Helical plc (HLCL) Earnings Call Transcript & Summary

Good morning, everyone, and I am really delighted to welcome you to a real presentation of Helical's half year results to 30 September 2021. And may I also extend a very warm welcome to all those who are joining us virtually on the webcast. Please let me give you the agenda for today. I will take you through the highlights from the results and then talk about the future of the office, the market and our strategy going forward. Tim will explain the numbers, then Matthew will update on sustainability and the portfolio. I will sum up, after which we will be delighted to answer any questions you may have. We reported profit of GBP 31 million. I'm also pleased to report our EPRA net tangible asset value has increased 3.4% and to 551p up from 536p months ago. This reflects a valuation increase across the portfolio of GBP 29.8 million. The main drivers of this increase are the developments at Kaleidoscope, 33 Charterhouse Street and The Bower. We are proposing an interim dividend per share of 2.9p which is a 7.4% increase from the last half year, reflecting our confidence, both in the quality of our portfolio and our future activity. When I presented to you in May, I described the office market being on the cusp of considerable change. As the letting market is emerging from the period of COVID-induced semi-hibernation, these changes are now becoming much clearer. We are seeing a strong flight to quality and a real bifurcation between the best, the green buildings where rents are rising and the rest, the brand buildings where the rents will be falling. In May, I also spoke about 4 trends that were driving the market. Sustainability is the most significant, and occupiers striving for net 0 carbon which is an ever-increasing number of them will want the most energy-efficient and sustainable buildings. This is reinforced following COP26. Wellness is particularly important post pandemic. Recently, I've walked around a few 20-year-old buildings and some of them are grim. In particular, one lawyers' HQ where there were internal offices with solid partitions and a wooden door containing just a small window, one can understand why those lawyers would want to work anywhere but there. Technology is now a vital feature in new buildings with tenant engagement apps, controlling access and the local environment as well as providing valuable information to landlords as to occupational timings and densities, which will feed in to make buildings more efficient. Enhanced amenity is also essential. This is secure internal bike parking facilities, high-quality showers and lockers. Bear in mind that most buildings more than 7 to 10 years old, do not have these facilities unless they have been retrofitted. And even then the scale and quality is usually poor. We will also see bifurcation in the investment market as investors follow the tenant choices. As the headline says, there will be downward repricing of brand assets to reflect the major CapEx required to bring these assets up to tomorrow's best-in-class standard. This repricing has not yet been fully recognized by all market participants. It was interesting to see recent research from Knight Frank which showed a rental premium of 12.3% for BREEAM outstanding buildings and a 4.7% premium for BREEAM Excellent buildings. Whilst one could challenge some of the assumptions of the research, it certainly highlights the direction of travel. The great majority of business now accepts full-time WFH is not viable. Some are currently adopting a model with all employees during the office Tuesday, Wednesday and Thursday. So the office will still need to be sized for the midweek peak occupancy. My view remains that the efficiency, productivity and profitability of a business will be much diminished by this approach as for 40% of the working week, collaboration, creativity and spontaneity are lost. I'm sure we have all experienced delays in getting things done over the last 18 months because of working patterns being disruptive. I do also worry as to how the less experienced will learn from the more experienced. Let me now give some evidence as to how the changes I've just described are reflected in the market. First, it is good to see activity returning to Central London, and the TFL chart shows the usage of bus and tube. TFL are saying recreational journeys are back to normal although business travel is 75% of pre-COVID levels. Against this backdrop, Q3 Central London take-up increased 58% on Q2 at 2.7 million square feet. Whilst this is 12% below the 10-year quarterly average, the under offers are 3.9 million square feet, which is 22% above the 10-year average of 3.2 million square feet. So there is good velocity building up. While the casual observer may say that vacancy rate in Q3 is 9%, about 25 million square feet, the key metric for London is illustrated on the chart, and this is the new and early marketed space, colored black and dark green, which is about the same level it has been since 2015. The oversupply is of the secondhand space, that's colored the light green of about 20 million square feet, which is double the 5-year pre-COVID average of 10 million square feet. Of the take up this year, 50% has been for new or refurbished space. 3.8 million square feet was completed in the first 9 months of 2021, with a further 1.9 million square feet due to complete by the year-end. 50% of this is let or under offer. Of the 10.2 million square feet, which is under construction and due to complete over the next 3 years, 30% is already let or under offer. The average annual take-up in London is circa 12 million square feet. And if, as I argue, the great majority of occupiers will be driven to the new space, you will appreciate that supply will be tight. The investment market has traded GBP 6.2 billion, and as seems to be the trend over the last few years, a strong Q4 is anticipated. In 2020, GBP 7.5 billion was transacted as against GBP 11.3 billion in 2019. Please may I remind you of the quality of our existing portfolio. 96% of our space has been recently redeveloped or refurbished. All our buildings are the small one in Chiswick, are EPC rated A or B. The significance of this is that of the 2,484 buildings in the Better Buildings partnership London database, only 5% have an EPC rating in the A or B categories and a further 18.2% are in the C category. The proposed government legislation is that buildings that are not A or B should not be let or continue to be let or sold after 2030. There is a lot to do. We continue to work hard, first, making sure our asset management is top class. You will see quotes from some of our occupiers later; and second, in holding our buildings as new. Since first April, we have let 18,319 square feet in 3 units with a further 9,268 square feet let at 25 Charterhouse Square last week. Letting the remaining empty space and space under development will add circa GBP 12.2 million to our annual rent, taking it to GBP 50 million. In May, we identified upside in our portfolio from our asset management and development activity, over the next 2, 3 years of more than GBP 78 million. We have captured GBP 30 million of this in the last 6 months, and in reevaluating the numbers, we have identified future upside remaining of GBP 80 million plus. How have we recognized this upside and still maintained broadly the same potential future upside on the table at 6 months ago? At The Bower, we have completed 2 further rent reviews ahead of the ERV and secured the letting at ERV, which fed in positively to yield shift to drive the valuation gain. At 33 Charterhouse Street, we have seen a valuation gain with more to come as we complete the building and let the space. I would stress we have not yet commenced marketing. The Kaleidoscope valuation increases as the rent-free period unwinds. At 25 Charterhouse Square, we've achieved a new letting ahead of ERV. Matthew will elaborate on the details of these transactions. This slide demonstrates the impact of changing rents and yields on our portfolio as at today. Our external values have prepared this slide, which shows yield changes in 25 basis points increments and rent changes in steps of 2.5%. For example, a 25 basis point improvement from our equivalent yield of 4.8%, adds GBP 64 million to the value of the portfolio and a 2.5% rent increase to our ERV of GBP 69.60 per square foot adds GBP 24 million. What is the investment thesis for Helical? In our view, London remains a world city. We believe demand for offices will continue and that this demand will be targeted at the best new buildings which will create a green premium with a strong rental performance, the gap with the brand discount for the poorer quality buildings, of which there are none in our portfolio will widen. Development ground-up or refurbishment will generate extra returns. And this was illustrated by our MSCI performance of 7% to 31st March 2021, versus the Central London performance of minus 1.7% and more recently, the performance of 33 Charterhouse Street in the period where we have seen a valuation gain of 11.6%. The Helical portfolio is new and sustainable. Our ambition is to double net assets over the next 5 years. I know the big question is what new opportunities will we find? We are focused on Central London. We have several balls in the air, and you will understand that I do not wish to speculate further on these just now. However, to put this into perspective, we have an A-list of potential opportunities running into the billions. As I have said before, we will maintain our discipline and only seek out opportunities where the new build or refurbishment, where we believe we can create best-in-class product, incorporating the 4 trends of sustainability, wellness, technology and enhanced amenity. We prefer island or corner sites rather than mid terrace, and we think the micro location is vital. We like to have external public realm. We either own or we borrow. And if that is not possible, we maximize the internal public realm and arrival experience at ground level. Thank you, and I will now hand over to Tim.

Thank you, Gerald, and good morning, everyone. While you all look at the view of London from the roof of our latest scheme at 33 Charterhouse Street on Slide 14, let me tell you what I want to speak to you about this morning. Gerald has briefly mentioned the highlights of the half year, and I want to take you through the buildup of our EPRA earnings, which, as you know, excludes valuation surpluses and then through to our accounting profit on a pretax and post-tax basis. I'll also take a look at our EPRA NTA per share and then on to our debt position and gearing levels. And finally, ending on a summary of our current financial position. Starting with EPRA and IFRS profit. Net rental income of GBP 14.1 million has increased by over 18% compared to the last half year, mainly reflecting full 6 months rent on Kaleidoscope. We made a development profit of GBP 1 million, with development management fees at 33 Charterhouse Street and a profit on the sale of a legacy retail scheme. Our recurring administration costs of GBP 4.9 million were marginally lower than last year, with performance-related costs reflecting the substantially improved half year performance, increasing total administration costs to GBP 7.4 million. Net finance costs reduced from GBP 7.9 million to GBP 7.1 million. And overall, on an EPRA basis, we generated earnings of GBP 1.1 million or 0.9p per share. The portfolio generated a revaluation gain of GBP 29.8 million or 3.9% on a like-for-like basis. There was a gain from the valuation of our financial instruments of GBP 4.6 million, reflecting the rise in medium- and long-term interest rates and a joint venture tax charge of GBP 3 million. Overall, we made a net profit before tax on the main group's activities of GBP 31 million. And with such a large revaluation gain in the period and the change in corporation tax from 19% to 25% from April 23, an additional deferred tax charge of GBP 8.8 million has been provided for, reducing post-tax profits to GBP 22.2 million. These results have encouraged the Board to increase the interim dividend by 7.4% from 2.7p last year to 2.9p this year. Turning to Slide 15. The EPRA earnings per share of 0.9p plus investment gains of 24.4p were offset by the final dividend for last year, which was paid during the half year of 7.4p, leaving an EPRA NTA per share at 30th of September were 551p, up 3.4%. While we're on the balance sheet, it's worth noting the total accounting return of 3.9% on an IFRS basis and 5.1% on an EPRA basis. Turning to our debt summary. Our total debt facilities reduced as we refinanced Kaleidoscope into our GBP 400 million RCF and canceled a separate facility, which had financed its development. We also repaid and canceled GBP 3 million of our development facility on Barts Square as we completed on the sales of 6 residential units during the period. We exercised one of our options to extend GBP 300 million of our GBP 400 million RCF and expect to exercise the remaining option next year. At 30th of September, we had GBP 197 million of unused bank facilities and GBP 139 million of cash balances, providing total firepower of GBP 336 million. The average interest rate at the year-end was 3.6%, with a marginal rate of interest on additional borrowings under the RCF of 1.6%. And the average maturity of our borrowings fully utilized and on the exercise of options to extend, reduced to 4.3 years. And just to note on our interest rate hedging. In a period of increasing inflation, at least in the short term, and rising interest rates, all of our borrowings are protected by a combination of fixed rate debt, interest rate swaps, collars and caps. This interest rate protection covers all of our debt for the next 2.5 years, and provides protection against interest rate rises thereafter for the majority of the debt to the current repayment dates. And finally, a summary of our financial position. With a net asset value of GBP 623 million and a net debt level of GBP 227 million, we have a current LTV of 25.2% and an NAV gearing level of 36%. We have, as just mentioned, over GBP 336 million of cash and undrawn facilities with a weighted average cost of debt of 3.6%. And as we just saw on the last slide, all of this is protected through a range of financial instruments. So we have a strong balance sheet. We have protection against interest rate rises and good capacity to acquire new assets. And with that, I'll hand you over to Matthew.

Thank you, Tim, and good morning, everyone. I'm going to provide an update on how we are approaching sustainability as a business to enhance long-term shareholder value through good governance, concern for the environment and social commitment. We have worked hard over the last 6 months and see an improvement across the board in relation to the key sustainability benchmarks. We were particularly pleased to be awarded a GRESB score of 85 out of 100 and a 4-star rating. This was as a result of our continued efforts to capture accurate performance data across our portfolio and holding BREEAM certification for the majority of our assets. We've also achieved a gold award from EPRA for our sustainability reporting. This is the highest accolade available and represents the transparency, accuracy and breadth of our sustainability performance reporting. We continue to hold the highest AAA rating from MSCI, indicative that Helical is an industry leader in managing its most significant ESG risks and opportunities. As we await our CDP score, which is due in December 2021, we hope to maintain our B rating with the ambition that our enhanced TCFD reporting will positively impact our CDP and GRESB scores in future years. As Gerald mentioned, our portfolio is largely newly built or newly refurbished shows that 99% of our portfolio by value is EPCA or B. As some of you may have seen from the excellent research on this issue by Panmure Gordon, we're in a very different position to most real estate companies in this regard. We have earmarked on property for sale, which once sold following the completion of some works we will -- we not only meet the proposed requirements in 2027, but also those in 2030. Following on from our built for the future sustainability strategy document, in April 2021, we launched designing for Net Zero, which is essentially a tool for our professional teams to use as they collaborate with us to reduce carbon use in our development projects. from the design and construction process through to occupation and operation. Work is currently underway on our pathway to net zero, which we aim to launch before our financial year-end. It is our intention to be bold and ambitious with our targets and ensure sustainability is embedded within our approach, both at a corporate and property level. Turning to the asset management progress. At The Bower, we have led the 17th floor previously let to Finablr to Verkada at a rent of GBP 85 per square foot. We have completed 2 rent reviews achieving an average 18% uplift, and we have 2 further reviews at an advanced stage of discussion. Infosys, an occupier of 4 floors at the tower have exercised their break on the 12th floor as the contract had expired, so we will be relaunching that to the market soon. At 25 Charterhouse Square, a tenant exercised a break on the ground and first floors, and we have last week, relet all but 1 ground floor unit to Entain Marketing, which is the tech arm of Ladbrokes above ERV and above the previous rental level. In Whitechapel at The Loom, we have completed on 3 lease extensions, and we continue to reconfigure units and offer flexible plug-and-play options. We are confident that we can let the vacant space over the coming months given current interest. At both 55 Bartholomew and Trinity in Manchester, we are approximately 50% let, having achieved good lettings at ERV in the period. And again, the focus will be on getting both fully let before the year-end. Residential sales at Barts Square have continued well with 6 sold in the period and 3 sold since the period end, leaving us with 19 remaining. We were pleased that the scheme won a housing design award promoted by the RIBA and 4 other professional institutions in recognition of its outstanding design and sympathetic approach to its surroundings. There is a much more detailed slide covering rent collection in the appendices. But for the year-to-date, this is a snapshot of where we are. We have seen consistent strong rent collection from office occupiers which account for 96.7% of the overall rent roll. And in this period, a marked uptick in the F&B collection now that they are back up and trading. We keep a rolling monitor of how our office buildings are occupied and you will see from this graph that occupancy rates have increased noticeably and are currently around 50%. Assuming there is no change in the direction of the pandemic, we would expect to see this trend continue in the new year. I won't read out the detailed quotes here, but these are the responses from some of our occupiers as they return to the office. We were pleased to see them as we and our managing agents Ashdown Phillips work extremely hard on ensuring a very high level of service is provided to ensure that our occupiers wish to stay in our buildings. At 33 Charterhouse Street, construction continues on time and on budget with practical completion due in September next year. Our ambition here is to create one of London's most sustainable technologically smart amenity-rich buildings with a focus on health and well-being. Working with our carbon Champion, we have strived to reduce the embedded carbon by about 40% below the RIBA benchmark, and we are looking at how we can deliver it as a net 0 building. As we've mentioned in the past, it was the U.K.'s first BREEAM outstanding certified building under the 2018 guidance for the design stage, and it is financed using the green development facility from Allianz. We have a fully integrated building management app, providing occupiers with control and information in relation to their environment, the light levels, temperature, air quality and air changes as well as access control for them and their guests, which is extendable to room booking and other building facilities. This app will have live links to choose bus, rail, airport and weather information and an ability to book taxes and other local services. The app also benefits from using the same security technology as many Internet banking businesses. With the arrival of Crossrail in March and the repurposing of Smithfield markets, the area is fast becoming one of the most sought-after submarkets and increasingly, a tech-focused one with the arrival of TikTok in our own Kaleidoscope building and Snap -- owner of Snapchat in the adjoining building above Farringdon Station. As such, we and our partner, AshbyCapital remain confident in the letting prospects. My final slide with a fine picture of Kaleidoscope at dusk currently being fitted out by TikTok, provides a summary table of some of the highlights I have mentioned. But I'll now pass back to Gerald to conclude.

Great. Thank you, Matthew. I will now finish with the milestones for this year. We have space to let at Trinity, and we hope to achieve this by the end of the year. We have sold 9 apartments at Barts Square since 1st April, and momentum seems to be increasing as Central London has opened up. We have continued to let vacant space and have maximized rent collection across the portfolio. Asset recycling will continue, and we are working extremely hard on acquiring new opportunities. Helical comprises a highly experienced platform with an excellent track record. There are 2 strings to our bow. The first is maximizing the potential of our existing new portfolio, which is EPC rated A or B and mainly BREEAM Outstanding or Excellent. We will carry on improving value through new lettings and asset management initiatives as we have illustrated today. Second, we have the firepower to acquire new opportunities to redevelop or refurbish to provide the best-in-class product required by occupiers seeking the most sustainable space in their journey to net 0 carbon. We are now delighted to answer any questions. So perhaps if we could start in the room, and then we will go to the conference call and then the webcast. So Miranda?

Miranda from Panmure. Just one question on 33 Charterhouse Street. Can you give us what rents the values are assuming on that incentives? And has that changed much over the last 6 months?

We are holding the rents there at the same level as they were 6 months ago.

Which is?

It is about -- I'm now being tested aren't I for -- it's about GBP 80 to GBP 50. But that's not to say that, that's the rental level. We would hope for something significantly better than that.

I'm James from Peel Hunt. Maybe just 2 questions on future kind of opportunities. And clearly, you've been looking at lots of opportunities, and I appreciate if you don't want to comment on the specifics. But can you talk a little bit about who you're coming up against and the competition in the market and whether you are some people just paying away over the odds or is it fairly finely balanced in terms of the other bids? And maybe just secondly, I mean, you talked a bit about in terms of what about the firepower. Given the pretty bullish outlook for the kind of portfolio realm, I'm just wondering how high you'd be willing to take the LTV if the right opportunities came along?

I will let Tim answer the second part of the question. The first part, I mean we're in a global market. There's a lot of capital from lots of different sources, looking at the opportunities that exist. So it's not like it was 25 years ago, it was the same sort of roll call of 5 or 6 parties who are looking to do these things. London is a world city and there's international demand.

Yes, in terms of gearing levels, we've operated at very high gearing levels in the past. We have no intention of going back to the kind levels you would have seen a few years ago. Currently, at 25%, we can comfortably operate between 30% and 40%. I would have thought for the foreseeable future. And indeed, if there are transactions out there that we want to secure, and we need to take our gearing to a higher level to do that. We -- I'm sure we will do that. But it would always be with a view of bringing it back down again. I think operating in the 30s is probably about the right place at the moment.

Good. Any others on the conference call are there any?

[Operator Instructions] There are currently no questions in the conference call.

Great, thank you. I've got a couple of questions here on the webcast. The first is are we concentrating solely on Central London or will we look elsewhere and at other asset classes. And I think the question (sic) [ answer ] to that is, as I said, we are concentrating solely on Central London. We've reorganized the business, and that is our area of focus. And we believe there is actually plenty of opportunity over the next few years, as we've explained with, right, creating best-in-class buildings, which are highly sustainable. Then we have a further question from Vanessa Guy of JPMorgan, asking for guidance on our expectations in regards to yield compression and rental income growth. There was a quote, I think, from Terry Smith, who said forecasters are a bit like magicians. So I wouldn't really want to make any forecasts on either of those. But I think the direction of travel, certainly on rental growth is strong for the best-in-class assets because there will be -- as we've set out, there is a potential shortage of supply of these best-in-class assets. And that is where the demand is focused. So we do see good rental growth for those assets. And as to yields, there are a lot of different factors that are at play, but there's certainly strong demand from the international investor market for London. And Matthew Saperia, he's asking how we will double our net assets over 5 years? And with that goal in mind, how do you think about the use of third-party capital versus your own on future opportunities? Look, I think it's entirely right. We have set out our ambition and we will, as we have in the past, I suspect, use a combination of our own capital and work with partners to enhance our returns. Good. Are there any more questions? Thank you very much, everyone.