Entra ASA (ENTRA) Earnings Call Transcript & Summary

Good morning, all, and welcome to Entra's third quarter presentation. On the picture here, you can see our building in nonacetate Ford Bergen, which was completed with the refurbishment this quarter. Moving on to the highlights. Rental income in the quarter is NOK 782 million, stable on previous quarter and 2% up year-on-year. Net income from property management of NOK 306 million, which is NOK 14 million below last quarter, mainly due to increased financial costs. and net value changes of minus NOK 746 million, which is mainly driven by the negative value changes on our investment properties of NOK 864 million, and this has been partly offset by positive value changes on financial instruments. Profit after tax was minus NOK 451 million in the quarter. And our cash earnings stands at 1.67% this quarter, slightly up from last quarter, where we had a one-off related to tax and our NRV per share is NOK 160 million in the quarter. We are pleased to see that we have continued to deliver positive net letting this quarter with NOK 14 million and also finalized our refurbishment in Bergen, Nonesetttergaten with a slightly higher yield on cost. And also, we have started the final phase of Steniskata 1 next to Oslo Central Station. The Board has decided to do a capital distribution for the first half of 2026 of approximately NOK 1.1 per share to be executed as a share. The Board has decided to do a capital distribution for the first half of 2026 of approximately NOK 1.1 per share to be executed as a share annual rental income of NOK 15 million have been terminated in the quarter, and net letting was positive with NOK 14 million, as already mentioned. Our occupancy is slightly up in the quarter to 93.8%. That is also largely driven by one of our buildings in Bergen now have been taken out from the management portfolio into project as we start preparing for a refurbishment of that building. Our average lease duration remains stable around 5.9 years and 48% of our contracted rent is from public sector tenants. Nonnesetergaten 4, as mentioned, completed in the quarter. This is, as you can see from the picture, located right next to the train station in Bergen and also bus terminal, 17,000 square meters. The project is 93% let when we take it back into the management portfolio. The total project cost is concluded at NOK 1.029 billion, which is NOK 13 million last quarter. The building has been upgraded to energy Class B and is EU taxonomy aligned. We have also started the redevelopment of our final stage in Stenersgata in the quarter. As you can see from the picture, this is a fairly huge quarter where the first part was completed in 2023. And we have since then worked to mature the product and also the tenant market on this product. And pleased to see that we, before the summer, signed a lease contract with Circle K, enabling us now to start the project at a pre-let ratio of 34%. The area around the central station of Oslo is currently going through a transformation. In addition to this project, we have our joint venture project with Skanska, only 2 minutes walk from here and also the PriceWC's new headquarter building will be located right next to this building. So all in all, this area is transforming into becoming a very attractive part of the office market in Oslo. And we're clearly seeing that the interest for the area and also rents are picking up around the central station. We expect the remaining project cost here to be around NOK 710 million. And the yield on cost is expected to be around 5.7% versus prime yield in Oslo, leaving us at a fairly decent spread to prime. The energy class here will be also B and EU taxonomy aligned upon completion. The completion is going to be done in 2 phases, where the first tenants will move in, in the first quarter of '28 and final completion 1 year later. If we move on to our list of ongoing developments, we currently have a total of 100,000 square meters on the list. Out of that, the 100% owned projects by Entra has a remaining CapEx of approximately NOK 1.3 billion spread out over the next 3 years. Let me start by saying that all of these projects are progressing according to plan, time and cost. In the quarter, we have seen that the occupancy is up on Vikstev 1 from 90% to 95%. At Kaigaten 9 in Bergen, we expect to see increased activity as we are getting closer to completion. The Bergen market has smaller tenants, which typically also take decisions about moving closer to completion, but we're seeing increased interest for the project and also an increasing pipeline of leads there. The joint venture with Skanska, Kristian Klrogskate 2 is separately financed, and this project has also had very good interest since we launched it in the market. So also here, we have good progress on letting. A few words on the Norwegian economy, which remains resilient, supported by strong public finances and the sovereign wealth fund. Economic growth in Norway is expected to be moderately positive going forward and also employment growth on a national level is expected to remain positive. We have seen that in Oslo, the employment growth has been more flat over the recent years. And in Bergen, our second largest market, employment growth remains stable. The September CPI came in at 3.4% in September and core inflation around EUR 3.0% and the Norwegian central bank chose to raise the policy rate with 25 basis points to 4.5% in September as an effort to try to bend down inflation within a reasonable time. The Central Bank now expects rates to remain at this level for some time with rate cuts pushed further out and additional tightening cannot be out-ruled if the inflation rates remains elevated. The rate path is a little changed in the near term, but somewhat higher further out than in the previous forecast. As we have highlighted before, nearly all of our leases are CPI-linked, also providing us a natural hedge against inflation. If you move on to the property market, letting activity in Oslo in the third quarter has been broadly in line with historic levels, also supported by large leasing has had a rental growth of 25% since the first quarter of 2023. And at the same time, CBD rents have been more flattish. So that clearly demonstrates also that the high-quality buildings in the city-center is now starting to close that fairly large gap towards CBD rents. Consensus estimates on vacancy have been revised upwards in the quarter. Currently, expectations are that they should remain slightly below 8% for the overall Oslo market and the increase is mainly driven by the fringe areas and also older building stock. New supply remains limited. This is the first quarter where the 2029 estimates have been included in the consensus. And we can see that there are large variations between the market experts this -- on this estimate. Some of them have also included the new headquarter building for the Norwegian Broadcasting Corporation, which is as much as 50,000 square meters. And they will be moving from an area which is going to be converted to residential, so that should have a limited impact on the letting market. The consensus estimates are now also around 10% or rental growth in Oslo over the years '27 to '29. If we take a few words on our take on the market. As we have highlighted before, we clearly see that the decision on where to locate is becoming very strategic for tenants. In the recent months, we have seen that more corporations, large corporations have publicly come out and said that they have revised their office policies going towards like DNB, F5 just recently announced that they're going back to 5 days a week of office policy with normal flexibility. And if you take a look at the demand side, it continues to be driven by demand for high-quality central locations. And the expansion-related demand has been more limited in the recent term. Tenants remain selective but at the same time, cost conscious. So what we're typically seeing is that they can choose more central location or higher quality, but at the same time, try to balance that out a bit with reducing space to have costs under control. Now as our city center locations are generally priced below CBD levels, we continue to see good rental growth potential in these areas. And the picture is more differentiated in the fringe clusters where local supply and demand dynamics play a larger role. Finally, also, we do expect to see that we, over time, we'll see that more building stock will be converted to alternative use, older building stock or with the wrong locations, which also should benefit the supply side over time. Now we believe also that replacement costs currently provide an important perspective on future supply-demand dynamics and also long-term rental fundamentals. The high replacement costs remains a significant barrier to adding new high-quality office buildings in most part of the city as new developments require sufficiently high rents to be economically viable. At the same time, we do expect to see that future supply may come from refurbishment of older building stock. -- rather than new build developments. These projects do, however, also face the same cost environment and also require higher rents to justify the investments. So this should support rental growth for high-quality offices over time. We find this also to be particularly relevant for Entra's portfolio as it is concentrated where we expect demand to focus increasingly going forward on modern high-quality office buildings on the central communication hubs. So with that as a backdrop, the comparison on the right also provides some additional perspective as estimated replacement costs remains well above the book value of Entra's management portfolio, illustrating both the cost of replicating comparable assets and also the robustness of our balance sheet. The comparison also highlights the cash flow characteristics of the portfolio. Based on the current share price, the implied fully let portfolio yield is approximately 7.3% compared to our fully let reported initial yield of 5.9% on the management portfolio. A few words on the transaction market. Activity continues to be influenced by interest rate volatility and geopolitical uncertainty. So we're clearly seeing that investors are very selective. And the financing market remains available with generally supporting lending sentiment and competitive bank financing. Year-to-date transaction volumes have been broadly in line with the last couple of years, around NOK 45 billion. The office segment represents around 25% to 30% of that volume in the year-to-date. This is below historic levels and a lot of that office volume is related to 2 mixed portfolio transactions. which have been done in the first half. Transaction activity within the prime office segment has been limited. However, pricing observed for prime assets included in larger portfolio transactions has generally been consistent with the prevailing prime yields currently. The consensus report now expects prime office yields in Oslo to increase slightly in the near term before gradually resuming a downward trajectory compared with last quarter, the anticipated decline in yields have been pushed further out. Property values remain, of course, sensitive to interest rate developments in the short term. At the same time, CPI-linked leases and expectations of continued market rental growth in attractive locations provide important support to cash flows and valuations. Yield expansion has already been feeding into valuations, as Ole will get back to shortly. Entra's management portfolio has already absorbed around 40 basis points of yield expansion over the last 12 months.

Thank you, Sonja. In Q3, our financial performance was lower compared to previous quarters. Rental income came in at NOK 782 million, unchanged from NOK 781 million in the second quarter. This is also in line with the bridge that we presented in the second quarter report. We had net positive effect from finalized project of NOK 8 million, primarily related to Nonesetttergaten in Bergen and Bergsvg 3 in Skøen, Oslo. This was partly offset by a negative NOK 4 million like-for-like growth due to 3 vacated offices in Drammensveien and Sandvika. Net income from property management came in at NOK 306 million, down from NOK 320 million in the second quarter, predominantly due to increased financing costs. Profit before tax is negative with NOK 518 million, including net value adjustments of approximately negative NOK 800 million related to our investment properties, JVs and partly offset by hedges. The improvement in pretax profits from the second quarter is due to less negative value adjustments. And I will come back with more details on this later on in the presentation. I have already covered the rental income. So let me comment on the other key P&L items. OpEx were NOK 73 million corresponding to 9.3% of rental income. This is a somewhat higher ratio, and this mainly reflects higher vacancy costs and, to a lesser extent, extended to a lesser extent, letting related costs. For the first 9 months of the year, the OpEx were 9.0% of rental income, closer to historical levels, but still above 2025 due to reasons explained earlier. Admin costs decreased slightly to NOK 48 million and a negative share of profit from JVs was mainly related to underlying result and impairment in USU, which impacts a negative NOK 78 million out of the NOK 85 million. also is a residential development company in Biovica, Oslo and the negative impact is mostly related to lower expected residential prices. Net realized financials increased by NOK 10 million to negative NOK 356 million, and this reflects higher borrowing costs. Value changes in our investment properties were negative with NOK 864 million, and I will return to the drivers here later on in the presentation. And this was partly offset by positive value changes in our financial instruments of NOK 118 million caused by higher long- and medium-term interest -- market interest rates. And overall, this resulted then in a loss before tax of NOK 518 million. Moving then over to our rental income development. Based on reported events, the bridge indicates that rental income will be broadly stable in the fourth quarter, followed by an increase from annual CPI revisions in the first quarter of 2027. For the full year 2027, the bridge is up NOK 21 million compared to the bridge presented in the second quarter, mostly related to letting effects. The NOK 30 million increase in the first quarter of 2028 is driven by about $10 million from completed projects and letting and NOK 20 million from annual CPI revision, where we assume 2.5% CPI adjustment, and this is the average of Bank of Norway and statistics Norway's forecast. As always, this bridge is not the guidance, it just highlights their reported events and in existing contracts and does not include future letting of vacant space or outcome for future renegotiations. The potential upside from vacant space is NOK 214 million, and then we have market rent reversal potential of approximately NOK 85 million. We also had a few larger properties vacated for refurbishments, which should support growth, but most of this is outside the bridge period. Moving then over to our property value, which is down to NOK 61.6 billion in the quarter. Value changes were negative NOK 864 million, a value decrease of 1.4%. The negative value changes are primarily due to higher rate of return requirements reflecting the increase in interest rate, and this is only slightly offset by positive letting effects and market rent prices. The development remains differentiated across our portfolio. Return requirements increased more in the fringe locations like Oslo East and Sandia while centrally locally properties remained more resilient. The value difference between the external prices increased also somewhat this quarter and is now at 1.3%. CapEx came in at NOK 269 million, broadly in line with the second quarter. We do expect CapEx to increase somewhat over the next 2 quarters as several ongoing projects are entering high production activity. But we will maintain a disciplined investment approach and prioritize CapEx to increase occupancy and enable us to capture market rent potential. Lastly, you can see that there's a negative value adjustments under other of NOK 77 million and this is mostly related to USU's results and impairment, as mentioned earlier. The management portfolio's net yield increased 5 basis points during the quarter and is now at 5.31%. And is up 38 bps compared to same quarter last year. On a fully let basis, using market rent, the portfolio and yield is now 5.9% compared to 5.8% last quarter. On the right-hand side, you can see that the net asset value ended at NOK 160 per share in the quarter, and the negative impact from value changes were partly offset by positive earnings from property management. Moving then over to our debt metrics -- the ICR decreased slightly to 2.14 measured over the last 12 months, while the ratio for the quarter was 1.96, reflecting higher interest costs. The leverage ratio also increased from 48.6 to 49.0 due to the negative value adjustments in our investment properties. The net interest-bearing debt to EBITDA is stable in the quarter at 11.0, and balance sheet discipline will continue to be a key priority going forward. We have created a solid financial platform with an average time to maturity of a total left at 3.8 years at Q3. We -- we had limited financing activities during the quarter compared to the second quarter. We issued commercial papers of NOK 1.8 billion. We did not issue any further bonds. The debt capital market remains open for Entra, but the credit spreads have expanded somewhat over the last 6 months due to increased interest rates and geopolitical uncertainty. Also, we have now completed the process to align all the bond agreements, increasing the permitted proportion secured debt from 15% to 40% of consolidated assets. This amendment will ensure continued access to competitive repriced bank financing as regulatory developments have increasingly favored secured lending. Over time, this will broaden our access to financing and reduce our dependence on unsecured debt, thereby creating more financing alternatives. Secured bank funding market remains open and credit margins have continued to tighten to increasingly attractive levels. As you can see on the slide to the right, we have undrawn bank credit lines of NOK 6.3 billion committed until 2028 and 2030. We have ample debt maturity coverage nearly for the next 24 months and we will continue to work to optimize our funding costs. Moving then over to our cost of debt development. The all-in net financial costs increased to 4.61% from 4.50% in the previous quarter, while the interest rate on our interest-bearing debt is up to 4.37%. The forward curve shifted further upwards during the third quarter. Our forecast here is based on the forward curve as of October 9. Based on this, we expect the cost of debt to increase further the next few quarters as illustrated in this graph. Our interest hedges cover 63% of the debt portfolio which will dampen but not eliminate the impact of higher interest rates. As mentioned earlier, the Board has decided to distribute capital for the first half of 2026 through a share buyback program of NOK 200 million. This is equivalent to NOK 1.1 per share and 31% of cash earnings, which is in line with our distribution policy. With Entra currently trading at a discount of approximately 40% to net asset value, we believe buying back shares is an attractive and value accretive use of capital. At the same time, we will remain disciplined and continue to prioritize our investment-grade rating and keeping financial flexible, that's on now you.

Okay. A few closing remarks. To conclude, we are pleased with the operational performance in the quarter, delivering both positive net letting of NOK 14 million and also finishing our project in Bergen with slightly higher yield on cost and starting the new redevelopment at Oslo Central Station here. . We continue to take a disciplined approach to capital allocation. And during the quarter, we increased our financial flexibility through the -- to the bond carve-out amendment, improving also our access to secured bank financing. As Ole mentioned, the Board has approved distribution for the first half up to NOK 200 million. to be executed as a share buyback program. And looking ahead, we remain focused on profitable growth. Rental income should continue to benefit both from CPI indexation, rental reversion, occupancy improvements and also income from ongoing projects. At the same time, we will also remain selective going forward in respect of future project investments and also look selectively at asset rotations. Finally, the long-term market fundamentals remain supportive as we have discussed through our presentation. So with that, I think we will open the floor for some questions, Isabel?

Now we have received a number of questions during the call. The first question is, Entera has highlighted broader access to competitive competitively priced bank funding after aligning its bond documentation, yet its bond credit spreads have widened recently. What do you see as driving this divergence?

Yes. Well, I think that we are more influenced by the interest rate and the credit spreads at the moment. It's true that credit spreads in the bond market has expanded somewhat over the last 6 months, but from very tight levels. While the bond -- the credit spreads in the bank market has actually tightened a little bit over the last few quarters. If you look at our maturity profiles, we're not really highly dependent on refinancing at the moment. We have really good runway there. And during the quarter, we aligned basically all the bond agreements so we can increase the proportion of secured debt from 15% to 40% -- of 15% to 40% of consolidated assets. And this creates basically much dynamics for us, and we have more broader access to financing. Also, it's important that this change -- I think this is credit positive for us also because we have more and now more sources for us to tap into if the market volatility in the credit market increases.

Thank you. With weaker credit metrics and negative property value changes continuing, why is the NOK 200 million buyback the right use of capital now?

So we basically -- according to our capital framework, we have a distribution policy to distribute a minimum 30% of cash earnings to the shareholder. And we changed this last year from 60% to minimum 30% to create more flexibility. Obviously, we are monitoring the development in our credit margins going forward, but then it changes to our capital allocation policy or a distribution policy will go through normal board procedures.

The credit metric outlook appears to move towards levels with limited headroom to the investment-grade rating. What is management's minimum acceptable ICR -- and what actions would you take if that level is approached?

Yes. credit ratings is not only dependent on the credit metrics in itself, right? It's -- it's a blend of several factors, which assesses our business profile. As an example, we have a portfolio of high-quality assets here in Oslo, which are highly liquid -- and that's obviously also credit positive. And there's a number of mitigating factors on this -- on the ICR -- sorry, on the credit metrics. So first of all, -- today's ICR is obviously in a -- it reflects much higher interest rate environment than we had a few years ago. Also, our portfolio it's higher quality. It's more in Oslo than we had a few years ago. So it's a lower-yielding portfolio compared to what we had earlier. And we've also shown a slide basically trying to describe the stability in our rental income going forward. We have acceptable occupancy level. We have CPI-linked contracts -- so we're showing that based on this bridge, indicates some kind of growth going forward, which also will help basically improve the credit metrics going forward. And lastly, which is very important that we have -- as we said now several times, we have changed the -- or align basically all the bonds to the same carved agreement from 15% to 40%, and this creates much more flexibility and availability of credit. So there are several things here that basically will help us great flexibility going forward. So it's not only about the credit metrics and Moody's numbers on that.