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

Welcome to the Fabege Fourth Quarter 2022 Conference Call. [Operator Instructions] Now I'll hand the conference over to the speakers CEO, Stefan Dahlbo; and CFO, Asa Bergstrom. Please go ahead.

Good afternoon, and welcome to Fabege's presentation of the year-end report 2022. As usual, we will finish up with a Q&A session, and it's also possible to submit questions by the e-mail ir@fabege.se. And you can do that during the whole session. Today, we have -- a little bit more than 100 properties worth a little bit over SEK 86 billion. As you know, we have a very modern portfolio with very good locations with rails and -- and so the infrastructure is very good in our areas. And we really continue to believe in that you being close to the market we are working on being close to our customers. And that's also -- that's why we are so much focusing on area and also the way we are handling all the property management charity along staff stages. Please go to the next slide. Summarizing 2022 is not so easy for anyone. -- easy to think of 2022 as I know is when that was a horrible year with a dynamic, with a war, with raising inflation, and rising interest rates. But after summer, the market was partly dominated by concerns about the possibilities for property companies in general refined financing. So it was a different year. And I just like to already now clarify that I am not worried about our refinancing possibilities this year and next year, but also will tell you more about that -- but there are also some positive things to look back on [indiscernible]. We had positive net lettings during all 4 quarters, and in identical portfolio, we increased our income by approximately 3%. We also started and continued on several projects. We have developed to continue to develop Flemingsberg, we continue to develop Solna. And also, when talking about the sustainability work, we continue to be at the cutting edge and taking step-by-step, especially in energy. We'll talk about editions. But now we will start in figures, and I will hand over to Asa to report a little bit more about what's happened for the last quarter, especially.

Thank you Stefan. Please turn to page 4. Our business is going well with increased rental income and positive net lettings, as Stefan mentioned. Inflation and rising market interest rates led to falling property values during the fourth quarter, and I will come back to this shortly. Rental income amounted to SEK 3.3 billion in an identical portfolio, income increased by 5%. The explanation was the same as the last quarter, increased rental income from completed project properties like Nationalarenan 3 and Poolen 1, positive effects from indexation, new lettings and renegotiations, which were offset by reduced income after the Swedish tax agencies relocation from Norton 4 in Solna. Increased operating expenses were mainly due to higher property tax and higher electricity costs. On the operations side, we still managed to reduce electricity consumption by 11% during the fourth quarter compared to the previous year. Meanwhile, other winter-related expenses decreased compared to the previous year. The surplus ratio came in at 74%, which is better than what we expected at the start of the year when we assumed a higher property tax than what was the outcome. Visible stats current earnings amounted to SEK 2 million before write-downs. However, we have written down the value of Visible stats development properties by SEK 81 million, which resulted in a gross profit of minus SEK 79 million. Income recognition takes place in connection with the completion of projects and partial recognition of a few projects occurred in connection with taking possession in 2022. Ahead of 2023, we expect a positive contribution from housing developments ongoing projects. Central administration costs came in at minus SEK 102 million. The previous year's expenses included also nonrecurring cost for Fabege's head office. Interest expenses increased compared to the previous year, which was due to an increased loan volume and higher average interest rates. The average interest rate increased further during the fourth quarter from 2.13% to 2.39%. High 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 32 million, of which minus SEK 56 million related to the capital contributions to Arenabolaget. This was partly offset by income of SEK 30 million relating to final recognition of the co-owned housing project in Lagern in Solna. And we therefore, reported a total profit from property management of SEK 1.4 billion, a decrease compared to the previous year, which was almost entirely due to higher interest expenses. -- unrealized changes in value amounted to minus SEK 233 million after the fourth quarter's write-down of almost SEK 3.4 billion. I will come back to this very soon. As a plus value in the derivatives portfolio decreased slightly during the quarter. All interest rate derivatives shows plus values and overall, we reported a positive change in value of almost SEK 1.8 billion during the year. And finally, the tax expense amounted to minus SEK 588 million, of which SEK 3 million related to current tax and the remainder to deferred tax. And now please turn to next page. During the fourth quarter, the increased market interest rates had an impact on yield requirements and valuations. There continues to be a few transactions in our market, but the valuations have also been influenced by transactions that were not completed. In the fourth quarter, we have independently valued just over 80% of the portfolio, all properties were thus independently valued during the second half of 2022. The average yield requirement in our portfolio increased by 12 basis points during the quarter to 3.99%. The increased yield requirements were partly offset by higher inflation assumptions. Both Newsec and Cushman & Wakefield now expect 4% inflation in 2023. In total, unrealized value changes during the quarter amounted to minus SEK 3.7 billion, which including the previous quarter's upward revaluations meant a write-down of minus SEK 233 million for 2022 as a whole. The changes in value in Q4 have been driven by the following factors. Yield, minus SEK 4.7 billion. Cash flow, including inflation, plus SEK 1.7 billion, and project and development properties, including development a write-down of minus SEK 0.7 billion. And now turn to the next slide, please. The simulation in this slide shows that we can withstand write-downs of further almost 25% based on today's market valuation without impacting our internal targets. And the margin is very high in relation to the covenants in our bank agreements. Next slide, please. Reported equity amounted to SEK 145 per share at year-end, an increase of SEK 4 during the year. The long-term net asset value, the EPRA NRV amounted to SEK 173 per share. The loan-to-value ratio increased to 38% and the equity asset ratio decreased to 49%. However, both fee rates continue to demonstrate a very strong balance sheet. The interest coverage ratio, as expected, has decreased in line with increasing interest expenses. Last week's transaction with JM when we saw development rights will strengthen our key ratios somewhat. And now please turn to page financing. Financing continues to be a topical question in the current market situation. However, I believe that the pressure on property sector has eased since the bond market improved for A-rated companies. The commercial paper market is working, and the banks have shown that they have more capital to lend to the sector. Since last summer, the spreads in real estate bonds have gone sky high. Now we see that there is interest from investors and that the margins are declining. However, still at levels which mean that we prefer to replace bond maturities with bank loans. We replaced the June and September maturities with bank loans. We will do the same with the maturity now in February. The commercial paper market is now functioning well again, and we have increased the proportion of outstanding commercial paper. We are currently borrowing almost 3 billion in the commercial paper market at an interest rate of STIBOR plus 70 basis points. During the third quarter, we raised new bank facilities. And in the fourth quarter, we agreed on a further SEK 2.4 billion in new facilities, existing bank facilities of SEK 3.5 billion were also extended. This means that at year-end, we had SEK 7.3 billion in unutilized facilities, including the backup for outstanding commercial paper. We get a lot of questions about what levels we sign. But as usual, we do not communicate in terms of individual agreements. However, the bank margins have only changed marginally during the autumn. Please turn to next page. As this slide shows, we are working with several different financing sources. Among other 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 the capital market has decreased as bond maturities have been replaced by other sources of financing. Please turn to the next 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 capital maturity is unchanged, and we aim for distribution of our land stock among several sources of financing. When it comes to short-term commercial paper, the green bar in the chart, then we have a full backup. In 2023, we have a total bond maturities of SEK 2.4 billion, of which SEK 1 billion in Q1 and the rest in the second half of the year. The Q1 maturity will be replaced with bank loans. But of course, we hope that the capital market will gradually offer more competitive terms. We are prepared, however, to replace even later maturities with other debt. And the work on refinancing bank debt that matures within 12 months is continuing. Please turn to slide 11. 65% of the loan portfolio is fixed, mainly based on long-term maturities and mostly through straightforward interest rate swaps supplemented by some fixed rate bonds. We will now hold off with further fixed rate terms, but the plan in the longer term 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 only have a more limited effect on our interest expenses. For a moving 12-month period ahead, an increase in the market interest rate generates of 1% generates an increased interest expense of just over SEK 100 million, all else unchanged. And now please turn to slide 12. Our own holding of treasury shares now amounts 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. We will retain these treasury shares until further notice. We have currently paused the buyback. And now, back to Stefan.

Thanks for the review Asa. Slide 13. As we started the only focus we have and continue to be the focus of the Stockholm market. On this slide, you can all see the average growth of the Swedish counties for the last 9, 10 years. And also what are expected for the next 10 years. And the Stockholm has been growing very well and will continue as expected to continue that growth. Stockholm is the real center of Sweden in many ways. Even if we can see grow higher growth in both north of Sweden and some part in the south of Sweden, but Stockholm is still center. Next slide, please, slide 14. The rental market in the Stockholm and in our districts remained relatively strong during the autumn. I'd say relative because at the end of the year, it was a little bit softer. The number of viewing is still at a good level and that also grew for the first quarter of this year. But it may still take time for the customers to take the decisions. When we started the year, as we said, we had the COVID-19 situation, then which came the war. And now we have all the question marks about the economy and how it will develop. So I think it's quite natural if we're sitting and making a decision of moving, for example, on a rating signing a contract, you take some time to, some discussions before you make a decision. But one -- so one of the effects of the dynamic was that many companies stayed up. They were stayed put and waited with taking decisions also how much office they need. We see both companies that are reducing areas, but -- and some are increasing after coming back to the office, but many are still discussing how to maybe not change the area, but how should the area be used, that's a common question right now, I think, how to use the area. And that's what also we are really in close supporting our tenants in that. The rental development for Stockholm is that is very stable. We have seen increasing rents in -- especially in the CBD over the even at the end of the year. So the rental market and the room level is still at a very good level as expected to continue to be so. Next slide, please, slide 15. And with that said, we will expect to see a little bit higher vacancy rates in the stocker. And especially in not industry, we're not talking about the CBD. We're not talking about the areas with good transportation or public transportation. It's more in the less attractive areas with less flexible offices that we expect to, we think, and also I agree with this forecast from Cushman & Wakefield that it can be -- that will continue to grow a little bit even in--. Next page please. We had for the whole year a net letting of plus SEK 86 million. And we had all positive net letting all the 4 quarters. We haven't seen our colleagues or sectorial products reported yet. But for the third quarter, most of the companies have positive net letting. And I said that is also the best answer where we are expecting the office market to go. Next page, please, page 17. We have a stable -- this is -- we have this every time because we think it's very important that showing you that our customer base is very long, very stable. It's strong companies and it's long leases. And as the lease we announced last year is, for example, running to 2047. It's not yet here because they will move in 2025, but the SEBs, 2037 and so on. So long contracts with stable and strong customers. And that also will, of course, is highly regarded in our discussions with the banks and the capital market. Next slide, please. This is off a little bit more than SEK 170 million, where were negotiated with an average increase in the rental value of 7%. But in addition, leases of more -- a little bit more than SEK 340 million were extended on unshared terms. And that is a little bit different from the year 2021, that was also mainly because of that, we saw that the indexation were helping us increasing well. So it was -- that's one of the reasons that we just extended on unchanged terms. But the indication from year-end will limit also the future potential for the renegotiations. There we have to be realistic and expect around 0%. And the majority of the leases will probably be renegotiated on unchanged terms. So it will look a bit from now, thanks to the station. Slide 19, please. Occupancy rate. We have, as we said before, we are about 90% occupancy rate. We're not satisfied with that. We have a focus in the coming years on increasing to more lower what we say, 95%. And it will take note can't expect that to come it will take some time, and it will step by step. The larger vacancies is mainly related to 3 properties in Solar Business Park. However, it feels positive with what's happening right now in Solar Business Park, and we have several good discussions, I'm optimistic. We also have some vacancies in Hagastaden and we have -- but I think not we have also -- but we have a very good group working with this right now, and I'm -- it's really will be focused on for the next years. Next slide, please. This is a rental development for the existing lease portfolio. And here, we can see very clear that it's -- we're increasing from 1st of January with about 10%. And for the whole year it looks good growth. We started the year with in total about SEK 250 million in increased rental income thanks to fixation. Next slide, please, slide 21. The investments increased by approximately SEK 400 million at 2021 and came in at about SEK 2.3 billion. We have a long-term goal as a forward being at an average SEK 2.5 billion in the existing market climate, and so we will, of course, be cautious about starting new products, mainly because of the costs. There's still questions about the cost. We're seeing the steel price coming down. We're seeing some of the prices coming down, but still it's a little bit too expensive. And also with the current question as for the economy developing, of course, it will be much more. But if we have a signed contract for a single ton of course, we will have new products. We were -- so hopefully, we can announce later this year, some new ones. We have the ongoing projects. And they are right now going into the next phase, and we see even more expensive and it's -- that means that we will expect 2023 to come in with an investment of about SEK 2.8 billion. And then we come back and show you where projects we're talking about. So next slide, please. There have been a couple of transactions in our markets during the end of the last year and the beginning of this year, there have been at very good levels. It's been a mix of buyers from the insurance companies and from the private investors. Here, we have some examples. AMF is a Swedish pension fund, America is private, actually equity partners that has been buying some offices. This is 1 of 3, 4 properties that have been acquired last years, America is 2 of the partners behind that company, we have [indiscernible] company acquiring [indiscernible] and maybe some of you have been staying at that hotel. We don't know exactly that price. The Billman was a record level of SEK 210,000 per square meter, but it was quite a good yield, it's 3.6%, 3.7%, but that mean because it was one single tenant, and it was a long contract. We also saw some other private investors buying both residential and office buildings in the Central Stockholm at very good levels. -- was at the building that --. So selling to a fast in the middle also see that are also at very good levels in the beginning of this year. Next slide, please. The project portfolio. Here, I would not all other figures, but we have been talking before about Noten, where we regulator in Flemingsberg, which is for Upland Martin. We have Haga Norra where we signed a contract with JM last week, and we also signed one with Jim. So it's -- we're now very -- we feel very confident that we fill that up during the year, and it will be -- will be able to move in during the second quarter and end of 2024. And so this is the projects you already know about and that we are working on. The building rights with for the residential last week, what we think very good price levels. And the rest, we will continue to work on, but it's especially in the planning processes and so in Flemingsberg, the works continue. And so we -- as we said before, we are not -- we don't have any new decisions for new projects during the last quarter. The next slide is talking about the -- or showing a little bit about the price development, everything last year got more expensive. -- we estimated the price increase to be at about 10% to 15%. It's still, let's say, the -- it has changed a little bit as we said, is steel and wood price has been coming down. Energy prices are still at a very high level even if it's very volatile, we expect salaries to increase by maybe best guess right now is for 4%. But the uncertainty is around the construction cost together with which is a food prices of tenant owners apartment in the residential market, there are very few projects started. We will see, but we are working at, we're also defining the product to be able to cut the costs for new products, both in the commercial and -- so I will hand over to Asa tell you a little bit more about the sustainability.

Please turn to Page 28, sustainability. Sustainability continues to be a prioritized issue in Fabege, and `we are working to contribute to more sustainable Stockholm. What is now new is that we have set targets on the path to net 0 emissions. By 2025, the carbon footprint of our projects shall be reduced by 20%. After that, a gradual reduction on the way to a goal of having the carbon footprint by 2030. We have also established a circularity target. It means that 20% of the material in reconstruction projects over SEK 20 million shall be reused material. Saving electricity has been in the focus during the autumn, supported by digitalization and target efforts, we have managed to reduce consumption by a total of 11% compared to the previous year. This is good both for the climate and for the financial position. And our social initiatives mainly in Flemingsberg, where young people in focus are continuing. And this is all from us today, and we are now pleased to open up for questions. Thank you.

Sorry to interrupt. Maybe we're-- leaving over to the question, say a little bit about the dividend with proposing. Or the Board of Directors are proposing a dividend of SEK 2.4 per share. It's a little bit down from the last years where we have been paying -- have quite a high payout ratio to compared to the cash flow. It's in line, the proposal is in line with the dividend policy that Fabege has and has had for many years. We think or the Board thinks it's a balanced in -- we also see in what we -- what the opportunity can be in the market and what's all the uncertainty that is in the market, as I said, it's staying around or proposal of the dividend in line with the dividend policy should be. And that it's 2.4% is a little bit higher than the policy, but -- but it's below the last year's and balance we think, what the Board thinks. So with that, we can leave over for questions.

[Operator Instructions] And our first question here will come from Paul May with Barclays.

Alright, thanks for the presentation. Just got 4 questions. First one is on the fixing period for the debt. I think it notes an average maturity of 2.7 years, but just wondered how much of that fixed proportion is expiring each year just to get a sense as to how the cost of debt will evolve. Shall I ask all the questions or do you want to do one by one?

One by one, I think it's-- We have to remember all the questions. Well, to start with interest fixing. Actually, on page 11 in the presentation from the Q4 report, there is a table explaining which interest rate swaps will come due over the next 10 years. So I think the full explanation is in that picture.

Okay. Cool. I'll take that one. You note, I think, in the report that market expectations after property yields to expand further. Is that also your thinking? And how -- if it is, how do you see those yields evolving over the coming year?

Well, what a question. No. But what we said is if interest rates continue to go up, I think we have to expect the yield to come up a little bit. But we -- I think it's very difficult to have a forecast for that. If we're now seeing more flat interest rates, maybe -- because it's difficult also difficult since we see the Stockholm market and especially the CBD in the city and now areas to be very attractive for the investors. And the inflation rate is also continuing with -- so we have -- we are expecting an uptick or continued uptick because of the index in the rent level. But I think we have to be and say that if it's increasing rate, it can be more higher. But we have no forecast for exactly what that would mean.

I suppose I asked a slightly different way. At what level would you think the market would be attractive again for acquisitions. I appreciate you've not acquired much in recent years because you felt things got too expensive. Just wondered where you would see it as being attractive again, given that a higher interest rate environment?

It's also difficult since we have the interest -- the potential we have in the portfolio of potential projects. So it will be me. But I think it also depending on the area, a little bit up from this level. So I think it can be attractive to look at. When we have said before that we have been bidding for some of the properties in the last years. And then we have been, say, let's below about 10% below that values and maybe whether -- now it can be possible if people really need money.

Yes. Okay. I think linked to this, you mentioned the slowing leasing market. I appreciate CPI has been strong, but I think you mentioned the limited reversion now in the portfolio. Does that play a factor as you said, you had people buying assets because of the reverse because of the inflation, but if the reversion isn't there, is it as attractive to pay the low yields on those assets. So just sort of seeing how you feel that leasing market will evolve over the coming months or coming quarters?

We have a lot of interest and a lot of questions and a lot of us, but it's still a very long time for the -- before we get the decisions. And I think that's mainly -- and it started last year with the COVID-19 situation. It came to war. And now it's more because of the uncertainty in the economy, I would say. So I think we have to expect this year to be -- I think we are positive, but we think that all the discussions will take some time and take time before we get the decisions. But the interest is there. But it's -- so that's also one of the reasons we have strength team so we can work with even closer with the potential tenants.

Is it a question of rents? Or is it just simply a question of certainty or confidence...

More the uncertainty to what -- first of all, of course, still, it's a question about how should we use the office and how should they be? But then we think it's very positive. People in the office is important, but exactly how should we use it and how should we plan it. And then -- but also that the cost for -- not for the rent, I think that's probably maybe of course, is always a discussion, but also taking the cost to move and this is the right cost to take. That's -- it's a long decision a little bit longer than normal, but positive discussions, but -- and a lot of them.

The last one a couple of initials there. CPI, I think, was 10.9% for the Swedish leases for this year. Are the annualizing of your sort of gross rent and income sort of guidance should we say, annualized in Q4, it looks like the forecast year is only up by about 6%. Just wondered, has that been -- have you had an issue pushing through the 10.9% for all tenants? Or is it a timing factor? Has there been some occupancy change? Just trying to understand why it's not up by 11%.

It's a very good question. We have said before, we will expect the rents for the year to come up with the cost thanks to the index, to SEK 250 million. It's a little bit less because in the Q4 also, you have to add, but we saw also some parking incomes -- that has been quite good in the Q4. And they are not really so -- but we have no problems to push the index through in the contracts. And as you also know, we have very stable and long-term contracts with big Swedish companies. So it's mainly because of some mix -- the mix of contracts and the incomes in Q4. But Asa can you...

Well, just maybe one clarification that in Q4, we had some extra income from parking, which is very difficult to forecast since they pay by the hour in many of the parking spaces that we have. And the other thing was that we debited electricity costs -- so increased electricity cost for Fabege also meant that the income forwarded on tenants was larger than before. So those 2 are the main reasons why income increased in Q4.

And I think you mentioned in the past that you may -- you felt you may have had some difficulty with some of the ground floor retail tenants. And have you had any issue with the rent increases there? Or has that just been passed through and maybe accepted.

Not really. We -- I think in general, maybe some of our colleagues have more, but we have not that much retail. So that's one of the reason so it's a very limited...

I think how you may notice it in 2023 is more in future renegotiations and that the uplift of 11% will have a negative impact on rent reversals going forward. So we don't really expect any additional income from renegotiations in 2023 since we are more on market plans now.

Yes. And if -- sorry, on that last bit, if inflation were to stay elevated, I mean who knows where we'll end up in October. Do you think that, that might be more difficult if you're already at sort of market rents limited reversion, I appreciate contractually, you can push through the indexation, but that would take you -- in that scenario, that would take you to an over-rented position. Is that a more difficult conversation? Or is that just for a conversation when the lease comes up for expiry?

I think we have to say it will be tougher the negotiations, it will be. But we still -- we have long contracts, strong tenants. And so I think everyone knows that the inflation is cost increase for everyone. But we can maybe add on that topic also that the inflation that the valuers are expecting for 2023 is 4%.

Okay. Okay. And do they make a negative impact or then renegotiating at a lower market rent? If you're already at reversion potential and then you increase your rents, so you're over rented, do they then have negative rents coming through in future years? Just trying to understand how the valuers approach it.

Maybe in some submarkets, but generally not in the Stockholm market.