Helical plc (HLCL) Earnings Call Transcript & Summary

Good morning, everyone, and I'm delighted to welcome you to the virtual presentation of Helical's full year results to March 31, 2021. Let me explain the agenda for today. I will take you through the highlights from the results and then talk about the market, the future of the office and how we will drive value going forward. Tim will run through the numbers, then Matthew will update on the portfolio and expand on our sustainability strategy. I will sum up, after which we will be pleased to answer any questions you may have. We reported profit of GBP 20.5 million. Our EPRA net tangible asset value has increased 1.7% to 533p, up from 524p 12 months ago. This reflects a valuation increase across the portfolio of GBP 23.9 million, 3.4% on a like-for-like basis. The main drivers of this increase are the developments at Kaleidoscope and 33 Charterhouse Street. We are proposing a total dividend per share of 10.10p, which is a 16% increase from last year and takes us back to the same level as in 2019, reflecting our confidence in our future activity. Our MSCI performance of 7% compares favorably to the Central London Offices Index at minus 1.7%. This outperformance illustrates the benefits of both a new high-quality portfolio and an active development program. I will now talk about the future of the office as we are on the cusp of considerable change. Four main trends are coming together, which will shape the office going forward and will provide a clear differentiation across the sector. I would expect that those who do not respond to these trends will flounder. First, sustainability. ESG has climbed to the top of corporate agendas, as exemplified by the annual letter to CEOs from Larry Fink, the CEO of Blackrock. He wrote of the tectonic shift in the reallocation of capital to sustainable assets. This will impact in several ways. Tenants will want to occupy the most sustainable and environmentally favorable buildings to achieve both their own net zero carbon targets and those of their stakeholders. In the same way, investors will be keener to buy these buildings. According to the Better Buildings Partnership, which includes many of the largest landlords in London, of their data of 2,844 (sic) [ 2,484 ] buildings, only 5% have an EPC rating in the A or B categories, a further 18.2% are in the C category. The significance of this is huge, if you bear in mind the proposed government legislation is that buildings that are not A or B should not be let or continue to be let after 2030, which is not that far away. As we all strive to achieve net zero carbon, much of the commercial building stock will no longer be fit for purpose. The second trend is wellness. In a post-COVID environment, tenants will require the most efficient and up-to-date air conditioning systems to minimize the spread of airborne viruses. Sensors showing air quality in a building will be essential. Density per worker will reduce as employers' previous desire to pack their staff together on smaller and more tightly placed desks will be reversed. Research from CBRE shows that even if densities per person return to where they were in 2015, an extra 20 million square feet will be required across Central London. Third, buildings will see a greater use of technology to optimize the local environment and the workspace experience. Sensors recording occupation levels will improve energy efficiency and the management of a building. Matthew will talk shortly about some of the initiatives we are incorporating into our development at 33 Charterhouse Street. The fourth trend is enhanced amenity. This is end-of-trip facilities, plenty of bike spaces, high-quality showers and ample lockers. Bear in mind that few older buildings have these facilities. As part of this amenity, we will see increasing hotelification of office buildings, with 5-star management a priority as we move from passive, low-risk, long-lease investments to intensively managed shorter-leased buildings where maximizing tenant retention, rental growth and building performance are the priorities. Generally, tenants will seek higher-quality buildings as they wish to both attract and retain the best people as well as encouraging them to work from the office rather than at home. On the much debated subject of working from home, I would question the veracity of asking staff who are still WFH if they would like to continue doing so. I believe that once they are back in their office, they will realize the benefits of being together and perhaps, more importantly, so will their employers. Last year, everyone had to WFH, and we all made the best of it. Going forward, those businesses that operate from an office will achieve a competitive advantage over those that adopt a mainly WFH model. The DNA of organizations where workers are remote and where the less experienced cannot learn by being in the office with more experienced will gradually unwind. How are these trends and changes going to be reflected in the market? In my view, there will be real bifurcation between the best, the real Grade A and the rest. Indeed, this is already happening. The market performance must be viewed against a 12-month period when we have been in 3 lockdowns. To the casual observer, the vacancy rate has increased over the last 13 months from 13.9 million square feet, 4.5%; to 26.2 million, 9.1%. This availability is 78% ahead of the 10-year average. However, 20.1 million square feet is secondhand space, of which 43% is tenant-controlled surplus space and 26% of it is in units of less than 10,000 square feet. By contrast, the supply of new completed 2.6 million square feet is only just above the 10-year average as is the 3.4 million feet of early marketed space to be ready within 12 months. Anecdotally, some agents are reporting weekly viewing levels back up to those last seen in February 2020, before the pandemic set in. I am also aware of some tenant-controlled space being removed from the market as they now wish to retain it for their own use. The investment market has seen a subdued level of activity with GBP 1.53 billion traded in the first 4 months of the year. Compare this against GBP 7.5 billion in 2020 which, in itself, was 48% down on the 10-year average. There have been few buildings on the market as vendors await the reopening of international travel to enable viewings. I can see we are in for a busy Q4. Yields are holding out for the Grade A stock that is traded but are beginning to drift out for the remainder. There will be a green rental premium and a brown rental discount. We expect to see an increasing rental divergence, and this will follow through to the investment market where yields will strengthen for the green assets and will weaken significantly for the brown assets. How is Helical placed to respond to the 4 trends and the market changes I've just described? We have 2 strings to our bow. First, our existing portfolio. 96% of our space has been recently developed or refurbished. All our buildings, [ but the small one ] in Chiswick are EPC-rated A or B. We own a multi-let portfolio where we can maximize asset management potential. We work hand in glove with our excellent managing agents, Ashdown Phillips, to ensure all our buildings are managed to the highest standard. I challenge our team that if there was an award for the best managed building and every building in London was judged, I would want all the Helical buildings to be equal first. That is the standard to which we must aspire. We hold our buildings as new. They are continually maintained to be in top condition. To reinforce my point on rental divergence within the market and to illustrate prime rents increasing, the average rent achieved at One Bartholomew, which we let in 2019, was GBP 81 a square foot. The average rent at Kaleidoscope is GBP 86.17. That is a 6.3% increase as well as being 5.4% above the March 2020 ERV. You are familiar with this slide, which highlights the reversionary potential within the portfolio. Following a further letting off the year-end, our contracted rent is currently GBP 38 million. Letting our empty space and delivering on our ERVs will add circa GBP 14.1 million to our annual rent. On a conservative basis, we identify future upside in our portfolio from our asset management and development activity over the next 2 to 3 years to be more than GBP 78 million. At Bower, we have completed 1 rent review. We have further rent reviews in process, and we are looking at various asset management initiatives on different floors. 33 Charterhouse Street will see valuation gains as we derisk by completing the building contract in September next year and letting the space which, I hasten to add, we are not currently marketing. The Kaleidoscope valuation increases as the rent-free period unwinds. At 25 Charterhouse Square, we have the first floor and 2 ground floor units available where the tenant exercised their break. To demonstrate the impact of changing rents and yields on our portfolio, as at today, our external valuers have prepared this slide, which shows yield changes in 25 basis point increments and rent changes in steps of GBP 2.50 a square foot. For example, a 25 basis point improvement from our equivalent yield of 5% adds GBP 50 million to the value of the portfolio and a GBP 2.50 increase to our ERV of GBP 69.20 as GBP 25 million. The second string to Helical's bow is new opportunities. As we had mostly completed and let our previous development program of over GBP 1 billion, by the end of 2019, we were looking closely at several new opportunities in January last year. Frustratingly, our plans were disrupted by the pandemic, and we adopted a more cautious approach as we entered the unknown. At the beginning of this year, having sold GBP 119 million in Manchester and in the knowledge of the Kaleidoscope letting, we started looking again in earnest for new opportunities. Little has been available during this lockdown period. And whilst we've bid hard on a couple of assets and have been told we were not successful, they've still not transacted. We anticipate the market will open up soon and there will be opportunities as many buildings do not satisfy the 4 trends identified so will no longer be fit for purpose. They will require repositioning as we did at The Loom refurbishment, The Bower or redevelopment at Kaleidoscope and 33 Charterhouse Street. The pricing of these assets must reflect full cost and extent of the required work. So valuers need to make realistic adjustments to their valuations. What are we looking for? Both the macro and micro locations are important. Is their external public realm and, if not possible, we provide internal public realm. Ideally, we do both. We must be able to satisfy the 4 trends to create best-in-class office space. As I mentioned earlier, the source of most of our valuation gains this year are the developments, and we see this continuing with significant contributions to our overall results as we add new schemes to our portfolio. We are flexible how we structure deals, either entirely on our own balance sheet or in joint venture: first, with existing land owners who do not have the expertise to maximize the potential of their asset; or second, financial partners, who wish to participate in our activity. There are big changes ahead as the market repositions and Helical is well placed to take advantage of this opportunity. Thank you, and I will now hand over to Tim.

Thank you, Gerald, and good morning, everyone. As usual, I want to go through the major components of our performance for the year and our financial position at the year-end. So let's look at a few of the metrics on Slide 14. Our total property return, which reflects, in monetary terms, the performance of the portfolio, was GBP 48.6 million this year. And we'll look at the components of this on the next slide. Our total accounting return, on an IFRS basis, was 3.3%; and on an EPRA basis, 4.5%. The total dividend is up 16.1%, and I'll come back to this later. Moving to the balance sheet. The value of the portfolio reduced to just over GBP 850 million, reflecting the sales of 4 investment assets during the year. And the net assets of the group were up 1.6%. Most of the other metrics on this slide will be covered in the rest of my presentation. Turning to Slide 15. This looks at our earnings where we see the makeup of the EPRA loss of GBP 2.2 million and the IFRS pretax profit of GBP 20.5 million. Net rental income has fallen by 12%, reflecting rent concessions granted to a small number of tenants, largely F&B, and the reversal of income previously recognized under IFRS in respect to our letting to Finablr at The Bower. The fall also reflects the impact of the sale of 90 Bartholomew Close and 3 of our 4 assets in Manchester. We made a small development loss of $300,000 with development management fees at 33 Charterhouse Street, offset by marketing and void costs at Barts Square. Our recurring administration costs were down 13% on last year with performance-related costs down 17%. Net finance costs were 7% lower than last year. Overall, on an EPRA basis, there were losses of GBP 2.2 million or 1.8p per share. Our portfolio generated a net gain on sale and revaluation of GBP 23.9 million or 3.4% on a like-for-like basis. And with a credit from the valuation of our financial instruments of GBP 2.9 million, reflecting the rise in medium and long-term interest rates, we made a net profit before tax of GBP 20.5 million. Turning to Slide 16. This is the first full year for which we are reporting under the new EPRA measures. And in common with most of the companies, we've adopted the net tangible assets per share measure to replace the net asset value per share used in previous periods. Turning to the detail of Slide 16, investment gains of 19.1p were partially offset by the EPRA loss per share of 1.8p and the payment of dividends during the year of 8.7p, leaving an EPRA NTA at 31st of March of 533p, up 1.7%. It is perhaps worth reflecting at this stage on our half year results where we reported a loss on our investment portfolio of GBP 4.5 million and a decline in EPRA NTA to 505p per share. The change since the half year is a reminder of the impact that 1 or 2 individual schemes can have on our overall performance. I now want to look at LTV and gearing on Slide 17. The graph on Page 17 shows the 10-year history of our portfolio value and net debt levels over the course of this development cycle. At 31st of March 2021, we had an LTV of 22.6% and a balance sheet gearing level of 31.9%, both at the lowest levels for over 30 years. Turning to Slide 18 and looking at our debt profile. We increased our bank facilities to provide finance for 33 Charterhouse Street with our 50% share of its GBP 140 million development facility. This green loan will fund all future budgeted development costs. Also, during the year, we repaid and canceled over GBP 30 million of our development facility at Barts Square as we completed on the sales of residential units at 90 Bartholomew Close. At 31st of March, we had GBP 261 million of unused bank facilities and GBP 162 million of cash balances. The average interest rate at the year-end was 3.5%, unchanged from the previous year with the marginal rate of interest on additional borrowings under the RCF of 1.5%. All our borrowings are at fixed rates or are protected with interest rate hedging agreements. The average maturity of our borrowings fully utilized and on the exercise of options to extend reduced to 4.6 years. Now I want to turn to our earnings, our NTA and dividends. Slide 19 shows the recent history of our EPRA earnings, EPRA NTA and NAV and dividends. As you know, EPRA stripped out any capital profits from our earnings calculation. And as a capital growth stock, we've seen great fluctuations with huge earnings in those years when we benefited from overages from our joint venture development schemes and losses when investment assets have been sold without compensating earnings from other sources. During this period, we've maintained a progressive and consistent growth in our total dividends, adjusting last year to reflect concerns over the coronavirus pandemic. Whilst earnings may have fluctuated over the years, leaving dividends uncovered in many years, we consistently recycled equity from our investment portfolio as properties reach their maximum potential. And so to the extent dividends have not been fully covered by earnings, realized capital profits have provided that cover. We've been encouraged by the results for this year and are optimistic about the future. As a consequence, we've increased the total dividend to the level of 2 years ago, pre-pandemic, and this has resulted in an increase in the final dividend of 23% and an increase in the total dividend of 16%. Finally, a summary of our financial position on Slide 20. As a reminder, we've performed well since the last financial year with high rent collection and reduced finance and administration costs. We had a portfolio valuation surplus, leading to an increase in EPRA NTA. We've recycled equity from 90 Bartholomew Close and the recent sale of 3 Manchester assets, generating over GBP 36 million of realized capital profits. And with an LTV at a historic low of 22.6% and cash and bank facilities of around GBP 423 million, we have considerable firepower to replenish our development pipeline with accretive acquisitions. And with that, I'll hand you over to Matthew.

Thank you, Tim, and good morning, everyone. I would like to provide you today with an update on the portfolio and some color with respect to what we are doing in relation to sustainability and the societal impact of our business activities. Our portfolio of assets is entirely London focused, apart from the one remaining building in Manchester, which we will sell once let. Our core holdings are in Old Street, Farringdon and Whitechapel where we have a broad mix of occupiers, predominantly in multi-let buildings let to tech-orientated businesses involved in online fashion, software and computing, fintech and creative media, amongst many others. This slide broadly reflects the mix by area and value. In terms of the investment sales during the year, we completed on the sale of the Powerhouse portfolio in November, which comprised 3 of our 4 Manchester office buildings. The portfolio was acquired by Pictet Alternative Advisors, and the headline purchase price was at a 4.3% premium to the March 2020 book valuation. 90 Bartholomew Close, which was part of the Barts Square project with Baupost, was sold to La Francaise Real Estate Partners in April 2020 and reflected a sub-4% net initial yield and just under GBP 1,600 per square foot capital value. During the year, we have made good progress with our residential sales at Barts Square with a further 16 units sold, 4 exchanged or reserved, leaving 24 currently available. A key highlight in the year was the letting of the whole of Kaleidoscope to TikTok on a 15-year lease at an average rent of over GBP 86 per square foot, with GBP 90 being achieved on the top floor. A 24-month rent-free period was granted, together with tenants-only break clause at the 10th year. We feel that this letting demonstrates the value occupiers put on a brand-new, sustainable, best-in-class office building with excellent amenities and transport links. It also builds upon the tech cluster in the Farringdon area. Our only scheme currently in development is 33 Charterhouse Street in a 50-50 joint venture with AshbyCapital. We are currently erecting the steel frame at level 8, and the completion is due in September of next year. With this project, we are aiming to create one of London's smartest and most sustainable office buildings. And I will talk a little more on that later. As Tim mentioned, we have received 93.3% of all rent due during the year, with 4.9% written off and 1.8% still subject to ongoing discussions. A significant proportion of the written-off rents related to F&B tenants as 96% of the office rents due were collected. The portfolio vacancy has reduced substantially following the lettings at Kaleidoscope and Trinity in Manchester, with total lettings amounting to over 123,000 square feet in the year, adding GBP 8.8 million to contracted rent. This has more than offset income lost through the sale of 4 assets and the impact of lease expiries and breaks, resulting in a GBP 0.2 million overall increase. 62% of contracted rent is secured for more than 5 years, with only 11% subject to lease expiries or brakes in the next 12 months. At The Bower, we have settled the John Brown Media rent review at The Studio building at a 31% uplift, and we've also regeared the seventh floor lease with stride at The Warehouse, increasing the passing rent from GBP 67.50 to GBP 78 per square foot. We have further outstanding reviews at The Warehouse with Farfetch, CBS, Allegis and VMware. We have made considerable progress as a business in respect of our sustainability credentials, increasing our GRESB score to 3 star and improving our benchmark scoring with MSCI ESG, CDP, EPRA and FTSE4Good. We have committed more resource to sustainability with the appointment of a new role as Head of Sustainability, and we will look to further improve our benchmark scoring, particularly on those which are disclosure-based. We have worked hard at reducing our carbon emissions at a corporate level, championing a range of energy-saving initiatives and have chosen to offset our remaining carbon emissions so that we are now carbon neutral, using gold standard verified credits as recommended by the UK Green Building Council, which we are now a member of. What we do feel is important to recognize, however, is that the investment market will increasingly focus on buildings which are green and have credible environmental credentials. Energy performance certificates provide ratings on a scale of A to G on a building's energy efficiency and are required when a building is constructed, sold or let. The current minimum rating to let an office building is E, but this is likely to change to C in 2027 and B in 2030. 99% of our portfolio by value is already EPC A or B rated. With respect to BREEAM, which is an international third-party assessment of a building's sustainability performance, 85% percent of our portfolio by value is either outstanding or excellent. 11% is currently under assessment. And the remaining 2 buildings not assessed, representing 4% of the portfolio, are expected to be sold within the next 12 months. We launched our Built for the Future document in June last year, which sets out our long-term sustainability vision with a series of short- and medium-term targets. We will be focusing this year on our ambition to become net zero by 2030 and to creating a pathway to how this might be achieved. In April of this year, we produced our Designing for Net Zero guide to help our design teams as they collaborate on new development projects. We are introducing a Carbon Champion as a key member of the design team, setting out with us the project's vision and monitoring the carbon journey through design, delivery and operation within a carbon implementation plan. It also incorporates a 10-step process so that carbon is considered at each stage of the design process. We have adopted the concept of a Carbon Champion at 33 Charterhouse Street, and it has been very effective at ensuring, at a granular level, carbon is seen as every bit as important as quality, cost and program. To provide some further detail, I would like to highlight the following with respect to our latest project. It is the U.K.'s first commercial office building to be awarded BREEAM Outstanding at design stage under the 2018 criteria. Operational carbon emissions are expected to be 43.3% lower than Part L of the Building Regulations. Embodied carbon is expected to be 20% lower than the current RIBA Benchmark through using low carbon concrete and high recycled content steel and other recycled components. It is connected to the Citigen district heating network, benefiting from a continued investment into renewable energy. There will be 144 PV cells on the roof, aiming to power 100% of landlords' energy consumption. It will have a smart gray water and rainwater storage facility linked to real-time weather data. We will have 750 square meter green roof seeded with indigenous flower species and 2 bee colonies. Wellness is front and center in the design, an enhanced air permeability and filtration, together with tech-enabled touch-free door-to-desk journeys and touch-free amenities. The building is also at the forefront when it comes to smart technology, providing information via an app on the building's use of energy, water and waste, together with data on CO2 levels and air quality using an array of smart sensors. Individuals will be able to control their own immediate environment in terms of heating, cooling, lighting and blinds. And the app can also provide relevant information such as travel status, update weather, local services, restaurants and cultural amenities. A digital twin of the building has been produced through BIM modeling to aid construction and help identify and resolve issues post completion. The technology not only enhance the occupier experience but help minimize energy use and waste, making it, we believe, to be one of London's smartest and most sustainable office buildings. As we continue to focus on new acquisitions to build our future pipeline, we will seek to deliver the most sustainable, best-in-class office product where we feel the occupier flight to quality will mean demand outstrip supply, and we can generate superior returns. I'll now hand you back to Gerald for a closing summary.

Thank you, Matthew. I will conclude with the milestones for this year. Kaleidoscope is now fully let. We have the final space to let at Trinity, after which we will sell. We have 24 residential units to sell at Barts Square as well as some office and retail space to let. There are some asset management opportunities across the portfolio. But absolutely, the real focus is on acquiring new opportunities as described. Helical comprises a highly experienced platform. First, we will maximize the potential of the existing new Grade A portfolio, which is EPC-rated A or B and mainly BREEAM outstanding or excellent, by ensuring it is well-managed and improving its value through new lettings and asset management initiatives. Second, we will acquire new opportunities to reposition, refurbish and redevelop to create best-in-class buildings that minimize carbon outputs, are technologically enabled and provide the amenity and wellness required by tomorrow's occupiers and investors. I would like to leave you with a final message. Given the environmental credentials of our existing portfolio and that any new schemes we produce will be the highest ratings, we represent a green and sustainable investment. Thank you, and we are now delighted to answer any questions you may have.

[Operator Instructions] We'll now take our first question. It comes from Matthew Saperia of Peel Hunt.

Two questions from me, if I may. And the first one concerns build cost inflation. I wondered where you were on 33 Charterhouse Street with regards to locking in your costs there. And also thinking about the future, do you think build cost inflation is likely to have an impact on the delivery of future schemes across the market and play a part in potential underwriting of new opportunities? And then following on from that, I think Great Portland said last week, they were tracking GBP 1.7 billion of potential opportunities in the market. Is that a number that you can collaborate. And indeed, thinking about sort of where you're looking and where you're potentially casting your nets, from geographic perspective, is it still very much in sort of your niche area of Farringdon and Old Street?

Good. Thank you, Matt, for those questions. So if I deal with those in order, on 33 Charterhouse Street, we have already bought the great majority of the contract. I think we're well over 90% fixed, and so I don't believe we'll have any great impact from inflation on that project. Obviously, going forward, it appears inflation, is it creeping up or galloping up upon us all? And it is something that we will obviously take into account when we underwrite future projects, and we'll get a handle on that. As to your final question, we are looking at a number of potential opportunities. We haven't actually quantified them in terms of value. And we are concentrating in Central London. And we've explained -- I explained earlier what it is we're looking for. We'll keep our discipline to ensure that we acquire assets that we can turn into best-in-class. If we can't do that, then we will move on to the next.

[Operator Instructions]

And we have 2 -- 3. First question we got is from [ Tim Lecky ] and Vanessa Guy on 33 Charterhouse Street, whether we've had any approaches for the space, the rent that we might achieve, whether we achieve a higher rent closer to completion. So dealing with those two, we aren't -- as I said earlier, we aren't marketing the building yet. We'd finish it on the 30th of September next year, and we will begin marketing it closer to completion. There are certainly 1 or 2 parties who have approached us. And -- but as I said, we're not doing any formal marketing. On the basis that we believe rents for prime assets will increase, perhaps we will obtain a higher rent next year than we will this year. I think I probably covered the point -- your final question on likelihood of finding new developments. As -- on that basis. We believe the market is changing, and I've outlined the 4 trends affecting the office market going forward. We believe that will produce a lot of opportunity for us going forward. And the same question from Robbie Duncan on new opportunities and will we -- how will we undertake those opportunities. We will either do them 100% on our own balance sheet, particularly the sort of slightly smaller projects. And the larger ones, we will probably do with a financial partner. So it depends on the opportunity in front of us.

Then there was one further question from Kieran Lee of Berenberg. He also asks about which areas of London we're looking at, current core or further across the city. And looking at the current supply/demand dynamics and construction periods, when do you see the balance of supply/demand shifting, polarization of stock notwithstanding? And how should we think about Kaleidoscope, with it being a dry and long let building, should we expect this asset to be recycled when it stabilized and the rents freeze run off?

Fine. We're looking in Central London. I think we will probably go as far west as Paddington. We don't want to go to Hammersmith, up to the King's Cross area, round to Old Street, Whitechapel or round the Southbank and back up to f Victoria. So that's probably the area in which we're looking at assets. I'll let Matthew answer the question on Kaleidoscope.

The ensure that -- we haven't made a decision yet on the sale of it, but we don't own many single-let assets, but the timing will very much depend on the outlook for the investment market and as things open up.

And then I've got a further question from Miranda Cockburn of Panmure Gordon. Of the 5% of rent written off last year, how much do you think will be paid this year? Or will a lower rent be agreed going forward? And when you were looking at opportunities, are you having to assume rental growth in order to be able to complete?

On the rents going forward, we hope that our -- mainly the F&B tenants, we hope that they are open and they will be able to pay rent.

And the second question was rental growth. Are we assuming rental growth for new acquisitions?

We believe there'll be a green premium, so that implies that there will be some rental growth. Good. Thank you very much, everyone. If there are no more questions, we'll end the presentation. Thank you very much for joining us, and we look forward to speaking to you soon.