Fabege AB (publ) (FABG) Earnings Call Transcript & Summary

Welcome to Fabege's Quarterly Report 2022. [Operator Instructions] Today, I'm pleased to present CEO, Stefan Dahlbo; and CFO, Asa Bergstrom. Please begin your meeting.

So, welcome to our presentation for the Third Quarter 2022. As usual, I'm sitting here with Asa Bergstrom, and after the presentation, it will -- of course, will be possible to ask questions. So start to change the slide, please. During the quarter and during the beginning of the whole year, our underlying businesses are actually doing much better than we can -- what we see in the capital markets expectations. There is, of course, uncertainties around this inflation and about the interest rates, and this is also -- this is what is reflected in the capital market. But we again showed a positive net letting of about SEK 25 million, even if we had a slight slowdown in the number for request and foreclosures after the summer. Compared to 2021, we have not -- and we haven't had any major project lettings such as of Alfa Laval and you also have to remember that 2021 was one of the top 3 years ever. The surplus ratio is developing at good levels. It was affected in the beginning of the year with a increase of the taxes, but they had that negative effect that we may be thought it could have. We saw during the quarter an increase of 8 points in the yield requirements in the valuations, which is naturally because of the higher interest rates. But despite this, we saw a value increase of a little bit more than SEK 250 million in the total portfolio. The increase in the yield requirements was offset by higher rent, mainly due to the indexation or higher rents expected for the next year because of the -- due to the indexation. Overall, a solid quarter. It was a solid quarter where the underlying business is doing well, as I've mentioned before. But with this said, now I will hand over to Asa, who will go through the results.

Thank you, Stefan. Please turn to Page 4. All of the turbulence we see in the world around us and in the capital market now is noticeable in rising interest expenses and the situation in the capital market. The day-to-day business, however, is rolling along with increased rental income and positive net lettings, as Stefan also mentioned. Rental income amounted to SEK 2.2 billion, in an identical portfolio income increased by 5%. The explanation was the same as the last quarter, increased rental income from completed projects in properties Nationalarenan 3 and Poolen 1. Positive effects from indexation, new lettings and renegotiations, which were offset by reduced income after the Swedish Tax Agency's relocation from Noten 4. Increased operating expenses were mainly due to higher property tax and the higher electricity costs. Meanwhile, in other winter-related expenses decreased compared to the previous year. The surplus ratio came in at 74%, which is better than we expected at the start of the year when we assumed a higher property tax than what was the outcome. SHH gross profit amounted to SEK 10 million, of which minus SEK 21 million related to costs for central administration. Income recognition takes place in connection with the completion of projects and final recognition of 1 project occurred during the period. Central administration costs came in at minus SEK 77 million. The previous year's expense included non-recurring costs for Fabege's new head office. Interest expenses increased compared to the previous year, which was due to an increased loan volume and higher average interest rate. The average interest rate at the end of the half year was 1.79% and it increased during the third quarter to 2.13%. Higher market interest rates and slightly higher spreads are having a gradual impact on our average interest rate. The result in associated companies amounted to minus SEK 8 million, of which minus SEK 38 million related to the capital contribution to Arenabolaget during the period. This was offset by income of SEK 30 million relating to final recognition of the co-owned housing project in Lagern 3 in Rasunda. And we, therefore, reported profit from property management of SEK 1.1 billion, an increase of almost 2% compared to the previous year. Unrealized changes in value amounted to almost SEK 3.4 billion and I will come back to this very soon. The surplus value in the derivatives portfolio continue to increase during the quarter. The Central Bank's interest rate hikes and market expectations of higher interest rates have affected the valuation. We currently have surplus value in all the interest rates swaps. Overall, we reported a positive change in value of SEK 1.8 billion during the period. And finally, the tax expense amounted to minus SEK 1.4 billion and related to deferred tax. And now please turn to Page 5. In the real estate market so far we see few signs that the financial turbulence is affecting values. The few transactions carried out on the Stockholm market show that there is continued capital and interest in investing at high levels. Before the quarter, 35% of the portfolio was independently valued. In addition, in dialogue with Newsec and Cushman & Wakefield, we have performed a corresponding internal review of all major properties in the portfolio. Yield requirements are slightly higher, an increase of 8 bps to 3.77% on average in our portfolio. The increased yield requirements were offset by higher inflation assumptions, both Newsec and Cushman & Wakefield have estimated 7% inflation this year and 3% inflation next year. Thus, on the low side of current forecasts. Now, please turn to Page 6. Total unrealized changes in value during the period amounted to SEK 3.4 billion, of which SEK 253 million in the third quarter. The changes in value have been driven by the following factors: yield minus SEK 1.65 billion; cash flow, including then indexation, plus SEK 1.8 billion; and projects plus SEK 0.1 billion. And now, please turn to Page 7, key ratios. Reported equity increased by SEK 12 per share to SEK 153 and the long-term net NRV -- EPRA NRV amounted to SEK 185 per share. A significant proportion of the increase related to positive changes in value in the property and derivative portfolios. The approved but unpaid share of the dividend of SEK 629 million has been entered as a liability. The only key ratio that does not currently meet our target level is the debt ratio, which increased to SEK 15.4, otherwise the key ratios are in line with our goals and expectations. Our balance sheet is still very strong with a high equity asset ratio and a low loan-to-value ratio. And now we turn to Page 9 and financing. Financing is, of course, a very topical question in the current market situation. Today's review of how we are doing and what we are working with will therefore be a little extra detailed. External factors such as war and inflation have created turbulence and resulted in rising spreads, mainly in the capital market. Since last summer, the spreads in real estate bonds have skyrocketed. There has also been decreasing demand and it is clear that it's now very expensive to refinance bond maturities. Against the backdrop of the high prices, we chose not to refinance the bond maturities we had in June and September. In total, we have repaid SEK 2.2 billion in bond maturities. We have partly used the revolving credit facilities that we have in banks just for this purpose. But we have also taking up new bank financing. A 10-year facility of SEK 1.2 billion was disbursed in July. In September, we signed a 10-year agreement with Nordic Investment Bank, which is a new lender for us. Furthermore, in September, we signed another bank facility of SEK 1 billion, which was disbursed in the beginning of October. We get a lot of questions about what levers we sign at. As usual, we do not communicate the terms on individual agreements, but I can say this much, that the levers are less than half of what the capital marketing is offering right now and only slightly more expensive than what we have seen from the banking market previously. The commercial paper market has functioned better, although with demand that we perceive as more ad hoc. During the summer, things went quite smoothly, but since then it has again been sluggish with a lack of demand. It has been a bit better now in October, but we are still a long way from normal turnover of commercial paper maturities. At the end of September, we had a reserve of undrawn facilities in the form of revolving credit lines of SEK 4.4 billion, including the backup facility for the commercial paper program. The goal is to maintain a high level of preparedness, which we are now working on. We have ongoing dialogues with several of our banks regarding increased financing. Please turn to Page 10. As the slide shows, we are working with several different financing sources, among the lenders, apart from the Nordic banks we also see Nordic Investment Bank, European Investment Bank and Brunswick. As I mentioned just now, the exposure to capital market has decreased as bond maturities have been replaced by other sources of financing. Please turn page. We have worked for many years to spread our loan maturities. The slide here shows how the maturity profile looks. The strategy of long-term fixed rate periods is unchanged and we aim for distribution of our loan stock among several sources of financing. When it comes to short-term commercial paper, the green bar chart, then we have a full backup facility. Next year, we have bond maturities of SEK 2.4 billion in total, of which SEK 1 billion in Q1 and the rest in the second half of the year. Of course, we hope that the capital market we have reduced its risk assessment of the property sector at least towards the end of the year, but we are preparing to replace the maturities with other debt. We will refinance the bank facilities that mature during the fourth quarter of 2023 with each bank before the end of this year. Please turn to Page 12. We have not entered into any new fixed rate period since year-end. Of the loan portfolio, 67% is now fixed, mainly based on long-term maturities and mostly through straightforward interest rate swaps, supplemented by some fixed rate bonds. In the longer-term, the plan is to replace maturities with new long-term fixed rate periods. The high proportion of fixed rate terms today gives us protection against rising market interest rates, in particular this is reflected, of course, in the derivatives valuation. In the short-term, the higher market interest rates will thus have limited effect on our interest expenses. For a moving 12-month period ahead, and increase in the market interest rate of 1%, generates an increased interest expense of SEK 100 million, all else unchanged. Next page, please. This slide shows how Fabege's average interest rate has developed since 2008. From a peak, just under 3% to the levels in recent years of under 2% and currently 2.13%. Please turn to Page 14. Our holding of treasury shares now amount to 16.2 million shares, equivalent to 4.9% of the total number of registered shares. The shares have been repurchased at an average price of SEK 120.23 per share. We will retain these treasury shares until further notice. And we have currently paused the buybacks. And now back to Stefan.

So Slide 15, please. We haven't seen any major changes in our portfolio compared to the previous quarter. In total, as you know, we have 103 modern properties in very good locations. And we think that the location will be even more important when now the customers are demanding even higher quality and flexibility. Please go to the next slide. As Asa said, our yield requirement is now about 3.77% in the valuation. And the required yield has been falling gradually over the years, as you can see here, but we have an uptick during the last quarter and we see an increase in all of our submarkets apart from Hammarby Sjostad. In Hammarby, we see small yield requirements fell a little bit and that was because of the transactions that were carried out in the area during the quarter, and at levels that we hadn't seen before. So, please go to Slide 17. Here are some of the transactions that has been done during 2022 for offices in Stockholm. A lot of them we have been talking about before and you've seen that before. The last transaction that was made, as we know about at least, is that the acquisition that Folksam acquired, very well located, Vasahuset, close to the central station in early October at a yield just over 3%. And that's also -- that show us that long-term investors with long-term capital are still willing to pay handsomely for quality in Stockholm in good locations. Slide 18, please. This slide you've also seen before, many times. But I think it's important to show it because it shows that we have a very stable customer base with long-term contracts. As average, our lease terms are in total or the entire portfolio is about a little bit more than 5 years. But if you just look at the 10 largest, which corresponds to 27% of the total rental value, then it's about 9 years from a contract as an average. Slide 19, please. Here, we see a good rental development in Stockholm in the different areas since 2011. It's from Cushman & Wakefield. And we will see the forecast have for them, that rental trend will support and what we have seen in the market. During the year -- during the summer, we have seen a number of new agreements, even large agreements well below -- above SEK 9,000 per square meter in the CBD. And we also see -- have seen a lot, of course, is a unique contracts which is large and it shows demand across the market. Slide 20, please. Here, we see the forecast under development in the vacancy rates in Stockholm from 2006. As you see -- as you know, we have been relatively at low levels so far. We see, of course, slightly increased vacancy rates in this now. And I think we have to expect it to increase a little bit more, but the rents are holding up well, nevertheless. The increased vacancies exist and will continue to exist in our view, in older properties with poor public transport options. Within different areas, there will be -- also will be large differences between A and B locations. Properties that are located more than 500 meters from a rail station will face a tougher time. This slide also shows that we do not anticipate any supply shock. The total office stock is expected to increase moderately. Slide 21, please. The trend that number of office is increasing in Stockholm is also continuing even after the pandemic. The occupancy at offices around Easter was very low. It was not until after the summer that the increase started to return to office in little bit more or more. Today, we see that we have much more activity in all our areas in the offices. And I think what we also maybe have to do will that is now we weren't expecting poor economy that maybe we'd like to be at the office a little bit more. So, where we see, it's still a little bit low and we're talking about the public authorities in their offices rented by them. Next slide, please. We had another quarter of positive net lettings. And we feel confident, I'm hopeful that we will also be reach our goal that we have been communicating for SEK 80 million for 2022. Our sector peers have also shown positive net lettings. As you see in reports, peer or colleagues that are working with other offices have also have good net letting. And that I think shows little -- what's happening on the discussions we have in the market. That's good discussions, maybe they take a little bit longer time, but there is a good demand for good office, flexible offices in the Stockholm area. As you know, 2021, it was our third best year ever in terms of net lettings and we will -- but that also included the Alfa Laval contract. And this year, we haven't had any large project lettings. Please next slide. In total, the renegotiations is up about 10%, which is a little better than we hoped when we started the year. But we also have extent -- but we have what -- and we can see now is extending a little bit more contracts unchanged time, but that has to be viewed in -- the circumstance that we also have the indexation that we will see it from the 1st of January next year and today, it looks like it will be around about 10%. And that was our index for the commercial portfolio is, we have almost 100% of our contracts with the index link. So, again, that's one of the reasons that we're now choosing to not maybe renegotiate it's extend instead. But as we said before, as you know, we have also -- I think it's important to once again stress that we have a very long relationship with very large and stable tenants. Slide 24, please. I've said it before and I still think the vacancy rate is too high, even if its decreased during the quarter. We are working actively to improve the vacancy rate and we will get up -- getting down to 5%. We have continued to strengthen our lettings team during the quarter and during the beginning of the autumn. So if we can increase the occupancy rate to 95%, we have another, approximately SEK 150 million per year in rental potential. In the development portfolio, we have over the years vacated some properties too early. We are now working to find maybe short lease contracts that can improve the cash flow from -- in those properties before they go changeover into projects and are demolished or reconstructed. In the product portfolio, the totally known contracts is equivalent an occupancy rate of 27%, but both the projects in Flemingsberg, Operan/Dramaten and Alfa Laval are close to 100%. However, even today just 27% in total, I'm confident that the projects will essentially be fully let upon when it's time to move in. And in the long-term, this will generate another rental value of approximately SEK 400 million. Next slide, please. Here's our rent and development for the next quarters, the one this chart we normally show you. What you can see here is that, we expect indexation of about 10% from 2023, that will mean that we generate an increased rental income of about approximately SEK 60 million per quarter. Next slide, please. In total, we have invested so far this year of about SEK 1.6 billion, approximately SEK 1 billion is in project and development properties. And we will end up the year just under SEK 2 billion as we said before. And we will tell you a little bit -- we can go through this a little bit more in detail later. Moving on, next slide, if we turn to that one we will see it. The ongoing office projects we have for today is about 140,000 square meters. And the ones are -- the new ones during the year is Alfa Laval down to the right and Operan/Dramaten in the middle, Pasen in Hammarby Sjostad, down to the left, which we have no signed contracts insofar. We have Noten in the Solna strand upper right. It's one of the Swedish Tax authorities left in the beginning of the year and then we now -- it's under construction for the new -- no signed contract so far. And Haga Norra, which is in the middle -- up in the middle, it's where we have another 30,000 -- almost 30,000 square meters of offices. We think this will be a very attractive in Arenastaden. We have signed during -- the last week, signed the first contract here, and we expect to sign more contracts, especially next year. And then to the left, we have Kungsholmen, a Gladjen, which is almost filled up now. We're signing some new contracts after the summer and it's not that much space left. So this is what we have ongoing right now in the office products. We also have a parking project in -- going on right now. Please go to the next slide. We still get a lot of questions about Flemingsberg, how is it developing? What's happening? And we -- I think it's going very well. We have started to construct Alfa Laval as we said, and Operan/Dramaten. We are working with -- we are close to the municipality to -- with the planning process and the next step of that and that is a progress. So I think we will continue to be a lot of news during the next years. We have what I think is important to maybe stress when we talk about Flemingsberg is all the opportunities that there are where we are seeing in the campus with that both Karolinska Institute and Royal Institute of Technology, they are moving more and more research out in Flemingsberg and it's the 8 largest student campus in Sweden. So as we said before, it's a lot of activity already now. And now we take the next step in the development. So this will be -- it's very -- we still believe very much in this project. Next slide, please. The price development for the construction of the building. We have seen or we see an increase of about 10% to 15% on a moving 12-month basis. Some types of work have gone up even more. This, obviously, creates effects on our projects which are in the very early stage, the creation of the construction of Alfa Laval's innovation center, for example, requires a lot of steel in the construction and this has caused -- this among and some other things has caused the project exceed the budget by approximately SEK 200 million. We also have a lot of groundwork that has been -- that are in the Alfa Laval project and they also above the average price increases in total. We have not -- but in Alfa Laval project, I also think it's important to say that we have not fixed all [ purchasing ] prices and we're actively working with Skanska to reduce the cost. We do not see any large effect in Operan/Dramaten and in Haga Norra so far. And -- but, of course, we can't rule it out totally but we -- it's moving on much, much better. So Slide 30, please. SHH or as it will be named Birger Bostad. It's Birger, as our founder Birger Gustafsson. We are completing in the residential -- we are completing the ongoing projects. We have no decisions that have been taken -- no decision has been taken right now for new projects. And we have, as you know, the luxury of being able to -- or we are being -- we can keep our development rights in the portfolio and we can start projects when we believe the market and the cost structure has stabilized and are the right ones for the projects. So -- but as things look today, we will -- I think we will see in the home market a few new housing projects. So first enterprise that have started during the next quarters. So, Asa, tell us a little bit more about this sustainability work.

Sustainability is a fully integrated part of our business that incorporates everything we do. This slide is not new but shows what some of the strategic initiatives have led to. And we then turn to Page 33. Netherlands-based GRESB, Global Real Estate Sustainability Benchmark, is a comprehensive benchmarking tool used by institutional and financial investors to monitor investments and navigate their strategic choices around new sustainable capital investments. The GRESB ranking covers a broad spectrum, such as environmental topics, social sustainability, governance and follow-up. A total of over 1,800 property companies in 73 countries participated in this year's ranking. And this year, we increased from 93 to 94 points, result we are very happy about. We are measured on many KPIs. You can see some examples here. It's about governance and policies, energy consumption, waste management, emissions, et cetera. And please turn to Page 34. Energy consumption and energy costs have been in the strong focus after the summer. Of course, Fabege is also affected by higher costs, however, to more limited extent than many others. For many years, we have worked to reduce energy consumption in our holdings through investments and streamlining processes. The graph shows how the consumption of total energy that is electricity, heating and cooling has decreased since 2012 from 140 to 74 kilowatt hours per square meters. Based on these figures, we are far ahead in the industry. The green line in the diagram shows the primary energy demand that applies to the EU taxonomy top 15%, that is the requirements for the properties to be classified as green according to the taxonomy. Not all of our properties meet that requirement, but the average shows that the majority of our properties meet the taxonomy' strict requirements. And now, please turn to Page 35. In the slide, we can see sustainability house in Haga Norra in Solna. It's our building establishment for project development in the area. The house is 70% built from recycled materials and largely all the furnishings and the furniture are also recycled. For us, this has been a pilot project to learn from before will now scale-up recycling in our projects. In all our projects. We are now have specified sustainability goals and CO2 is calculated with the aim of reducing CO2 footprint as much as possible. We also have an ambition to contribute to the community around our district through various measures. This work has become even more important by virtue of our investments in Flemingsberg where we are present with several different initiatives. And that's all for me. So, back to you, Stefan.

Thank you, Asa. So with all this said, it's of course, very turbulent markets we're living in. We have a lot of challenging geopoliticals. We have a very challenging geopolitical situation. And it's a -- there are many -- it's a tough sea that we have to navigate here. But it means, of course, a lot of challenges, but it also means a lot of opportunities. I think we were well prepared to take both challenges and handle them and take care -- take the opportunities when they are arriving. So with this, thanks for listening to us. And we'll now go to -- time for questions. So, please.

[Operator Instructions] We have received a question from a number that ends with 1793. Can you please introduce yourself and ask your question?

So I have a couple of questions. Given the current level of funding cost that you are seeing in the debt market, what level of property yield do you think -- what's the yield outlook that you have currently? Also, given the overall level of market rental growth, again, I just need to have a sense of the valuations, property valuations, what kind of outlook you have? And another question that I have is regarding the various sources of debt. What -- given that current differences in rates in the various markets and of the upcoming maturities, is there then a risk that you may become overreliant on banks, if such conditions continue? Yes. That's all from me.

Look, yes, we start with the last one maybe, Asa.

Yes, I can start with the last one. Regarding the financing, as mentioned during the presentation, we have several different sources of financing, including bank financing and capital market financing. And with the conditions that we have indications on from the capital market at this moment, we are more considering to replace capital market financing with bank debt. So this is also what we have done during the second and the third quarter of this year, and we're also preparing for going over to more bank financing if needed. Our target is, of course, to be present on the capital market, but not on the conditions that we see right now. So hopefully, the capital market will recover at least towards the end of the year, but we are preparing for replacing capital market financing with bank debt. And I think also important is that, with the loan-to-value that we have of 36%, we have plenty of securities for secured bank debt if needed.

I think that is an very important comment. When talking about the valuation, I can say, as you know, and as you said, we valued externally more than 1/3 of the properties this quarter. Majority or all the larger ones are also were valued internally. In this close discussion with external Cushman & Wakefield and Newsec. And where will market go? I think, increasing interest rates will, of course, normally mean high yields. And -- but then we also have to look at the submarkets where the transactions with -- a few transaction we have seen has been at much lower yields and we have had in the valuations. So we haven't -- exactly what we think is the yield -- the best is the valuation we have. And when talking about the indexation, we expect rents to go up about 10% next year and that's also what you can see on one of the slides when we said we expect plus SEK 60 million per quarter -- quarterly next year in rental growth because of the -- thanks to the indexation. So I think it's very important for us. It has been for many years to use external values every quarter and we're close to them because they have the best view of the market. Is that the answer for your questions?

And the next question comes from the telephone line that ends with 1894. Could you please introduce yourself and ask your question?