-yielding assets and used the liquidity to amortize debt and thus lowering our financial cost and at the same time, improve our LTV and strengthen the balance sheet. Our loan to value ratio was 53.4%, which is 0.5 percentage point lower than last quarter. And as we have said before, we are targeting an LTV of 50% over time. We have 72% of our financing in banks, SEK 1.5 billion in unused credit facilities and a secured loan-to-value ratio of 42%. We will also add additional borrowing capacity during the year through completed projects. And this, together with good relationships with our banks, makes us feel comfortable about future refinancing. We still have a conservative balance sheet approach, which reflects our commitment to financial prudence and risk mitigation. We have reduced our financial risk over time, lowered our LTV, improved net debt to EBITDA and extended our interest rate fixing and debt maturity. We have improved our financial key figures through divestments and a more cautious strategy regarding new investments. This, together with available liquidity, means that we now see opportunities for growth, which includes both start of new projects and acquisitions. We are currently analyzing several potential acquisitions where we see potential for value creation, and we still see a good demand for new builds especially from government-related tenants. And yet again, I feel comfortable with our current financial position and action taken. Our strong cash flow will serve operating expenses and committed CapEx. And as I said, we have positioned ourselves for future growth. I will now leave the word back to Knut.

Thank you, Rolf. Let's talk about the market. We experienced the greatest industrial transformation of our time when the Swedish industry is moving towards fossil free production. New industries supporting the green transformation are establishing, like battery productions and electro fuel. We have industries which are looking for more suitable and efficient location, for instance, fertilizer production. Apart from all above, Sweden's NATO membership that comes with increased spending in defense and infrastructure impacts our region in a positive way, growth-wise. These investments are being made by both the Swedish government and private companies with risk capital and public-related companies, which give a great incentive to create synergies between businesses in different sectors. The government has now, as I mentioned in the beginning, established a green acceleration office to speed up the decision-making processes in Sweden, facilitating business investments. The foundations for all these investments are incredibly robust and enduring, thanks to our natural resources such as minerals and forests in Northern Sweden. We have access to clean and green electricity through hydropower and wind power. We have a colder climate and a lot of available land for development. We also benefit from the strong and predictable governance in Sweden, characterized by a robust legal framework and a high degree of transparency. Over the next 10 to 20 years, the region is projected to receive investments totaling of EUR 150 billion, and that's excluding NATO-related funding. Experts predict that this influx of capital will create approximately 100,000 new job opportunities. Additionally, there will be a demand for around 200,000 individuals to migrate into the region to support this economic expansion. All in all, this defines the thriving market, and we are in the center of all this. Keeping the anticipated population growth in mind, along with the investment being made in our market, we can analyze the developments over the past few years. The focus has largely been on inflation, geopolitical challenges, interest rates and the slowdown in economic growth, resulting in increased unemployment. However, in Northern Sweden, we are witnessing a somewhat contrasting scenario. Economic activity is demonstrating resilience and unemployment rates continue to improve and are the lowest in Sweden. When we translate this into the context of our business, it means that our tenants are better positioned than those in many other locations. The turnover in hotels and restaurants remains robust, and we are not seeing any increase in bankruptcies. We are now focusing more on accretive earnings and growth. We have succeeded and taken ourselves to a good financial position. ICR is anchored above 2x and pro rata loan-to-value is now around 52%. We are still aiming towards 50% in the near future. The transaction market is picking up and a number of deals is increasing. We have our eyes on interesting properties to acquire where we see potential for value creation. We are targeting properties with good location and vacancies where our local teams can create synergies for our existing portfolio and our tenants. We see a continued good demand for new builds, especially from government-related tenants, like Rolf said. We are targeting higher return on investment today compared to 2-3 years ago. I'm sure that we will announce some major projects during the year. However, I think there will be major refurbishments rather than new builds. With lower interest rates, the demand for acquiring building rights in our cities is definitely picking up. We have an attractive land bank from which we can build ourselves or divest. We work continuously on producing new building rights as part of our value creation. We continue to invest for a more resilient property portfolio with higher energy efficiency and lower CO2 emissions. It's encouraging to see that we are reducing the energy use like-for-like by 1.6%. On a portfolio basis, we have had a good starting point regarding the new requirements related to energy performance building directive with only 3% to 4% at or below coming threshold levels. We have increased our requirements regarding green assets to align with the latest levels. Our target is intact despite higher requirements; to have 55% green assets by end of 2026. We have a very positive outlook on our market and we will continue to invest for a more sustainable portfolio and accretive growth. And as I stated before, we collect more evidence that properties will -- with higher sustainability score, lower EPD environmental certificate, et cetera, are achieving increased demand, higher rents and a higher value. Let's summarize. The overall sentiment has shifted significantly during the first half of 2024, evidenced by a very active Swedish bond market with high volume and clearly lower credit margins, and the higher activity in the real estate transaction market. Among our tenants, we experience more optimism, and I believe the business activity will take off after the summer holidays. The result for the second quarter is strong. We continue to see rental growth and the resilience of our tenants is robust. We have a peak interest rate behind us and we have acted to secure our financials' KPIs. Refinancing risks are manageable, and we have act to lower our LTV towards 50%. With average cost of debt in line with the marginal cost of debt, we are in a good position to grow income from property management per share. The office is key for a vibrant and growing city, especially in our 15-minute cities. This is why we focus more on that segment. We see good potential in rent reversions and growth is boosted by the green transition in Northern Sweden. And with our great mix of offices and urban service in the city center locations, we can create synergies for all our tenants in different segments that will benefit both our cities and us. As we have announced, David Carlsson will be my successor as the CEO. I feel I'm leaving Diös in good and safe hands. David has a solid knowledge of the cities of Northern Sweden and many years of experience in leadership and development. Most recently, he has been based in Umeå. Our markets continue to attract new companies' investments. NATO-related investments in infrastructure and government-related initiatives are making the growth outlook even more promising. As the largest property owner in our market, we are in an excellent position to capitalize on this growth. This takes us to the end of this presentation. Thank you all for listening. We are now ready for questions.

[Operator Instructions] First question we have on the phone lines comes from Markus Henriksson with ABG. You may proceed.

First, a question on building rights portfolio. Could you highlight a bit more in depth how you are thinking about that portfolio, potential project starts, in which cities and where you're looking to divest?

Good question. And we are -- we have had a time now for 3 to 4 years that has been rather low in big projects. And I would say that this had -- have a build -- a good time for actually create building rights. So we have in half year maybe and what maybe 1 year, we have about 300,000 square meters of building rights. Half of it is for residential and half of it is for commercial use like office premises. And as now, we are actually not working very hard on divesting building rights. We would like to use them ourselves. And -- but of course, since the times are what they are, it's hard to start with, for example, residentials but we are actually building condominiums in Umeå. We are -- we have a sort of question -- questionary in Luleå, where we ask the market if they are interested in new condominiums. And there, we -- on Västra Stranden, a very good location, we can build condominiums for, I think, it's 75 apartments. So just now, we are working with creating more building rights, and we are not actually into divesting just now.

Then a question on banks and credit margins. Are you experiencing lower credit margins? Or are they more or less stable?

Rolf here. A little higher compared to maybe 2 years ago. Stable if we look at the last 6 months. And I think there will be a pressure on bank margins in the future according to the activity on the capital market with bonds. So I think there's a pressure down on bank margins, but stable at the time.

Then are you done with your divestment program? Or are you looking to sell more to reach the LTV target of 50%?

Well, we are actually not selling only to reach the loan-to-value target. We are actually following our portfolio strategy by selling properties with low potential and where the location is sort of not in that position that we want it to be. So yes, we will divest some more, but we are also looking into buying. And I think you will see in the near future that we are looking into acquisitions as well and also to swap properties with other companies. So we are very active just now, both in divesting, swap properties and to acquire properties. And we can see that the market for transaction is picking up really fast now. So it feels still a prosperous in that way.

Then looking a bit kind of at your historical leverage. If we look at the net LTV, it's heading downwards. But you have a quite stable trend on interest-bearing debt to EBITDA. So it's been quite a bit higher historically. You're now at around 10x and it's been about 12x historically. So wouldn't you be able to be even more forward-leaning than you're actually kind of communicating to the markets?

Well, the net letting historically has been affected by when we go into large projects. So now, when we're selling some properties and using the liquidity to amortize, we are -- the net debt to EBITDA is going down. So I think maybe Knut could fill in with the -- in more offensive way to look at the market with transactions.

Yes. And of course, when the transactions market is picking up, it's easier for us to actually work with the portfolio and work with our LTV, of course. But I think the time now is going from sort of managing the balance sheet to actually talk about more rental income, cost control and actually to work in our very prosperous and lean-forward market to look at more acquisitions. And I think our LTV, our leverage, so to speak, gives us more to work with when we talk about acquisitions. So I'm sure that we will be more active. And I'm sure you will see that in the near future.

It was just to try to focus a bit on -- I think you've had a good EBITDA development. So top line have increased and the key metric, net interest-bearing debt to EBITDA, has actually followed a quite nice trend. And I just felt that there was a lot of focus on the net LTV. Last question on net leasing. You've been quite vocal in recent 3, 4 quarters of the outlook for net leasing. What kind of activity are you seeing in your respective markets?

You can say that it's a little diversified. You can say that some of our cities, it's very, very active, and the potential for new leases are very, very good. In other places, they are a little slower, so to speak, and I think that's very normal. And of course, the green transition gives us possibilities in that sort of way. We are not into the green transitions when we talk about factories and industrial buildings, but we do everything else. And what we have realized in the last year, so to speak, is that the cities, they don't look the same. There are differences in what demand they have. Some cities have demand for more residentials. Some properties are -- some cities have the demand for a more very -- for offices with high quality in the city centers. And other cities are more into education and schools. So there are different demands in the cities but one thing that's very common is, for example, hotels. We can see that -- you know we had a press release on Scandic Go in Umeå, sort of lifestyle hotel. Most of our hotels now have the highest turnover for the last couple of years. So hotels is something that's going really well just now. And we are very positive when we see the outlook for our partly rent reversion, but also new leases when we see what levels we can reach when we talk about the rent level per square meter. So we just now reached top levels at SEK 3,500 per square meter, and that's very good for us. 11 years, when I started, we were at SEK 800 to SEK 900 per square meter and now our top level is SEK 3,500. And I've been in the business for so long, and I've never seen that before. And it looks like it's -- that's a trend. It's going to continue.