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

Welcome to Fabege's presentation for the second quarter and the first half year of 2023. As usual, we will finish up with the question-and-answer session. And it's also, as usual, possible to submit questions by e-mail to ir@fabege.se. And you can do that -- that was the question on answering question. So please go to Slide #2. I will not use much time to go through this slide. But as you know, we -- but I'd like to stress the focus we have at Stockholm and especially some suburbs in Stockholm, where we have the modern portfolio in rail-bound locations. So very good public locations in focused areas. So next slide, please. To summarize the first call to say, it's a strong half year. We had increased rental income, we had an operating surplus. We had, of course, negative values in the property portfolios. I think that was -- one could expect. But we have a positive net letting in the second quarter, and in total of the [indiscernible] of SEK 22 million. And on top of that, we have signed, as you know, the LOI regarding the rental of entire Noten 4 at Solna Strand, in total that is 66,000 square meters. And we will give you more information about that when the contract is signed and that will let you know what we plan. But of course, during the quarter, we also increased interest costs. And Asa will now tell you a little bit more about the figures in more detail.

Thank you, Stefan. Please turn to Slide 4. In the first 6 months of 2023, we reported increased rental income and improved net operating income, which was not fully covered by increased interest expenses. However, we reported a higher profit from Property Management for the second quarter specifically compared to the previous year. Increased yield requirements in the property portfolio have continued to put pressure on property values. Rental income amounted to SEK 1.7 billion, corresponding to an increase of 12% in an identical portfolio. The increase in income was mainly due to the index linked increase that did into effect at year-end, higher parking revenue and positive net occupations during the period, of which Convendum's move into Bocken 39 at Kungsgatan was the largest one. And this was partly offset by a negative effect of the Swedish Tax Agency's relocation from Noten 4 on the last of March last year. Increased operating expenses were mainly due to a higher cost for energy and snow clearance, and the surplus ratio came in at 74%, which was in line with expectations. In the [indiscernible], gross profit amounted to SEK 27 million as 5 projects were completed and were final recognition took place during the second quarter. Central administration costs came in at minus SEK 55 million, in line with the previous year. Interest expenses increased compared to the previous year, which was due to a slightly increased loan volume and higher average interest rate. The average interest rate increased from 2.39% at the year-end to 3.1% at midyear as higher market interest rates are gradually having an impact on our average interest rate. The result in associated companies amounted to minus SEK 27 million, of which minus SEK 36 million related to capital contributions to Arenabolaget during the period and SEK 9 million -- positive SEK 9 million related to contributions from [indiscernible] co-owned projects. And we, therefore, reported profit from Property Management of SEK 703 million, a slight decrease compared to the previous year, which was due to higher interest expenses, but as stated, somewhat higher in Q2 specifically. Unrealized changes in value amounted to minus SEK 3.8 billion, and I will come back to this very shortly. The surplus rate in the derivatives portfolio decreased by SEK 100 million. The tax expense, which only related to deferred tax was positive and amounted to plus SEK 687 million. Please turn to Page 5. During the first 6 months, the increased market interest rates continued to have an impact on yield requirements and valuations. There were still only a few transactions in our market and the valuations are most been influenced by transactions that were not completed. During the quarter, we have independently valued approximately 60% of the portfolio and the other properties have been internally evaluated. The average yield requirement in our portfolio increased by 6 basis points during the quarter to 4.17%. The increased yield requirements were partially offset by higher inflation assumptions. Both Newsec and Cushman & Wakefield now expect an inflation rate of 6% in 2023, and the average yield requirement is now back at a level equivalent to what we reported at year-end 2018. Total unrealized changes in value then amounted to minus SEK 3.8 billion. Please turn to Page 6. The simulation shows that we can withstand write-downs of a further almost 20% based on today's market valuation without impacting our internal targets and the margin is even higher in relation to the covenants in our bank agreements. Next page, please. Reported equity decreased during the quarter and amounted to SEK 134 per share. the long-term net asset value, the EPRA NRV amounted to SEK 161 per share. The loan-to-value ratio increased to 40%, and the equity/asset ratio decreased to 47%. However, both key ratios continue to indicate a very strong balance sheet. The interest coverage ratio as expected, has decreased in line with increasing interest expenses and amounted to 2.6. Calculated on a moving 12-month basis, the interest coverage ratio was 2.9. Next slide, please, financing. Financing continues to remain a focus in the current market situation. The commercial paper market is functioning well and the banks continue to show that they have more capital to lend to the sector. The bond market is still volatile with high prices. In connection with the bond maturity of SEK 1 billion in February, we carried out a small issue of SEK 250 million. The spreads have then come down to [ 11 ], which was, as a first step, felt sufficiently okay to show the market that we would like to be active. Since then, the spreads have widened again, and we have continued to prioritize bank debt. During the first 6 months of 2023, we have raised new bank facilities of SEK 2.9 billion, and we have repaid bonds of SEK 1.2 billion. We are now in the process of refinancing bank maturities in Q2 and Q3 2024, and we are also increasing our bank facilities in connection with this by a further SEK 1 billion. Taken together at midyear, we had SEK 5.9 billion in unutilized facilities, including the backup facility for outstanding commercial papers. Slide 10, please. 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 a distribution of our loan stock among several funding sources. The short-term funding via commercial paper, the green bar chart is fully covered by backup facilities. During 2023, we have remaining bond maturities of SEK 1.2 billion in total during the second half of the year. We are prepared to change over these maturities to bank financing if the market does not improve. And as I just mentioned, we are also in the process of refinancing upcoming bank maturities, including raising increased bank facilities to manage upcoming maturities. Page 11, please. Just over 60% of the loan portfolio is fixed, mainly based on long-term maturities and mostly through straightforward interest break swaps, supplemented by some fixed rate bonds. Just over 40% of the current loan portfolio is matched by fixed rate terms beyond 2025. We are currently holding off on entering into further fixed rate terms, but the longer-term plan is to replace maturities with new long-term fixed rate periods. The high proportion of fixed rate terms today provides us with protection against pricing market interest rates. In the short term, the high market interest rates will thus have a more limited effect on our interest expenses. For a moving 12-month period ahead, an increase in the market interest rate of 1% generates an increased interest expense of approximately SEK 127 million, all else unchanged. And now back to Stefan.

Thank you, Asa. A little bit short about the transaction on the Stockholm market. In the beginning of the year, we saw a couple of transactions done mainly between institutional investors, pension funds [indiscernible] they were pension funds or relisted companies as selling. In the second quarter, we haven't seen that many transactions, but a few that have been done are -- has been on good levels. There are some also done with family offices that has been on buying side. Next slide, please, a little bit more on the rent development in Stockholm. The contracts we are signing has been on good levels. The whole market are still good -- stable levels. Even in the CBD, we can see record levels of some -- not in our -- and we haven't signed any of those levels, but I think we are -- connects us in -- so even 10,000, 11,000 [indiscernible] in the CBD. So it's a stable market. And we're talking about -- we got the index -- indexation of 11%. I can say that we haven't had -- we have very few discussions with tenants. And also when renegotiating, we are -- I think the levels in -- certain levels we have seen -- so it's a good, stable run onto the market. Next slide, please. The take-up at the beginning of the year, a little bit lower. It's less activity. But even here, we see a good demand, but -- but it will, it's longer decision process. So it takes longer time for -- get to signed the contract. Next slide, please. The offices in Stockholm has the last 10 years [indiscernible] been growing, but are flattening out the last almost 5 years now. But a number of office employees has been continued to grow, even if we're now seeing a little bit more down, but it's a very good, very high levels. And then we see that will continue. And with that said, if we go to the next slide, please. The vacancies. We have seen a little bit increasing vacancies over the last years in -- especially in some part of Stockholm. In the inner city and the CBD, it has been very low, but in some other parts of the -- for example, [indiscernible], we have larger vacancies. But we see -- it's also now we continue to grow a little bit in the beginning of this year, continue to grow. But it's surprising, I would say, stable, and it's a good market here. The next slide. But of course, we're all the tenants, potential tenants and I think all companies and tenants are discussing how will the future of the office look like. We will see more and more people coming back to the office. We see more and more companies saying that the office is the base for the business. Of course, as the digital transformation changed how we're working, of course, both from how we travel and how we do -- how we have the meetings. But we see -- I think also we have -- we'll be -- refurbishment, we're doing more smaller rooms, for example, so I think in a smaller meeting room for team meetings, et cetera. Another trend is that the sustainability is even higher up not only for the owners, the property or real estate owners, but also for the tenants. I see much more discussions about how we can help them to be sustainable. The need for flexibility is solicit and services also on those issues that we are discussing now. So of course it's changing. Of course, there's a lot of discussions, which is positive discussions that the office is still or even more important, but the public transportation [indiscernible] is even more important than 3, 4 years ago. Next slide, please. As you know, we have a negative net letting during the first quarter. In the second quarter, we have a positive net letting. And in total, for the first half year, we had plus SEK 22 million. On top of that, we had the LOI we signed with a tenant for Noten 4, and we will announce more details for the contract is signed Q3. But so -- there has been more -- a lot of activity, as it's been positive discussions. And I think it's still a good market here. Next slide, please. We used to show you this slide, and I think it's important to do so at every presentation we have to stress the quality of the tenants we have. The 25 largest tenants represents more than 42% of rental value, but it's long contracts, it's good quality tenants. So next slide, please. The renegotiations. As we said before, it's -- we got the uptick with 11% in the 1st of January. And now we extended during last year -- large amount -- unchanged terms, and we continue to do so. On the ones we really have the renegotiations discussions, we had -- were up about 1.5%. So I think it's quite natural for us -- now also when we see the index, maybe up 6% to next year to act or to extend on those terms. So next slide, please. We have positive trend of the occupancy rate. We have said this before. Our goal is to increase this to 95%. It will take some time, but the beginning of this year since we are increasing, and we're working with this with a focus on the rental or the letting discussions, as you know -- the letting work. So we -- this -- we are happy that we have a trend that is right -- in the right direction. Next slide, please. We tried -- we since couple of years given you this slide about the rental development in the existing lease portfolio. And it looks like this today. As you know, we also said before, the Q2 was a little bit better than we said before, but that's mainly because of the parking income we have. So you see this as help to know what we see as what we know today and -- in the existing lease portfolio. Next slide, please. There's a couple of years, we try to show this picture on this slide to give you our view of what we know today about the rental development on the existing lease portfolio. And it's about what we know, relocations and renegotiations we've had so far this year and -- but no index. So if you can add maybe another [indiscernible] before. So it's to show for what is under contracts today. I think -- the Q2 this year is a little bit better than as also said before that we said [indiscernible] because of the income as in the fee parking has been better than we expected it to be. So please, next slide. CapEx. This year, as said, we will end up with approximately SEK 2.9 billion. Next year will be a little bit lower. I will not -- I don't think I have to comment that much more. So next slide, please. In the Project portfolio, the positive here is, for example, in quarter 1, where we have now signed even more contracts. And I think we will -- this will be up to about 67%, over 70% after now signed contracts. And that hopefully, we will have the whole contract later this quarter. It will be a little bit larger area, but because it's a whole -- even the common area, so we will be good in that complex. So on in that, we'll add quite a lot to the total. So we're -- after that, it will be up more than 75%, I think. In Flemingsberg -- they were bringing on and they were -- it's less than the year when [indiscernible] will move in. [indiscernible] is still low [indiscernible] here, but we have very good discussions about the tenants there. So I feel very positive for all those projects actually. Semaforen, we have to remember that, that is parking house. So that will be a little bit different. So we will now have -- not having signed long projects. Next slide, please. When talking about the suburbs. And I just like to say some few words. We are on journeys. We are in a journey from, for example, in Arenastaden, the industrial area that was less than 15 years ago to what we are today. We know that [indiscernible] the offices, and on top of that, we have [indiscernible] last year at 50 million visitors and it's owned, as you know, by Westfield. We have 2,000 people living in Arenastaden and we are only half way, as we used to say, we are in the journey. And in Haga Norra, we are also at the journey. Five years ago [indiscernible] facilities look like. You can see here in the middle of the picture. Right now, we're halfway through the vision for 2028. We have the first quarter, as I said before, under constructions. We have the first apartments [indiscernible]. It's a journey. And if you go to the next slide, please, is Solna Business Park. We're also on the journey. But we're much more existing buildings. But during this quarter, we had opened a new food court, which increased the activities in the area. We have new gyms. We have other facilities for an active life. We have signed a couple of new contracts with, for example, [indiscernible]. And we have the hub for recycling also here in Solna Business Park. So it's lot of things going on. It's a journey. If we go to [indiscernible] -- also to have on the first one, I can say the same, it's a journey. We have been working with this for more than 20 years. It started as an industrial area, and it's now area full of activity. We have some of the houses of the buildings are the old that have been developed but also a lot of new build, both residential and offices. It's a really attractive area and it will continue. And as you know, we have a couple of future projects in -- even here. And in all these areas, we are the #1 of real estate owners. So it's a really attractive and interesting areas. In Flemingsberg, the journey has already started. But the real -- the whole of Flemingsberg started 60 years ago when there were only 350 inhabitants in the area. Here, you can see the first building. It's our building [indiscernible], which was built in 1964. You see in the next slide, please, you can see what we have today or rather what's today in Flemingsberg, it's 15,000 workers, 15,000 residents, it's 18,000 students. It's the eighth largest student campus in Sweden actually. And also here, we are now taking the next step to -- for the vision of Flemingsberg, which you can see on the next with a 50,000 resident, 50,000 workers and 50,000 students. And we are right now in the planning process. It would not look exactly like this in real, but it's a vision of which direction we work in. Next slide. Here, you can see that you know about the project in Alfa Laval [indiscernible] project. We are now also -- you can see here a new that we are talking about [indiscernible]. It's an old building that the first in the area as we said, where we're now work and we will keep this. It will be developed, and it will be part of the future of Flemingsberg. So we were investing even in this now typically for new tenants. We have signed some new contracts and to take this more than I see it. If you look really close to this picture to this slide, you can also see that is a new, small light on -- in the town the level and above the slide, you can see a small building, which we have acquired during the quarter. It is [indiscernible] and we thought it was important to be had control over this for the future development. It's a small -- it's an investment of about SEK 20 million, but can be the important part of that for the future. Next slide, please. We hear a lot about the residential market in Sweden. And it's tough. It's tough for many, it's especially in no new projects or almost very few -- or very few at least, very few new projects started. But on the ongoing projects for Birger Bostad, they are running as expected. We have completed 5 projects during the period. And what maybe was surprised you, we have sold 21 apartments since the year-end, and this is especially -- mainly the south of Stockholm. In the joint venture, we have with BRABO and Haga Norra, we have since the 1st of January sold 34 apartments. And we now have only 10 left. We had [indiscernible] when we started some years ago, and we had now 10 left to sell and 34 has been sold. So in total, we have sold 55 apartments since the 1st of January. And with that one, we're very happy and satisfied with. But it also means that if they're ready to be -- almost ready to move in, that still a market for residential -- in Stockholm. And on this next slide, you can see also where -- just to summarize the building rights we have, both for the commercial and residential. And talk about the building constructions costs, unfortunately, nothing new, I would say. They're still at the same high levels as we saw a year ago. Some of them, for example, concrete, wood, some steel has been coming down. On the other hand, the weak Swedish krona had impacted in price of electronics, for example, and some also work labor forces. So -- but we see now more problems for the construction industry. We hope it will come down during the next 6 months but still at very high levels. Next slide, please. Asa, please tell us a little bit more given our update on sustainably work.

Yes. Sustainability continues to be a prioritized issue at Fabege, and we are gradually working to contribute to more sustainable Stockholm. On the energy side, we have set the target to reach an average energy use of maximum 70-kilowatt hours per square meter by 2025. We are currently at an average level of 73, and the goal is to reduce this by 1 per year over the next 3 years. Part of this work involves investing in expanding -- expanded solar cell capacity. And we are also investing in more charging points, which are being increased and demanded by our tenants. Recycling is also a very topical issue. We introduced the circularity goal for the year, but at least 20% of the material in our projects must be reused material. One part of this work is our recycling hub in Solna Business Park, where we now collect and catalog material, which can be recycled. So far, this is only -- this only occurs in Fabege projects. But in the longer term, we hope that this will become a more general marketplace for recycling. Next slide, please. Here in this slide, you can see our sustainability house in Haga Norra. The sustainability house, which is constructed by using 70% reused material has attracted a lot of attention. Technologies for retention and reuse are being developed and we have a lot to learn from each other in the industry. And you can shift to the next slide, please. And for example, here, you can see what different materials have been reused, everything from facade to floors, doors and cooling units. And finally, I will hand over to Stefan, who will say a few words about our social sustainability efforts.

[indiscernible] summarize, that is a special focus on Flemingsberg, and what we can do there to increase the trust, the safety -- working together with other real estate owners, together with the local community. And we are especially focusing on education, the employment and on the leisure time. And there can be activities in sort in sport, in dance, for example, culture, where we have a little big project with [indiscernible]. We had a festival last -- 2 weeks ago for the [indiscernible] with the music and we're helping the schools. And also I can say that the [indiscernible] academy, which is going to get people out to work last year held 62 people. I think it was [indiscernible] work or to start study. And that's really made a change for the local community. So please, now time for questions or comments. So, Ansa, please.

[Operator Instructions] The next question comes from John [indiscernible] from Kempen.

Could you provide a bit more color on what your expectations are for market rental growth? I mean looking at your numbers last quarter, you were signing some leases at roughly 4% below ERV. But then now it's flipped to 1.5% year-over. Is this reflective of the market? Or is this more of a sampling issue?

I assume you mean renegotiations which was slightly negative last quarter and which was slightly positive this quarter. I think last quarter, we said that those renegotiations that went minus were dominated by a few contracts on the retail side. And those renegotiations that we have done in the second quarter are mainly just ordinary office rental agreements. So I think the plus 1.5% is more or less 0, which is also what we have communicated before, that we are quite happy just to prolong contracts according to existing terms, which means that there is not really any uplift. But the figure, 1.5% is, of course, on the positive side. But on the other hand, there's only a small amount of contracts being renegotiated, more contracts are just being prolonged on existing terms.

Okay. That's clear. And then that essentially means that your reversion in your portfolio is currently 0 after the indexation?

I think, as you know, we got the indexation uptick of almost 11% from 1st of January, and now they're expecting inflation of about 6% for next year. And so I think we are at a good -- we have a good rent level now that I think is also the market rents. So some contracts may be still under-rented, but also maybe some that are over-rented because of -- but in general, I think it's a good rent level, and we continue to see the good stable market in Stockholm.

Okay. Perfect. That's clear. Maybe on the Noten 4, what exactly does the LOI depend on?

Sorry, I didn't get your question. What exactly?

I mean it's only an LOI at this point in time. So it's not converted to a lease. Is there any conditions that needs to be met?

We have some discount to finish, and we will sign the contract during Q3, the lease contract. But we'd like to announce this because we draw the Noten 4 from the market, and we also have had to say, no thank you to some potential -- other potential tenants. So that's why it was important for us to announced that we have an LOI and that we're going for signing a contract during -- lease agreement during Q3.

Okay. Fair enough. And in your report, you mentioned that the new approach is being adopted and that the investment will be adjusted. Any color you could provide on which direction the total investment will go? And anything that could be set on yield on cost after this adjustment?

Regarding Noten 4.

We will announce more figures when we also are announcing the tenant and the tenant -- the contract. So we will give you all information at that time. So today, we will not say that much more. But it's included. You can say also that we have -- when you look at the investments, we are -- the CapEx for 2024, for example, for about SEK 2 billion. It will be -- I think it's around that in the way. So there's so much we can say.

We can maybe add 1 more thing about Noten 4. Since there's been some rumors that the potential tenant is only going to be there for a very short time. And so we confirmed earlier today in the Swedish call that it's a long-term contract. It's not a temporary contract.

The next question comes from Kownator from GS.

Kownator from Goldman. Just as a quick follow-up on Noten. I think if you -- if we calculate the yield on cost from your development pipeline, it's around 5%. Is that ballpark of the number? Or is that number going to evolve? I appreciate you don't want to comment on the latest conditions, but just be good to comment on that number that is from your release. First question, and why don't we start by that? And then the second 1?

I'm sorry about -- even here, we'd like to say that we give you more figures, and we'll give you more details when we -- will have signed the contract.

Okay. So which didn't rely on the existing parameters from that slide at this stage that effectively we should understand?

Yes. As long as nothing as has been said, so yes.

Okay. Second question, if I may, just to follow up on the interest coverage and the increase in interest costs given the hedging that you've also in place. How should we think about the interest coverage ratio? It's 2.6 currently for half year. How do you expect that ratio to evolve? Is it going to go down a bit further? And what are the rating agencies tell you about the sort of threshold that you need to maintain not to be downgraded given you're always on negative watch?