Grainger plc (GRI) Earnings Call Transcript & Summary

Good afternoon, ladies and gentlemen, and welcome to the Grainger plc Half Year Results Investor Presentation. [Operator Instructions] The company may not be in a position to answer every question received during the meeting itself. However the company can review all questions submitted today, and we'll publish our responses where it's appropriate to do so on the Investor Meet Company platform. And before we begin, we would just like to submit the following poll. And if you could give that your kind attention, I'm sure the company would be most grateful. And I would now like to hand you over to the executive management team from Grainger plc. Helen, good afternoon.

Good afternoon, and thank you all for joining us this afternoon. I'm joined by Rob Hudson, our CFO; and Kurt Mueller, our Head of Corporate Affairs. I'm very conscious that some of you know Grainger very well. Some of you will know us from the past and some of you won't know us at all. So I'm just going to start with a very short introduction to the business. We are the U.K.'s largest listed residential landlord. We've been around for 113 years. But in 2016, we changed our strategy to focus on purpose-built build-to-rent. And we now have a significant portfolio of over 11,000 homes. But importantly, we've got a pipeline of 5,000 homes. And that means that we're going through a period of significant earnings growth. Before I start talking about the results for our half year, which we presented last week, I just wanted to take a moment to look at, a, how resilient this business has been, but also the pillars for growth as well. Thanks, Kurt. So just looking at that, we have had an outstanding period of performance, and I'm going to talk more about that in a moment. And in fact, this is driven by the fact that we've gone through a rapid portfolio expansion, but also we've gone through a period of strong like-for-like growth. One of the great things about Grainger is it has this lovely inflation-linked characteristics. We're in a structurally supported sector. By that, I mean we're in a country with a housing shortage and also, there is a particular shortage of good rental homes. We've got a growing population. We've got growing demand. People are pausing the point at which they buy a home. So there's significant growth to come in the build-to-rent sector. And then we're accelerating our growth. I mentioned the pipeline, but we have got a leading operational platform. We do most of the things ourselves. So everybody is interfacing with the Grainger person. And that means that actually we can drive our margin and drive further efficiencies. And all of this, we're going to explain, is leading to an accelerated period of earnings growth. And in fact, we are guiding 50% earnings growth by full year '29 and 25% by full year '26. I'll briefly touch on the headlines. Despite some things you might see in the newspapers, et cetera, actually, like-for-like rental growth is still higher than the long-term average at 4.4%. We've got a 15% growth in our net rental income. Our earnings were up 23%, and our dividend is up 12%. And we've got very robust valuations. Our values have been protected, in fact, are growing at GBP 3 per share. This is really built off a strong operating platform. So we've got -- we've 96% occupancy, which we consider to be full. We do like to have some void so we can refresh it, et cetera. We've got our gross to net, so that's the cost taken out of our gross rental is 25%, which is extremely efficient. And then we've got very strong customer retention at 62% and very healthy customer affordability at 28%. I'm just going to skip to a slide that -- it's one of my favorite slides. And it really talks about the track record of Grainger. So the top lines here at the top are the way that we have grown our rental income over recent years. We have grown our earnings and dramatically improved that EBITDA margin. So that's our track record of delivery. But what's really positive is we've got clear visibility of future growth in our income, in our earnings and in our margin to come. And I'll just show you why that is by going to our pipeline. So some of you will remember Grainger from a long time ago when we were mainly regulated tenancies. Those are tenancies where people have the right to stay in property for life. And as they come empty, we actually -- we sell those and that funds our pipeline. We have got over GBP 2.8 billion of purpose-built build-to-rent, and then the exciting thing is on the right-hand side, we have the pipeline of GBP 1.3 billion. And the important thing to note is that, that GBP 1.3 billion is funded. It's funded from our asset recycling. And the committed pipeline alone is what's going to add the 50% turning growth in the short term. So what I'm going to do is just hand over to Rob, who can explain how those schemes that will come forward in the near term will generate greater earnings growth.

Thank you, Helen. So we've got some very significant rental growth coming through. And you can see here how that pipeline, which Helen has just spoken to translates to very strong growth in rent and ultimately then in earnings as well. So just staying on the midsection of the chart, you can see our committed pipeline. This is where we're on site. In fact, we're largely through the delivery of these schemes. So we've got great visibility over this. And this is growing our rents to GBP 153 million. And this is actually growing off the base of GBP 110 million last year. So you can see it's very material growth, which is coming through. And that growth is immediate. So GBP 7 million being added from these schemes in the second half of this financial year, GBP 10 million next year and then continued strong growth thereafter. So very rapid growth coming through in terms of the top line. And then we have our secured where the planning permissions are already in place and then planning and legals where we're working through that process. That has the ability to add a further GBP 40 million in rents on top, which will continue to feed that pipelines, we'll continue to have that nice progression in very strong rental growth. Now we've given some visibility over the compounding benefit that this further has on our earnings growth, which we're all very excited about at Grainger. You can see here our guidance towards EPRA earnings growing by 50% by FY '29, so over the next 4.5 years now. And that's off the base of GBP 48 million that we delivered in FY '24. And just giving you a flavor of the key building blocks, which are going to deliver that growth. The first one is rental growth. So this is our organic like-for-like rental growth, which we've assumed as a very long run rate average of 3.5%. This is a relationship which goes back over decades. And of course, at the moment, we are performing slightly ahead of that. The second piece is the pipeline effect. And this is looking just purely at that committed pipeline, that midsection that we just saw in the rental bridge. This is where we're on site and taking that element of the pipeline, the committed pipeline. And this is the rent which is coming through from that, net of the assets that we're disposing of to fund that, which is our older style regulated tenancies, we're selling out of a 2% rental yield, and we're reinvesting into a 4.5%, 5% rental yield. So we have a very nice income pickup. The next piece is the EBITDA efficiencies. We've invested a lot of time, effort and resourcing into establishing our CONNECT digital operating platform throughout the business. This has digitized the whole of the customer journey, which has improved the customer experience and also importantly, make things more efficient for us to operate. So that means in practice, as we're delivering this very rapid expansion in the business, the central overheads are being very tightly controlled. They're just growing broadly in line with wage inflation. We're not having to add lots of new heads in order to deliver this growth. So each new home, which we add on to our platform is very accretive to our profitability and our earnings. And our EBITDA margins, our net margins are growing with this growth from 54% for last financial year to 60% by FY '29. And that's purely the impact of scaling up. And then the final element is higher interest costs. So here, we've modeled rebasing to higher interest rates. Clearly, we're in a higher rate environment. We took a lot of proactive action when the Ukraine war broke out, and we refinanced the business. We did GBP 900 million of refinancing at that point. And we also locked into fixed interest rates for what was nearly 7 years at that point. So we still have 3.5 years of that left to run, and we don't need to refinance over that time. So we're in a very strong position financially. But towards the end of this guidance period by FY '29, we've shown here the effect of rolling off and see what current projections for interest rates will be, which would be around 5.5% in the mid-3s that we're at today. And then we've got some modest reduction in our leverage and debt levels, which is very deliverable for us given our ongoing strong cash generation in the business and the sales which we make. And then that's the net impact. So we're fully absorbing those interest costs, and we're still growing our earnings by 50% over the period through FY '29, which we believe puts us in quite a differentiated position to many in the real estate sector. And then we have further growth potential beyond all of this with the further elements of the pipeline that's secured and the planning and legals, which we've seen. Now if you look at the bottom left of this slide, all of this translates to what we see as an 8% plus sustainable total accounting return. So this is the growth in NAV and dividends, albeit with the share price as it currently stands, this would actually reflect on a share price basis around an 11% per annum return. The 2 elements which are driving that assumption are the 3.5% like-for-like income growth, which leverage that gives a 4.5% capital return and then the 3.5% income return, which is driven by the growth in the earnings that we're delivering here. So again, lots of visibility. And we regard that as a very low volatility return. I'm just going to quickly move back a couple of slides to talk to the strength of our financial position. And we are in a great position with respect to this. We, as I mentioned earlier, have our cost of debt fixed in the mid-3% for another 3.5 years, and we're effectively fully hedged at 97%. So we're very well protected. We actually generate more than GBP 200 million per annum of operating cash flows as a business through selling out about all the properties to regulated tenancies. So that's meaning that we can self-fund and continue to grow the business for many years ahead. And we've got no material refinancing requirements until 2029. You can see at the bottom right, our path to reducing leverage over time. And we will ultimately -- we've given a bit of an indicative range here. You can see it's coming down. This is very deliverable for us. It's around GBP 300 million or so of debt reduction. But ultimately, we will judge that level of reduction according to preserve our guidance of 50% earnings growth. So ultimately, where interest rates will settle down to, but we've got lots of optionality, lots of time to deliver this, and it's actually equates to around a year's worth of sales for us. And then the final thing, which we're all really looking forward to at Grainger is REIT conversion, which has been trailed for some time now, and we remain on track with respect to our program for delivery. And that's conversion, which is set for early September as ready for our first full financial year of being a REIT, which will be FY '26. So not too far away now. We're under 6 months, and all the preparations have been done for this. And we just need to meet the technical balance of business test 75% of the assets and profit sitting in the build-to-rent as opposed to the legacy trading business and the regs. So we hit that point towards the -- ready for the start of September. People often ask me what this actually means. In terms of how we operate the business, the strategy and the execution, there's no change to the business model at all with respect to that. We can continue to sell our regs and we will do so. There's no impact on our growth or the funding. And in fact, residential businesses really we regard as being the perfect fit for the REIT structure given when it was first established many years ago in the U.K., it was in contemplation of residential businesses being a great fit. In terms of the impact of the dividends, I have seen one of the questions come in about this, which I think I can just talk to here. Because we've anticipated becoming a REIT for quite some time, we set our dividend on a trajectory, which means that there's no significant step-up or step down on converting to a REIT. It will continue to be maintained as a progressive growing dividend. And we will move to the dividend being linked to EPRA earnings from next financial year FY '26, paying out at least 8% of those 80%, should I say, of those EPRA earnings from that point in line with other REITs. And we will have a top-up of our regs profits in the first couple of years and will be fully covered then by EPRA earnings from FY '28. What that means in practice is that the dividend will continue to grow when we convert to a REIT. And because our EPRA earnings are growing so much 50% plus in the years ahead, that provides a great backdrop for the dividend to continue to grow.

Thanks, Rob. I'm going to just now take us to Grainger's shareholder value creation model and just look at the 5 ingredients that actually are delivering shareholder value. So on the top of this slide is obviously the structural market tailwinds, and I'll talk about those. We've got this fantastic correlation between inflation and rental growth, and that's proven itself over recent years. We've got a scalable operating platform, and that means it's going to accelerate the scalable operating platform delivers in terms of customer service, customer retention, but also for shareholders through accelerating our EBITDA margin. And then, of course, we've got this substantial pipeline to grow. The regulated tenancies and their reversionary income, because we keep those regulated tenancies in our books at about 80% of value, actually are the growth engine for the business because we recycle out of those and fund our pipeline. And all of it is on the basis of a strong balance sheet. So I'll just quickly touch on supply and demand dynamics. Obviously, there's a growth in rental demand, and that's set to continue. In fact, the English National Housing Survey and Savills predicts that we need 20% more rental homes by 2031. And also growth segment on the chart top right here, the biggest growth segment is the 25- to 34-year olds. But the professional build-to-rent sector still only represents around 2.3% of all rental properties, which obviously the majority being buy-to-let landlords. So just looking at what is affecting supply as well, at the point when demand is growing, supply is reducing, and it's reducing because there is an overall shortage of housing. And I used a stat in the results presentation that of the 33 London boroughs, 23 of them haven't seen new housing starts in Q1 of this year, which is quite worrying when it's one of our biggest growing cities. And then we've obviously got small landlords leaving the market because of increased regulation and increased financing. But it has proven to be a really strong asset class. On the next slide, you can see that actually rental growth mirrors very closely wage inflation. But it's actually much -- on the bottom right chart here, you can see that residential rents outstrip CPI, they outstrip the commercial real estate. And so generally, they're a really great hedge against inflation. We obviously look quite carefully at what this means to our demographic. On demographic, I mentioned earlier, healthy affordability, 28% of net rent -- of net household income spent on rent. And this is the group whose salaries move the longest, I think over 45, sadly, your salary starts to dip. I mentioned -- I think it's worth mentioning the political backdrop. The -- and it's worth mentioning because, obviously, there were some concerns when the general election was called last year that a socialist government would introduce rent controls, but our Prime Minister -- Deputy Prime Minister [indiscernible] the Housing Minister have been absolutely adamant that they're not introduced. And we now have really clear visibility about the Renters' Rights Bill and what that's going to do. It will make changes, but actually, we've got a modern energy-efficient platform -- properties. We are pet-friendly in many of our properties, and we've got really great data and insights that are helping us run that. One of the things I would say is that we are changing some of our processes to respond to the proposed Renters' Rights Bill. But by and large, we see our business as being extremely resilient in dealing with that. So just going back to that shareholder value creation model, the structural market tailwinds, supply and demand imbalance that we have, the inflation-linking characteristics and the accelerating EBITDA margin as well as the method by which we fund ourselves, that's leading, as Rob said, to a 50% growth in our earnings by full year '29 and actually an immediate 26% growth in our EPRA earnings by 2026. 8% plus total accounting return with very low volatility and of the current day share price, that's about 11%, a progressive dividend, as Rob has described. And we think generally, this is a business that offers excellent risk-adjusted returns. And with that, I'm going to pause and ask Kurt to ask us some questions from -- please send in your questions.

Thank you, Helen. We've answered the first question around expected dividend post REIT conversion. The second question is related to the 50% EPRA earnings growth and whether this is on a per share or an absolute number basis.

Yes. Thank you, Kurt. That's a great question. Actually, it's all of the same because we're -- all of this is based on self-funding. So we're recycling out of our older noncore assets. So there's no new share issues assumed in order to deliver this increase. So it is 50% growth in absolute and per share.

Our next question is from Alan, and he's wondering whether there are any potential property acquisitions as part of our pipeline.

So we're always looking. When we started on the strategy, there were not many purpose-built high-quality rental blocks for us to buy, but obviously, that's increasing now. So we're looking at stabilized acquisitions, and we've also got a fantastic land bank adjacent to our existing properties to bring forward when the timing is right.

Thank you, Helen. Our next question from Marcus. We have GBP 1.1 billion of low-yielding noncore assets earmarked to fund our growth. How quickly do we expect to recycle these assets? And what impact will it have on overall portfolio yields?

Yes. That's a great question. I mean we -- just to give you a feel for that, we've done GBP 549 million over the last year and -- 2.5 years, yes. So we're getting through around GBP 250 million. I think last year, we peaked at GBP 274 million. So you can see that there's probably about 5 years to go through that. But what's really great about it is that, of course, we're rolling off that lower yielding into the high-yielding assets. So that's going to have -- that's in part what's driving that growth in earnings.

Thank you, Helen. We have a question from Peter. How do we see upcoming legislation, renters bill, et cetera, impacting on our business model and the broader rental market?

Yes. It's a really interesting point. We have in our business at the moment, I think, it's 19 working groups on making all the changes to our technology. We are very fortunate. We've got a sort of -- we've got a basis of our technology platform which we built from the start of our strategy. And I think it's going to be quite easy for us. I think it's going to be quite hard for smaller buy-to-let landlords who manage through managing agents who may not be as familiar. And so we -- a lot of the aspects because of the quality of our properties, the energy efficiency of our properties, we don't have to worry about things like damp and mould. We're already very familiar with pet-friendly policies, et cetera. I think it is going to be quite challenging for some elements in the market. And we've seen that because that's been part of what's driven small landlords to exit the market. And I think in the autumn of last year, I think 2 of the major estate agents put out data showing that something like 16% to 18% of all sales on their books were ex rental properties. So actually, I think it will actually impact on supply.

Great. Thank you. Peter -- I believe it's the same. Peter has another question. Given the current hedging position and debt maturity profile, how flexible is your capital structure to opportunistically respond to market shifts or acquisitions?

Yes. I mean we have a very flexible capital structure because if you look over time, we've had many sources of funding available to us. And the key source of funding at the moment is our focus on the GBP 1.1 billion of noncore assets, which there's quite a lot of flexibility over selling through those, which gives us quite a material amount of firepower when compared against a lot of other real estate businesses. Also within our debt structure as well, we have flexibility to temporarily flex up or down. We do have an ongoing plan to reduce debt, as I referred to earlier. We are incredibly attracted to lenders, by the way, because of the low risk, low volatility. So we get a lot of inbound in terms of debt. But we actually have around GBP 0.5 billion of undrawn headroom to give you a sense of that degree of firepower there. So we do have an awful lot of flexibility.

Thanks. David has a question. What criteria do you consider or favor when assessing which developments to own?

I don't know that you can do 2 things at once. Kurt, get back to Slide 27. Forgive me if you can't see this very well. But basically, we don't invest in Scotland because of rent regulation, but we do look at the 58 towns and cities in the U.K. We don't -- we invest in the top 22 rental cities. And what we're looking at on the chart on the top right here, we have a research team, and we're looking at 20 different -- 22 different economic growth data sets. So that's things like population growth, wage growth, the growth in a local economy, 6 success factors that will mean that it's a great place to live. And then we're also looking at supply and demand in the submarket. And it won't surprise you that the best rental city in terms of supply and demand and also -- is London. But we have great investments in Bristol, Manchester, Birmingham. You could probably list the main cities where we are because they usually have big employers, big teaching hospitals, big good universities, et cetera, although we do cap our students at no more than 10% students. And that's because we want to create a real differential between what it's like to be in a student property and what it's like as a young professional in a well-managed block.

Thank you. Second question from David. Do you have in-house maintenance teams? Or do you outsource?

We outsource the larger repairs and then where we have a cluster of properties together, we will actually have handyman services. So small things that are easily fixed. It's surprising how many people find they can't change a light bulb, sort of small things, we have people that are based in the cluster of buildings that they can fix. But larger things, we have a really good supply chain. And one of the things about clustering is that it has actually improved our procurement of goods.

Thank you. A question from James. Beyond cladding, are the emerging regulatory or compliance risks related to building safety or environmental standards that could materially affect your portfolio?

Yes. So I should say, James, that our portfolio, most of it was built post-Grenfell. So actually, we don't have major planning issues within our portfolio. Some of the legacy assets, we took 100% provided for those. So that's -- and also we've got recourse to the original constructors of that. In terms of the changes, obviously, there are changes in building safety. We've managed to thread the needle quite well there just because of the timing. I think the building safety regulator is finding their feet at the moment. But coming to your sort of third element, if you like, which is environmental standards, we operate at really high standards. Over 95% of our portfolio is already compliant with the proposed 2031 standards. And actually, this makes great business sense for us because when people rent with Grainger, they get more than just their property, they get low bills, they get Wi-Fi included in their rent and they get a gym in the building. So you can see that it actually makes it quite economical for our customers as well. So in summary to that, I don't think any of those issues will materially affect our portfolio. And obviously, we're watching very closely the development of the building safety regulator to make sure that it doesn't affect our pipeline either.

Thank you. Question from David. Do you have a program of refurbishment works? For example, things like retrofitting ventilation systems, either passive or mechanical solutions, if required?

Yes, we do. We basically have sort of an asset management team that look at refurbishments. I should say that the small sort of refurbishments, unlike a lot of our European counterparts, we put that through our gross to net. So we don't capitalize them. We assume that this is business as usual to do refreshes, et cetera. We are looking to -- we have -- many of our properties have air source heat pumps, and we are looking as the gas boilers phase out, we will introduce other forms of heating to continue to drive our energy performance standards. The only time we really capitalize, if you like, our repairs and maintenance is really where it's a big refit, maybe taking it back to the frame or doing a comprehensive repositioning of a building.

Thank you. Question from David here. Are build costs a possible negative to your assumptions for FY '29?

Well, I'll come on to Rob. I'll just talk about build costs at the moment and explain that one of the things that Grainger does is it always fixes our costs before we go on site. And that 2029 guidance is everything that's on site. So it's our committed pipeline. So you can see that actually it won't impact it. Also, if the contractor is delayed, we take compensation for rent as well. Is there anything you want to add to that?

No, no, I think you've highlighted all the points, we are derisked with respect to that. So we're in a good position overall.

Great. Thank you. I have no more questions. We've answered them all online. So if you have any questions, please add them. Otherwise, I think that's it.

Absolutely, Kurt, Helen and Robert, if I may just jump back in there. Thank you very much indeed for your presentation this afternoon and for being so generous of your time there and addressing all of those questions that came in from investors this afternoon. And of course, if there are any further questions that do come through, we'll make these available to you immediately after the presentation has ended. But Helen, perhaps before now, just really looking to redirect those on the call to provide you with their feedback, which I know is particularly important to yourself and the company. If I could please just ask you for a few closing comments just to wrap up with, that would be great.

Yes. So I think just I'll go back to our shareholder value creation model and say that for Grainger, we're in a very, very good sector. We've got structural demand and undersupply, and we have evidence over this recent period and over the longer term that we can provide inflation-linking returns. And all of that is coming in the immediate term as well. And all of that is giving, we think, shareholders a very good risk-adjusted return. And I say this because we're very proud of our product. If anybody would like to go and have a look at the Grainger property, then we'd love to give them the opportunity and wherever you are, we've probably got in one of the major cities, something that you could have a look at. So many thanks for joining us this afternoon.

Thank you.

Thank you.

Perfect, guys. That's great. And thank you once again for updating investors this afternoon. Could I please ask investors not to close this session as you'll now be automatically redirected for the opportunity to provide your feedback in order the management team can really better understand your views and expectations. This will only take a few moments to complete, but I'm sure it will be greatly valued by the company. On behalf of the management team of Grainger plc, we would like to thank you for attending today's presentation. That now concludes today's session. So good afternoon to you all.