Helical plc (HLCL) Earnings Call Transcript & Summary

Good morning, everyone. I'm delighted to welcome all of you to the presentation of Helical's half year results to 30 September 2022, whether you are here in the room or virtual on the webcast facility. Please let me set out the agenda for today, and we will follow a format that is familiar to many of you. I will run through the highlights from the results, provide some commentary and set out the way forward. Tim will explain the numbers, particularly concentrating on debt, and Matthew will report on the portfolio highlights and sustainability. After this, I will sum up, and we will then be delighted to answer any questions any of you may have. Our profit after tax is GBP 17.2 million. Our EPRA NTA value has decreased 3.3% from 572p in March to 553p. The valuations are down by 2.2% offset to some extent by 4.3% ERV growth. Generally, we have seen a downward yield movement of 25 basis points with an increase on The JJ Mack Building valuation. Now practical completion has been achieved, and developers' profit is released. Our LTV has reduced from 36.4% to 26.4%. We are proposing an interim dividend per share of 3.05p. We became a REIT on 1st April, and I will describe our key achievements since then. We have sold Kaleidoscope, 55 Bartholomew and Trinity at a total value of GBP 196.7 million, 5.3% above March book value. Practical completion of The JJ Mack Building was achieved 4 hours ahead of program on the original date of 30 September and within budget. We are pleased to have let 2 floors to Partners Group. More on that shortly. In total, 62,340 square foot has been let at an 8.5% premium to ERV. What is happening out there? We've had ultra-low interest rates since 2008, and we had all become complacent about them going up. The post-COVID inflation spike felt around the industrial world, accentuated by Putin's invasion of Ukraine, has caused the Federal Reserve to lead the way, pushing up interest rates. And this has been followed by other central banks. As a consequence, property yields are rising to reflect the increase in the cost of debt. We wait to see where interest rates finish up. While we identified bifurcation in the letting market a few years ago and had always maintained rents for best-in-class space would continue to grow, the rise in interest rates is the catalyst to create the same bifurcation in the investment market. [ Martin ] was stressed as the finest land, but now only the best-in-class, most sustainable buildings will achieve the prime yields. The rest have decoupled, and pricing rediscovery is ongoing. Thirdly, the prime yields have moved. We have seen a 25 basis point shift, and perhaps we will see a further expansion going forward dependent both on the path of interest rates and the rental growth story. However, we expect this to be in a narrow band. This is supported by recent sales of 50 Finsbury Square, 21 Moorfields and our own Kaleidoscope, which all reflect the scarcity of best-in-class products. The pricing of the poorer-quality secondhand space must be realistic and should surely be the vacant possession value at lease expiry plus the value of the cash flow until that point. The real CapEx cost must be factored in to enable the building to be refurbished and relet at requisite rent and to achieve the prime yield. There are going to be some nasty surprises as owners face up to this new reality. Anecdotally, a poor-quality city building which was on the market at GBP 157 million, at 4.8% net initial yield earlier this year, is reported to be under offer at GBP 105 million, 7.25%, a drop in capital value of circa GBP 300 a square foot and reflective of the amount of CapEx will be required. The top graph shows pre-2008 and the collapse in interest rates. The gap between the prime London yield and SONIA was much narrower. Going back further to the 1980s, prime yields in London were around 5%, whereas the average U.K. base rate at that time was around 11%. I would also remind you that London offices are not bonds, and the middle graph shows some correlation with an increased level of transactional turnover as rental growth is anticipated or achieved. We will see this for the best in class. While values are changing because of the shift in interest rates and the bifurcation that is occurring, the fundamentals of the prime market remains strong. We do not have an oversupply of good-quality office space in the way that we did in the downturns in the early 1990s dot-com burst in 2001, nor the GFC. On all these occasions, the oversupply led to falling rents. The bottom graph shows investment activity tailing off after a strong first quarter, and we await the Q4 stats with interest. Barring a pre-Christmas surge, it feels like a subdued fourth quarter. By the way, the graphs are all on single pages in the appendix, so they are easier for you to read later, if you wish. Bifurcation in tenant demand has been accentuated between the best, the newly developed or refurbished buildings, at the forefront of sustainability with top-quality amenities; and the rest, the tired, secondhand buildings with weak sustainability credentials and poor amenity. According to JLL, of the 7.88 million square foot of take-up reported so far this year, 57% has been pre-let or a newly built or comprehensively refurbished space. Of the 3.5 million square foot currently under offer, this percentage rise is 75%. In looking at this, it is important to differentiate between the best in class, which is where Helical are operating, and what is described as Grade A as this has become such a wide definition that in CBRE's analysis, it includes 75% of all the Central London office stock. There is a pull for tenants to move to the best. This is to attract and retain the brightest staff, to encourage greater attendance at the office, to provide a dynamic and exciting workspace as well as to meet their net-zero carbon and other sustainability objectives. The push for tenants to move out of the poorer-quality space is the ratchet of the minimum energy efficiency standard needs, whereby the landlord will be in breach, letting space below EPC E from April 2023, rising to below EPC B by 2030. The graphs highlight the shift to new or comprehensively refurbished space from the secondhand, which is on the bottom graph, which represents a long tail of about 70% of total availability. Some agents are saying that they cannot buy a viewing for the poor-quality secondhand space. Assuming London maintains its attraction as the leading world city, which it will barring economic or political catastrophe, there will be ongoing demand for best-in-class office space. The first graph shows the constrained nature of the future pipeline. Annual Central London 10-year average take-up is 12.5 million square feet. As explained, this take-up is ever more targeted to the best-in-class space. There is a shortage. The second graph shows the net addition to the occupied stock. More space is being occupied. This is because of, first, more office employment, it has increased 150,000 in the 12 months to March 2022; and second, because of less dense occupation. As greater amenity is incorporated in buildings, the British Council for Offices in their latest specification have pushed out their density from 1 person to 8 square meters to 1 to 10 square meters with a reduced utilization factor of 60%. Each occasion, there is a downturn on things what is different this time. The third graph shows rolling 12-month construction starts since 1985. Look at the peaks, 13 million square feet in the early 1990s crash, 10 million square feet in the dot-com 2001 downturn, 8 million square feet in the GFC and 4 million square feet now. So much less space is being completed, and occupiers are much more focused on this new space. I believe that is the difference. And it is going to take 10 to 15 years to upgrade the London office stock to the correct level of sustainability, so there will be an intrinsic shortage, which is a great opportunity for Helical. We are cognizant of market conditions and do not wish to raise our LTV beyond the band of 20% to 35% in which we are operating. We have recycled capital from the 3 sales mentioned earlier, and we will continue with this capital recycling as we find new opportunities. We remain focused on Central London. And may I take this opportunity to stress that the fully open Elizabeth line is a fantastic piece of infrastructure which really enhances our capital city. We prefer island or edge of block rather than mid-terrace locations. We want good public realm, whether we control or borrow this, and we are looking for larger floor plates. The reason for this is we believe the market for smaller floor plates, many of whose occupiers' more furnished space is standard, is overcrowded. While we will do ground-up new development where there is good reason, we believe there will be far greater emphasis on refurbishment going forward. This has the advantages of considerable savings in carbon, less planning and construction risk and greater speed back to market. That's our carbon-friendly new building. Any building should be net-zero carbon, BREEAM Outstanding, NABERS 5 Star plus and EPC A. In our buildings, we will maximize tenant amenity with plenty of bike parking space, high-quality changing facilities as well as the latest technology and wellness. In short, we are only interested in best-in-class buildings. If we do not think we can create that, we will not touch it. We believe interesting opportunities will continue to arise particularly as passive overseas owners will not have the experience nor skill sets to vote the tad old buildings back into the best-in-class category. This slide shows that our portfolio is new and will be added to by 100 New Bridge Street when completed. Our assets are multi-let, giving opportunity to regularly add value. We are tireless to ensure our building management is to the highest standards and that our buildings are maintained as new. Since 1st April, we have let 62,340 square foot in 8 units, delivering GBP 3.3 million of contracted rent. The vacancy across the portfolio was 19.2% at 30 September. And today, it is 16.3% or 7% on a like-for-like basis, up from 6%. I thought it would be interesting to look at the rents we have achieved in Farringdon over the years, which illustrates ongoing rental growth for best-in-class space. In 2016, we let all of 25 Charterhouse Square at GBP 75 a square foot. In 2019, we completed and let One Bartholomew. And the highest rent of GBP 85 a square foot was achieved on the 10th floor, which benefited from a large roof terrace overlooking St Pauls. The average rent is GBP 81 a square foot. Kaleidoscope was let at the start of 2021 to TikTok. The fifth floor, the highest, was a portion of rent of GBP 90 per square foot with an average across the whole building of GBP 86 per square foot. There is a large terrace on the roof available for all floors to use. The JJ Mack Building was finished in September, and we have let both the 6th floor and the 7th, which has a large terrace, a rent of GBP 95 and GBP 107 per square foot, respectively. This is somewhere ahead of the previous highest of GBP 90 a square foot at Kaleidoscope. The blended rent will come down as we let the lower floors, but the upward direction of travel is clear. Our passing rent today is GBP 34.3 million, and the chart shows how this rent doubles to almost GBP 59.7 million with contracted rent uplift of GBP 4.8 million, rent from letting the current available space of GBP 9.6 million and a development pipeline of GBP 9.3 million of additional rent. Let's look at the future upside we see in the portfolio. And with yields moving around, we have concentrated on rent reversion and growth. The Bower, The Loom and 25 Charterhouse Square show good increases as we either let the vacant space or complete rent reviews. The JJ Mack Building provides a further surplus as we have set the rental tone post the valuation date. And 100 New Bridge Street gives us surplus as we go through the development process. On that positive note, I will now hand over to Tim.

Thank you, Gerald, and good morning, everyone. Gerald has mentioned the highlights of a good half year for the company, and I'm going to look at the buildup of our EPRA earnings, our EPRA NTA per share before moving on to our gearing levels and debt profile, including looking at our interest rate hedging, our loan covenants and the cost of our debt. Finally, we'll look at a summary of our current financial position, highlighting the strength of our balance sheet and the extent of our current firepower. Turning to Slide 16 and looking at our EPRA and IFRS profit. Net rental income of GBP 18.2 million is 29% higher than last year, mainly reflecting the contribution from our acquisition of 100 New Bridge Street earlier this year. Worth noting that our rent collection is strong with almost 98% of rent for the period collected. And our bad debt provision for the period was less than GBP 100,000. We made a development profit of just under 100 -- just under GBP 1 million from development management fees at The JJ Mack Building and profits from the sale of residential units at Barts Square. Our total administration costs of GBP 6 million were almost 20% lower than last year but our net finance costs is marginally higher at GBP 7.2 million. Overall, on an EPRA basis, we generated earnings of GBP 5.8 million or 4.8p per share compared to GBP 1.1 million or 0.9p last year. Moving on to the non-EPRA components of our profits. An outward movement in yields generated a valuation loss of GBP 35 million in the main group, which was partly offset by a gain of GBP 15 million in the valuation of The JJ Mack Building held in joint venture and a profit on sale of investment assets of GBP 5 million. The biggest movement in the period was in the gain on the mark-to-market valuation of our derivative financial instruments, which contributed GBP 26.6 million, reflecting the low level of our interest rate swaps against the current forecast future interest rates. Overall, we made a net profit before tax of GBP 17.2 million. And as we are now REIT, there is no tax charge to set against these profits. So our post-tax profit is also GBP 17.2 million compared to GBP 22.2 million last year. The rise in EPRA earnings and the level of realized capital profits support an increase in our dividends despite the current economic backdrop. And the Board has taken the decision to increase the interim dividend by 5.2% to 3.05p per share. Turning to Slide 17. The EPRA NTA per share at March were boosted by EPRA earnings per share of 4.8p but reduced by investment losses of 12.4p and dividends paid in the half year of 8.3p, leaving an EPRA NTA per share at 30th of September of 552.6p, down 3.3%. Our EPRA NDV per share, however, was up 1.5%, reflecting the impact of the surplus on the valuation of our hedging instruments. While we're on the balance sheet, it's worth noting the total accounting return of 2.3% on an IFRS basis and minus 2.5% on an EPRA basis. Looking at our LTV and gearing on Slide 18, which shows a history over the last 10 years. The profitable sales of Kaleidoscope, Trinity and 55 Bartholomew as well as residential units at Barts Square all contributed to a reduction in the LTV to 26.4% and the balance sheet gearing to 34.9%. Turning to Slide 19. We used GBP 150 million of sale proceeds to reduce the outstanding borrowings on our GBP 400 million RCF, reducing them to GBP 250 million. We also extended the expiry date of this facility to July 26 and converted it into a sustainability-linked loan. All our borrowings are now either green loans or sustainability-linked loans. Most of the remaining metrics on this slide will be referred to on the last page of our presentation, but just to mention, we have a GBP 60 million RCF which is undrawn and which will expire next month. Turning to Slide 20. And in a period of high inflation and increased interest rates, all of our borrowings are protected by a combination of interest rate swaps and fixed rates. This interest rate protection covers our debt until the current expiry of the facilities with the RCF expiring in July '26 and the joint venture loan expiring in July '24, although that has a 1-year extension option. Looking at our loan covenants and debt costs on Page 21. It's worth noting that we can withstand the 48% fall in property values and a 37% fall in rental income before we start to reach our banking covenants. And even then, we have the ability to cover any potential breaches using our cash resources, increasing the percentages on the slide from 48% to 58%, from 37% to 50% and from 60% to 72%. Looking at our cost of debt, the weighted average cost at 30th of September was 3%. Without our interest rate protection, the average cost of debt at that date would have been around 4.7%. And looking forward to the expiry of the RCF using the current forecast SONIA rate for July '26 of 3.5%, the weighted average cost of our debt fully utilized will be around 5.5%, all other things being equal. And finally, a summary of our financial position on Slide 22. We have a net asset value approaching GBP 700 million, a net debt level of around GBP 242 million, giving an LTV of 26.4%, down 10% since March. And as Gerald has noted, we're comfortable operating in a range of between 20% and 35%. We have GBP 293 million of cash and undrawn facilities, although as mentioned, GBP 60 million of those facilities fall away next month. And we're protected against interest rate rises until the expiry of our debt facilities. So we have a strong balance sheet with protection against future interest rate rises and good capacity to invest in new schemes. And with that, I'll hand you over to Matthew.

Thank you, Tim. Good morning, everyone. I would like to provide you with an update on our portfolio highlights and our sustainability initiatives. The JJ Mack Building, comprising just over 200,000 square feet of offices and 5,500 square feet of retail, was completed, as Gerald mentioned, on the 30th of September. It is EPC A, Platinum WELL enabled. And we are targeting BREEAM Outstanding and NABERS 5 Star. The building is intelligent with advanced technology to both maximize the efficiency of the building services and the occupiers' experience. It benefits from quality changing facilities, touch-free access from door to desk and smart app user controls within a data-rich environment. And in station now with the game-changing Elizabeth line added is 2 minutes walk. Reflecting this quality and location, we have let the 6th floor of 22,500 square foot and the 7th floor of 15,500 square foot with a 6,000 square foot roof terrace to the Partners Group on 15-year leases at a blended rate of GBP 100 per square foot. We have good interest from a range [indiscernible] other parts of the building. Sustainability has been a core focus on this project with a carbon champion appointed at the outset as part of the design team. This has helped to reduce the embodied carbon by over 40% against the RIBA current benchmark. And we're in the process of offsetting the remaining carbon such that it will be our first net-zero building. We are also expecting it to be the first U.K. commercial building to achieve outstanding under the new 2018 BREEAM assessment criteria, incorporates a range of sustainable technologies, including intelligent and dynamic water management and recycling system to real-time weather forecasting, financed using a green development facility. 100 New Bridge Street was acquired in March, and we are receiving rent of GBP 7 million per annum. Apologies. We submitted a planning application in June for a comprehensive refurbishment, retaining the existing frame and core but recladding most of the facades. By adding space at the top of the building and by infilling the existing atrium, we increased the NIA from 167,000 square foot to 191,000 square feet. The building occupiers are prominent and well-located island site surrounded by public realm, which we will enhance to include a pocket park. We will create a best-in-class, carbon-friendly new building aiming for BREEAM Outstanding, NABERS 5 Star and EPC A. Given the retained structure, we are targeting a much-reduced embodied carbon figure of 430 kilograms of CO2 emissions per square meter. As well as the normal amenity, there will be an extensive roof terrace with great views of St Pauls. We aim to start on site next October with a rapid program to completion in Q1 2025. At The Bower, the offices remain fully let. We have let the 12th floor to Stenn, a digital finance platform, at GBP 80 per square foot. We also have rent reviews on 11 floors at the tower over the next 18 months. At The Loom, we have let 1 unit at GBP 60 per square foot in the period and have completed a further letting since the period end of GBP 55 per square foot. We have 1 under offer and a further 4 under negotiation, so we're making good progress reducing the vacancy in this building. At 25 Charterhouse Square, we have let the ground floor unit to SolidNature, a natural stone retailer. And we are in active negotiations on the 4th floor, which has been refurbished after the previous tenant exercised their break clause. During the half year period, 3 office buildings were sold. In May, we completed the sale of Trinity, our last remaining building in Manchester, which was sold to clients of Mayfair Capital, at a net initial yield of 5%. The following month, we completed on the sale of 55 Bartholomew to a private European investor at a net initial yield of 4.5%. And then in September, we sold the corporate vehicle which owns a long leasehold interest in Kaleidoscope to the Chinachem Group at a disposal price of GBP 158.5 million, reflecting GBP 1,789 per square foot capital value and a net initial yield of 4.25%. Each asset was sold at a premium to the 31st of March book value. On the residential front, at Barts Square, we have in the period completion on a further 6 sales, leaving 8 available, 2 of which were reserved. We have also sold the residential ground rent interest to the residents for GBP 3.7 million. Our efforts on the sustainability front has meant that we have maintained the highest scores in MSCI and EPRA Sustainability Best Practice and have improved our GRESB rating to 5 Stars for both our developments and outstanding investments. At a property level, our portfolio by value is 99% EPC A or B rated and 87% BREEAM Outstanding or Excellent, demonstrating the highly sustainable qualities of our portfolio, which is almost entirely new or recently refurbished. I will now hand back to Gerald to summarize.

Thank you, Matthew. As Tim explained, we are well placed to take advantage of any opportunities. We have been busy recycling capital and with the 3 sales at Kaleidoscope, 55 Bartholomew and Trinity. Our existing portfolio is new and sustainable. We will continue to asset manage it to advance performance, and we take every opportunity to improve sustainability and energy performance. We seek to let the remaining floors at The JJ Mack Building at equally strong rents. If anyone would like to see the building, please let me know. We look forward to our new project at 100 New Bridge Street, and we will be aiming to continue achieving market-leading rents. We will be judicious adding new opportunities to the portfolio with our recycled capital within sensible LTV parameters, where we can create best-in-class space for discerning tenants. Thank you. I'm now delighted to answer any questions any of you may have. Matt?

Matthew Saperia from Peel Hunt. Can I ask you 2 questions? The first one, you talked about your carbon-friendly new build strategy. Is that going to make it harder for developers generally to add new space to buildings given that you have to retain the core and the structure? And the second question, thinking about the progress you've made in securing ever-increasing rental values with ever more sustainable buildings, thinking about the occupiers' total occupancy costs, are these buildings more cheaper for them to occupy, and therefore, you're able to charge more rent? And is that a trend that we're likely to see continue going forward?

Look, I think on your first question, obviously, sustainability is pushing refurbishment much more, and we're also seeing that coming through the planning system. So if you want to demolish an existing building, you have to present a compelling case to the planning authorities as to why you want to do it. And you're seeing the riot -- or the debate going on with the Marks & Spencer's building in Oxford Street, where they want to demolish it and put in a new store, and various people have objected to it, and it's currently with the Secretary of State. So that is a living example of what's going on. So yes, certainly, we'll see more refurbishment. But obviously, it's what I'm saying in the carbon, they're quicker, there's less planning risk and easier to deliver. And your second question was on costs. Now obviously, if the building is highly energy efficient, it's going to be cheaper to run. And we're certainly seeing The JJ Mack Building, the service charge there is going to be very reasonable. And it's interesting where the service charge is in some of the towers. And certainly, Partners Group will be making a big saving in their service charge coming to The JJ Mack Building.

It's Max Nimmo at Numis. Just 2 quick questions, if I can. On JJ Mack Building, what sort of time frame should we factor in for lease-up? I appreciate there's -- you want to hit the best rents you can there. But what kind of -- when would you be happy to kind of commit to leasing up the rest of it in terms of time frame? And then secondly, just on the potential of adding new assets, I think kind of roughly know what kind of areas you're looking for. But just what kind of things are you looking for in secondary repricing or the types of assets that appeal to you for potential acquisition?

On the letting of The JJ Mack Building, I'm conscious I'll be standing here at 6 months' time, so we've got -- as Matthew said, we've got strong interest. And hopefully, we can push that into signed leases and, I would say, a good level of viewings. So we'll see where that gets us. And there is a shortage of this high-quality space. And on the second point, I mean I think I outlined the sort of thing we're looking at. And the pricing rediscovery, as I said, is still ongoing. So -- but obviously, anything one buys has got to build to reflect the full cost of turning it back into a best-in-class building. And some buildings we look at, we just think we can't turn them into a best-in-class building because, yes, the micro location might be poor or the building is -- doesn't have a good outlook or just the way the building was originally built is -- doesn't make a good space.

Miranda Cockburn from Panmure. Just on The Loom, just interested, the vacancy there is always a bit higher, and I know you do the sort of constant refurbs, et cetera. Just interested whether or not you're letting that up as quickly as you would like. And also, are you getting the rental levels that you hope to achieve there?

Matt, do you want to...

Yes. Miranda -- yes, it is working. I think the -- when the COVID hit, we found a number of the tenants there were relying on relatively few sort of clients, so some of them were quite susceptible to a downturn. And I think -- so we did see quite a few tenants disappear relatively quickly. Rent-wise, I think we're getting still pretty similar rents of GBP 55, GBP 60 a foot. And we're now getting -- it's -- the interest level has picked up quite substantially. We're monitoring the nature of the space that we're after. So we're fitting out a lot of that space. It seems to -- we're making it very easy to lease the space with very simple leasing structures, managed space to make sure that we have that flexibility. And we're also very flexible in terms of the breaks and the lease lengths that we provide. So I think we will see now some momentum. I think these buildings sometimes just go through a period where you just have a little bit of bad luck, and then I think it's picking up now. And I'm sure we'll ensure that we're getting there with -- when we report back in the next 6 months.

Yes. And I think just from a financial point of view, that is the one building that has quite small tenants in, so they don't have the balance sheet to be able to survive things like a pandemic. So that's another reason why The Loom went under.

Any more questions? Thank you. Are there any questions online?

[Operator Instructions]

Thank you very much, everyone. And we look forward to seeing you again soon. Thank you.