Grainger plc (GRI) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen, and welcome to the Grainger plc Full Year Results Investor Presentation. [Operator Instructions] Before we begin, we would 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 morning.

Good morning, and thank you, everyone, for joining us this morning. I'm joined today by Rob Hudson, our CFO; and Kurt Mueller, our Head of Corporate Affairs. Last week, we presented our full year results, and they were very strong in terms of the growth in our earnings, in our income and in our margin. And what we're going to do today is take you through an abbreviated presentation and then leave plenty of time for question and answer. One of the things that has happened to Grainger this year that we've actually delivered, we are the U.K.'s leading residential REIT. So we converted to a REIT in September. And what that means is that now -- we're free from corporate tax on our income. We are the largest build-to-rent investor operator in the U.K. And one of our real strengths is our operational platform, which is a real barrier to entry in a business that has a high degree of customer interface. and we have a long track record of proving our earnings and our growth in value. The one thing I would say about our underlying business is that we're a low-risk business, but we offer really attractive inflation-linking income stream. On the top right of this chart, which I hope you can see, is actually how closely we track wage inflation. And also, the quality of our product is very high. The majority of it was built since 2017. Those of you that know us for a while know that we've been around for 113 years. So we're obviously -- the last 10 years, we've just been concentrated on new purpose-built build-to-rent. In terms of our guidance, we're still guiding to GBP 60 million in terms of EPRA earnings to full year '26 and GBP 72 million by full year '29. And as a reminder, that's a 50% growth from full year 2024. And that's after we absorb higher interest rates. Our current debt is fixed in the mid-3s. But as we refinance that, obviously, interest rates will go higher. But actually, our earnings still grow considerably. Our rental growth is expected to stay at 3% to 3.5%, and we've got a really sustainable track record of rental growth with a very strong and diverse customer base, and we've got strong underlying fundamentals of demand for new homes and actually the shortage of smaller landlords exit the market. And all of that is going to deliver our earnings growth. So I'll just quickly capture the headlines of our financial performance. Our net rental income was up 12%. Like-for-like rental growth was 3.6%, 12% growth in our earnings, 10% growth in our dividend. And our value of our assets, our NTA was resilient at 298p per share. And then in terms of operations, we had very strong operational delivery, 98.1% occupancy, which is higher than we would normally run, very strong customer retention at 61% and good customer affordability. On average, our customers are paying 28% of their income on rent, which is below the national average. And we've got a very efficient operating platform. We're running at 75% margin on our rent, so 25% gross to net. And one of the things that we've been doing during the year and over the last few years is proving our values by delivering sales. So I want to just remind people that over the last 5 years, we've sold GBP 1.9 billion of assets. We've constantly been refreshing our portfolio. And over the last 3 years, which has probably been one of the harder investment markets, we've sold GBP 640 million, and that's been at our valuation. So our valuations are robust. We still have over GBP 900 million of noncore low-yielding assets to recycle out of, and that is actually funding our future investment. I think it's worth talking about our capital allocation strategy. One of the things that we have a strong pipeline for growth. And in our committed pipeline, so those are the schemes that are on site, we have GBP 343 million of committed pipeline. It's this committed pipeline that's going to drive the GBP 72 million of earnings. We only have GBP 130 million remaining to invest in that. And then we -- our next step will be to reduce our debt. So that's -- we're planning on reducing it by GBP 300 million to GBP 350 million. And in a moment, I'll ask Rob to take you through that. And that's in order that we manage our finance costs. Then, as we continue to recycle out of that GBP 900 million, we can consider other routes to growth. We've obviously looked at stabilized acquisitions. We've got a very strong secured pipeline, and we've got a pipeline in planning and [ legals ], which is our future growth pipeline. And then, of course, we will consider increasing our capital returns to shareholders. So we have a very clear order as to how we deal with our capital. Just looking at our pipeline, we still have over GBP 0.5 billion in regulated tenancies. As a reminder, these are the tenancies that were created before 1988. And as they roll off, we sell them, and that funds our new pipeline. Our overall operational portfolio is GBP 3.5 billion. GBP 343 million, which is the dark bar on this, is the committed pipeline that I've just spoken about. Only GBP 130 million left to invest there. And then we've got a secured pipeline of GBP 541 million and GBP 393 million in planning and legals. And of course, as we add more homes onto our platform, our platform becomes even more efficient, and we're looking at EBITDA margin expansion to 60%. I'll show my favorite slide because it's our direction of travel. Obviously, we have seen very, very strong growth in our rental income, an average of 14% per annum. We've got very strong growth in our EPRA earnings. And our operational leverage was originally at 19%. It's now at 55.5% and as I say, growing to 60%. So we've got a good -- a really strong trajectory in terms of where we're going. So the highlights of the first half are the successful -- of the full year, sorry, successful conversion to a REIT, very strong occupancy, robust rental growth. And the one thing that's come through this year is that the Renters Rights Act, which I'll talk more about in a moment, which actually demonstrates that we have no rent controls. The government have absolutely confirmed no rent controls. Very strong financial performance with 12% net rental income, 12% earnings growth and a very strong cash flow within the business and 10% dividend increase. And our key focus for the future is maintaining that occupancy and rental growth, continuing to target earnings growth. We're focused on cost efficiencies. We are taking cost out of the business, and Rob will talk more about that in a moment and then in the short term, reducing our -- short to medium term, reducing our net debt. So just going back, it might be worth, Rob, now you taking us through how we have achieved that GBP 72 million.

Yes, absolutely. So firstly, just to start off in terms of the rental growth that we delivered, so we've come off back of a very strong year, and we've got really strong momentum continuing in the business. So if you look at the key drivers of that rental income, the first point is the like-for-like rental growth, which we delivered in the year, 3.6% overall. And we are guiding to continued strong like-for-like growth for the year ahead in our typical long-run historic range of 3% to 3.5%. Although with the market normalizing that, we would expect some level of seasonality, given we always have a strong second half of the year, reflecting when people move over those summer months. We had an excellent year in terms of continuing to deliver the pipeline and the lease-up that added a very significant GBP 18 million to our overall rent. And then as we trade down to our noncore assets, including some of the other assets and the [ regs ], that was GBP 6 million of rent attached to disposals. So overall rents up very healthy 12% overall. And I'll just take you now to the earnings bridge that we in front of us. And we've got some very strong growth locked in the coming years. And you can see here, as Helen mentioned, we have GBP 60 million of earnings being guided for the year ahead, so a continued strong step-up over what we've delivered for the last financial year and that continuing to grow by 35% to GBP 72 million as compared with FY '25. So this growth is actually very much secured and locked in. We've got a great level of visibility. So the key building blocks that are driving this. So firstly, we assume over this period to FY '29 our long run rate of like-for-like rental growth of 3% to 3.5%. The second building block is this guidance is based purely of the committed pipeline where we're on site and currently delivering those schemes, which are on the ground. And that's continuing to drive strong profitable growth. And we're funding that by recycling out of our lower-yielding noncore assets, particularly rates and some strategic land and some older PRS assets. So low-yielding assets being recycled into new high-yielding BTR that income accretion. And then the next element is our EBITDA margin. We were at 54% for FY '24 when we originally set out the guidance. We've said we're on a path to 60% by FY '29. We've already made a big step-up for the year just ended to 55.5%. So we're well on track. And this is actually just leveraging the central platform as we add each new home from the committed pipeline onto our platform that's dropping through to an incremental margin of 75%, and we're not adding lots of new cost centrally in order to deliver. In fact, we are driving efficiencies. With this set of results, we did announce a GBP 2 million cost takeout from -- continue to drive efficiencies across the vast majority of areas of the business. So that's helping us on our journey to improve the margin. So we get clear visibility of that. And then that last element, which you can see in gray on this chart, is the fact that towards the end of this period, we're actually locked into low interest rates in the mid-3s for the next few years, but we will be looking to refinance towards the end of that period. And this is based on the forward interest rate curve prediction of 5.5%, 3.5% today. So we do have that full refinancing of all of our debt. And we assume some modest deleveraging at GBP 300 million to GBP 350 million, which will effectively mitigate around half of that impact and still mean that we're growing our earnings despite that higher interest rate headwind, which I think puts us in a good position. With the set of results, we also give a little bit more color on our debt trajectory. And here, we provided, as you can see on the bottom right, a little more specificity around where we plan to take our debt. So we do plan to reduce the debt from where it is today by GBP 300 million to GBP 350 million. We regard that very achievable, given the GBP 175 million plus of sales, which we are making each year. So really, it's just under a couple of years of sales. And that in turn will drive our LTV down to 30% and our net debt to EBITDA at a healthy level of 8x. So this is really thinking about the impact of higher interest in our business and managing that impact so we can continue to progress our earnings growth. And then, of course, in September, we converted to a REIT, which is a really significant milestone for the business. And what that means is that the biggest implication is actually GBP 15 million of tax saving that we made in the first year of being a REIT, which we've now [indiscernible] into FY '26. That adds around 60 basis points to our total returns. And our dividend policy is to maintain a strong progressive dividend. So we expect it to continue to grow. We move our dividend policy in line with other REITs and paying out EPRA earnings. And over the next 2 years, we'll do a top of our regulated tenancy sales profits. And by FY '28, we expect to be fully covered by EPRA earnings, which puts us in a really strong position. And this, of course, growing the dividend is despite the fact that we have the impact of higher interest rates feeding through. When we look over the longer term, with an organic growth rate of 3% to 3.5% and the operational leverage inherent in our business, that will provide for a growing dividend at the rate of 5% per annum before considering any other growth opportunities such as acquisitions or the continued development pipeline. So I think a healthy level of continued baseline growth [indiscernible].

Thanks, Rob. What I'm going to do now is just take you through Grainger's investment case. And I think it is really compelling. And there are 5 main plans of this investment case. The first one is the fact that we are a very low-risk asset class with resilient growth. We've got strong market fundamentals of really strong demand for rental homes and a shortage of supply. We've got a strong customer base, which is very positive for our rental growth outlook. And then now we've got real clarity around our regulatory environment following the Royal Assent of the Renters Rights Act. And then, of course, we've got our sector-leading platform, which is underpinned by the technology and data and insights. And I'll just quickly go through each of those. So the first one is, yes, we are lower yielding than many other real estate asset classes. But actually, there's a good reason for that, and that is because we're significantly lower risk. And I've just put a couple of charts in here, which demonstrate that residential rent and residential capital values have significantly outperformed commercial property rents and commercial property values. But also, we've -- rents generally have provided above-inflation rental growth, outstripping CPI, which obviously is not the same for all. So to a certain extent, our lower-yielding nature is a reflection of that lower risk. And then we've got the market fundamentals. And the main one here is the -- we know that in this country, we've got a shortage of all homes. The shortage is about 4.3 million homes. In the residential sector -- residential rental sector, we have 5.6 million homes. Still, only around 2.5% of them are owned by professional landlords. And smaller private landlords do continue to exit the market as they find the regulatory environment a lot more difficult, a lot more challenging. Fewer homes are being built, fewer homes are still getting planning consent. So that's the sort of supply-side shortage. And then we've got a growing population of renters. And just to put a couple of major stats out there from the English National Housing Survey, a 10% increase in the number of households in the 10 years to 2032. And then rental demand set to grow by 20% in the 10 years to 2031. So that is a growing population and a diminishing supply. And both of those give us very strong market tension. Grainger's customer base is in a very strong position. On average, our customers earn around GBP 38,000 per annum. And the average Grainger household is GBP 62,000. So we have a lot of sharers. Our core demographic is in that 20 to 40 age range, and they're the ones that are normally seeing the higher growth in their income. And we have a very diverse customer base from all sectors in the market. But actually, the one thing that we do is we cap students at no more than 10%, and there's good reasons for that because we're trying to build really strong settled communities. So our average rent is around 28% of earnings, and that's below the market average. Just carrying on to the Renters Rights Act, now that was passed last month. We've worked alongside government trying to give them insights into the implications of some of the changes. The act itself is meant to raise standards in renting. So as you can imagine, Grainger has nothing to fear from that point of view. And we have had work streams in the business working to make sure that we're ready from day 1. We know now that it's going to be implemented from next May. And over the longer term, we know that this government is supportive in trying to achieve more rental homes in the U.K., more homes of all sorts, but obviously, build-to-rent features in there. The 5 main areas are the abolition of no-fault evictions, well, that's consistent with our business. You can still evict for nonpayment of rent and anti-social behaviors, which is obviously where we mainly move tenants on, but we have very few of those. We have an annual rent review process, which will now be ensuring pet-friendly policies. We already work with the RSPCA to make sure that we have pet-friendly policies. And then open-ended periodic tenancies. That's really at the moment our tenancies come to an end at the end of the lease, and then we renew the lease with -- whereas now we're just going to -- it's going to roll on. And then decent home standards. And most of our buildings are new, but all of them are to modern energy-efficient standards. In fact, 96% of our homes are already at 2031 standards for energy efficiency. The final limb is a very important limb, which is the operational excellence that we have within the business. We have been using technology since we started to grow our build-to-rent platform. And so we have moved recently from using a lot of that data that we collect from everything we do from our leasing, our renewals, our customer surveys to really understand what people want from their home. So we've moved from instinct of what we think people want to insight, real clear data of what people are telling us they want. And all of that is leading to sector-leading scores in terms of our Net Promoter Scores as people who are advocates for us in our buildings. So we're ahead of the likes of Coca-Cola and aligned with Google. And the combination of technology and our great customer communications as well as our very friendly [ front desk ] staff mean that actually we've got great customer service, and that's a real differentiator. And it helps both in the leasing of our buildings and also in the retention of our customers. So I'm just going to go on to -- this is a case study of the building that we completed in September of this year. And the reason for that is because Seraphina is part of a 3-building scheme in Canning Town -- it's opposite to Canning Town Interchange. Most of our sites are very well connected. The first building we launched there was Argo in 2017, then [ Northrhine ] in 2023 and then Seraphina in 2025. And normally, we allow a year to lease up, but this building is -- the majority of it is leased up in a couple of months. The thing that I'm really impressed about and proud of is that the differential between our first building that's launched in 2017, its current rent is only GBP 60 a month cheaper than Seraphina. And what that's really showing is the lack of depreciation and real resilience. And we do our refresh through our gross to net. So we don't capitalize it. And that's really showing the fact that with residential investment, you get a true net yield, you're not harboring up lots of depreciation. So finally, greater shareholder value creation model. We are a low-risk asset class with good structural drivers. We're delivering inflation-linking rental growth. We've got a sector-leading platform that's capable of scaling and we're expanding our EBITDA margin, and we have strong growth opportunities in our pipeline. We're disposing of our lower-yielding assets, and we've got a strong balance sheet, which we're lowering leverage on. And all of that, we believe, will deliver shareholder value and excellent risk-adjusted returns. I'm going to stop there and invite questions.

[Operator Instructions] Just to remind you that a recording of this presentation along with a copy of the slides and the published Q&A can be accessed via your investor dashboard. Guys, you can see that we have received a number of questions throughout your presentation this morning. And thank you to all of those on the call for taking the time to submit their questions. But Kurt, at this stage, if I may hand over to you just to share the Q&A with the team and if I pick up from you at the end, that would be great. Thank you.

Thank you, Jake. The first question we have submitted, I'll read it out loud. Over the last 4 years, the share price has tracked lower from a high of 330 to now 180. Please explain why? And what are you going to do to reverse the trend?

It's a great question because it's a question that the Board are discussing all the time. So like many real estate companies, we have been grouped together. I think the interesting thing about our values is the fact that 330 was a premium at the time to our net asset value, representing our growth. 180 is significantly below our current asset value, and we're actually selling. So we're proving our underlying values. It's extremely frustrating. It's frustrating for the whole leadership team that we're not being differentiated for the value protection that we've had during this time and the resilience in our underlying real estate values. And it's worth saying that if you were to look across the market as the whole other NTAs, I think retail has dropped about 40%, office is about 28%. We're actually up over that period. There were probably two or three main things that affected our share price. The first one was at the end of '22 when interest rates moved out. I think the whole of the real estate sector, we've been closely correlated to gilt yields. And yet one of the things I would say is that although in the real estate sector, people look at the 5-year swap, the 10-year gilt, one of the other things that I think we should look at in relation to is actually the index-linked yield because we're actually producing real growth in our income, and that's index linking. So I would say, it's extremely harsh. We can -- the other thing that hit our share price in the -- with the announcement of the general election. So we're on a route to recovery. And then I think there were concerns about rent controls. We've got real clarity about the rental regulatory environment in the future. So coming to the main point about the question, what are we doing about it? Obviously, the importance is to continue to run the business well to delever, which is I think we're going to come on to a question on that; and to continue to sell down our noncore assets, prove the value. And as I alluded to earlier, we will look at all the opportunities to reinvest and grow the business and grow the margin in the context of that sales process.

Thank you, Helen. The second question we've had submitted around deleveraging is from David. You target GBP 300 million to GBP 350 million deleveraging to FY '29, how much is dependent on disposals versus operating cash flow?

So we actually have GBP 900 million of noncore assets, which we've earmarked to dispose off over the medium term, the majority of which sits in our regulated tenancies. We also have some strategic land, which is not yielding. And then some of the smaller element is POS disposals of older POS assets. So of that GBP 900 million, we are earmarking GBP 300 million to GBP 350 million of it to delever and GBP 130 million on our cost to complete our committed development program, which still gives us further capital for investment. So our deleveraging is being funded out of disposals. And our EPRA earnings are effectively as the dividend policy is paying out EPRA earnings, then effectively the EPRA earnings are funding the dividend.

Thank you, Rob. Next question is submitted by Charles. What percentage of your homes have energy performance certificates of either A, B or C? And is it possible to provide a split?

I would -- so it's 96% are A, B and C. I'm not sure we've actually given the number to A and B...

Within that...

Yes. But having said that, the majority in our specification for new build, we have the majority aimed at A and B. So that's the -- so over time, as our new product is delivered, we'll see far more A and B. But C will be in the future, I think will be the requirement, and we're already 96% there. So I'll see if we can put on the website afterwards, we'll see if we can answer that in more detail.