Instone Real Estate Group SE (INS) Earnings Call Transcript & Summary

Good day, and welcome to the Instone Real Estate Group AG HY 2020 Results Conference Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Burkhard Sawazki, Head of Investor Relations. Sir, please go ahead.

Good morning, everyone. Thank you for joining our H1 conference call. You have also seen the news from last night as another major topic for today. Our management team represented by our CEO, Kruno Crepulja; and our CFO, Foruhar Madjlessi, will walk you through our presentation to give you an update on our business and our growth strategy going forward. As usual, this will be followed by a Q&A session. With this, I will hand over to Kruno Crepulja.

Yes. Good morning, everyone. I'm glad you could join us to our Q2 earnings call. Today is an eventful day for us. We are not only presenting our results and our business outlook, but we are also preparing for a step change in our growth strategy with our first equity raising since our IPO. The second quarter was, of course, anything but a normal quarter with the impact from the COVID-19 pandemic. We all experienced that the world has changed with such an extreme event. From an economic or investment [Audio Gap] to be clear, the German residential as an asset class is a relative winner. Also, during this recessionary period, German residential has once again proven to be highly resilient and residential property prices continued to move up. Our business at Instone definitely saw a noticeable temporary sales decline due to the pandemic. But we have also witnessed a subsequent strong rebound of our sales activities. This recent development also provides very good reasons for optimism that Instone will be a key beneficiary of the structural trend of sustained high demand for German residential real estate assets. So let me, first of all, start our presentation with an overview of the recent developments. As mentioned, we have seen a severe short-term impact on our sales with the breakout of the COVID-19 pandemic and therefore, we have also decided to postpone the marketing of new projects. However, since middle of May, we have seen a steady V-shaped recovery of our sales. Meanwhile, our sales have now fully normalized. They have reached the strong precrisis levels again. This also holds true for institutional business, where we, after [Audio Gap] have received strong indications of interest, especially for institutional investors, German residential has gained further relative attractiveness also vis-à-vis other real estate subsectors. Nevertheless, we will not be able to catch up the temporary revenues losses this year, which will have a short-term impact on our 2020 results. I'll come back to this in a minute. Part of the continued normalization is also the restart of our acquisition activities. We have exercised a purchase option on 2 projects with a GDV of around EUR 190 million. We have started construction of 3 projects with a GDV of EUR 235 million and launched the marketing of 1 project with a GDV of EUR 36 million. On top, we have several projects in the premarketing phase. Also on the financing side, we strengthened our business profile recently. We successfully refinanced the term loan provided by Deutsche Bank with a coupon of 5% by EUR 100 million promissory note at favorable terms of 4%, and therefore, we have further reduced our funding cost. This underscores our low cost of capital also in relation to other listed peers. So let me briefly give you an overview of the development of our financial KPIs, which were heavily affected by the pandemic in Q2 after we had a good start to the year in the first quarter. Despite the decline in Q2, our revenue still showed a moderate increase of plus 3% in H1 compared to first half of 2019. Our gross margin stayed at a very high level of more than 32%, reflecting the quality of our project portfolio as well as the execution capabilities of the Instone platform. Our adjusted EBIT decreased in H1 to EUR 28.2 million year-on-year due to temporary loss of revenues and investments into our platform, i.e., into planned future growth. While our tax rate in 2019 benefited from a positive onetime effect due to the first time recognition of a tax loss carried forward, we saw the expected return to a normalized rate in current fiscal year. This resulted in an expected stronger decline in the adjusted earnings after tax. Coming to our outlook. Fiscal year 2020 will be a transitional year. The compelling secular growth trend for our business will be overshadowed by the short-term distortions from the pandemic as we lost roughly 1/4 of annual revenues. We reinstate our 2020 guidance with an adjusted revenue [Audio Gap] and the target for adjusted earnings after tax of EUR 30 million to EUR 35 million. We feel very comfortable regarding our 2021 growth targets. Accordingly, we reiterate our revenue guidance of EUR 900 million to EUR 1 billion as well as our earnings guidance of at least EUR 90 million of adjusted earnings after tax. Also, our plan to distribute 30% of adjusted earnings as dividend, starting with fiscal year 2020, remains unchanged. By launching our valuehome product, we have added a second pillar to our business. We believe that Instone's business model offers huge growth potential going forward. Therefore, we decided to raise equity to fund the step change in medium to long-term growth and to take advantage of our excellent competitive position. On the next slide, #7, you find an overview chart with the terms of the imminent fully underwritten transaction. We are going to raise EUR 170 million of equity at a subscription price of EUR 18.20 per share. This corresponds to a standard discount to the theoretical ex-rights price, TERP, of 23.1%. The subscription ratio is 4 new shares for 15 old shares. Hence, we are increasing our capital by 27%. We provide an overview for this capital markets transaction. We strongly believe that now is the right time to raise fresh equity as there is an excellent window of opportunity for an acceleration of our growth strategy. The proceeds from the capital increase will give us the financial firepower to invest into incremental projects with a GDV of at least EUR 1.5 billion. This allows us to raise our sustainable medium-term revenue target to EUR 1.6 billion to EUR 1.7 billion annually. We actually see 2 strong factors supporting our view. First of all, we see that there is a window opening up with a temporary opportunity to benefit from increased land supply and the less intense competition. There is decreasing competition that is driven by the current absence of highly leveraged players predominantly relying on mezzanine capital. On the supply side, you can expect a positive impact from the conversion of the one or other commercial development project into a resi project due to economic downturn reinforced also by structural headwinds. Overall, we are currently observing largely stable land prices, and we expect them to remain rather stable for some time. With an unchanged positive outlook for medium-term price inflation, the current situation forms a great basis to generate excess returns above our internal IRR and margin targets in the years to come. After we put acquisitions on hold due to the crisis, we bought our first 2 projects at the end of Q2. One of these projects, we were even able to renegotiate the previously agreed price to lower providing evidence for our thesis. The second very good reason in our view to raise equity is the planned rollout of the valuehome product. On the basis of a standardized, highly scalable product, we are entering a new market segment, the mid-market segment. This market is completely undersupplied, and there's huge growth potential for us with our innovative product. We at Instone have a substantial competitive advantage, which we are going to exploit in the coming years. On Slide 11, we provide additional information regarding the use of proceeds and the impact on our growth outlook. While maintaining a strict capital discipline, we believe that we can spend the money within the next 6 to 18 months, at least in line or even above to our clearly defined investment criteria. We are striving for a margin target of [Audio Gap] and IRR target of 20% and 25% for our traditional and our new valuehome product, respectively. We have already secured a pretty high visibility with identified projects with a total volume of some EUR 4.3 billion of GDV, thereof, a volume of around EUR 1.3 billion has reached a more advanced stage. This comprises either the successful negotiation of term sheets or an approval of the management. Projects with a volume of EUR 115 million have even reached an agreement with the management approval. The funds allow us to raise our medium sustainable annual adjusted revenue target to a level of EUR 1.6 billion to EUR 1.7 billion. This is up by 60% to 70% from the steady-state level we have discussed with you at the time of the IPO. The table on Slide 12 provides you with a more detailed breakdown of our current project pipeline with a total volume of some EUR 4.3 billion. As mentioned, for around EUR 115 million, we are close to signing. The potential projects are spread over our 8 regional branches, a high share of this pipeline is designated for our new valuehome product. Of the total pipeline volume, there's maybe a 50-50 split between our new and our traditional core product. On the following slide, we illustrate the mechanism of how the net proceeds [Audio Gap] EUR 25 million from the capital I translate into future growth potential. With EUR 175 million of equity and at a loan-to-cost ratio of 40% to 50%, we are going to acquire plots of land over the next 6 to 18 months' worth more than EUR 300 million. As a rule of thumb, the value of land on average corresponds to some 20% of the GDV. Accordingly, you can calculate that the equity injection eventually translates into an incremental GDV of more than EUR 1.5 billion, which we are going to realize over a period of a few years. The residential product we are offering to the market enjoys very strong demand. An end of the structural positive trend is currently not in sight. During the current COVID crisis, this asset class gained further relative attractiveness, especially related to other real estate subsegments such as retail, hotel and also office facing structural headwinds. The strong resilience of residential prices during the pandemic is no longer only a general market observation, but it has now also been confirmed by all relevant data providers and surveys. You'll find a summary of the recently published market data on Chart 12. They all point into the same direction, that property prices, also during the second quarter, remained at least stable or they moved up, an exceptionally strong result during a recessionary period. An important factor contributing to this is the fact that the financing environment stays very supportive. So far, there has been hardly any negative impact on mortgage rates or the availability of loans. Mortgage rates remain nearly at all-time lows and at significantly below 1% for 10-year loans for most private investors. Hence, affordability remains high. On Slide 16, we provide an update of our current project portfolio. There are no material changes. Instone's unique position in the German development market is reflected through diversified nationwide pipeline of EUR 5.7 billion, corresponding to more than 13,000 residential units, mostly spread across attractive German [ ACEs ]. After the reporting date, the portfolio GDV further slightly increased to some EUR 5.8 billion. You are also familiar with the chart on Slide 16, on the right-hand side. We currently have around EUR 2.3 billion of GDV, either under or preconstruction. And there are some 87% or EUR 2 billion have already been sold, providing a high earnings visibility for the coming years. With that, I would like to hand over to Foruhar for the financials.

Thank you, Kruno, and good morning, everyone. Let's go right into our Q2 results of operations on Page 18. While our Q2 revenues of EUR 80 million fell short of our original expectation as well as previous year's Q2 figure. Against the backdrop of the COVID-19 pandemic and associated lockdowns, we are satisfied with the results. In particular, we feel very good about our ability to achieve a Q2 gross margin in excess of 35%, exceeding previous year's strong figure. The result is indicative of the quality of our projects as well as our ability to maintain pricing at pre-corona levels for all our projects. As we had always anticipated, the second half of this year will come in at lower margins. So for the full year, our expectation is a gross margin of 28% plus. This is above our [Audio Gap] 27% at the top, but in line with our previous statements that lower revenues than originally anticipated will lead to margins at or above the top end of our initial guidance. Platform [Audio Gap] the moderate increase to EUR 29.9 million for the first half of 2020, primarily reflects the continued buildup of our platform with an increase in FTEs from EUR 267 million to EUR 323 million over the last 12 months. Over the course of fiscal years 2018 and 2019, we have rapidly increased profitability as well as investments into new projects. The financial results line for the first half of 2020 reflects these investments and the resulting increase of our gross debt and interest expenses. Finally, as you know, in fiscal year 2019, we did benefit from the first time recognition of tax loss carryforward to the favorable corresponding IFRS tax rate. The 26.2% adjusted IFRS tax rate for H1 2020 reflects a more normalized tax rate for our business. We expect the full year tax rate to amount to around 30%. On Page 19, you can see the development of our customer sales contracts. The amount of concluded customer sales contracts are a key driver of our revenues. Q2 2020 sales contracts amounted to EUR 54 million, a decline of more than 21% versus our Q1 2019 sales. Again, this is a reflection of: one, a temporary but severe reduction in our sales to retail customers, as evidenced in our sales ratio trough of 0.5%; second, our decision to postpone a number of marketing launches at the height of the COVID-19 pandemic; third, the temporary hold of negotiations and resulting delay in completions of institutional sales. In the meantime, we have witnessed a complete normalization regarding all of these temporary impediments. Hence, we do expect the second half of fiscal year 2020 to result in a much higher customer sales figure than H1. In fact, our guidance for the total concluded sales contracts in fiscal year 2020 amounts to at least EUR 450 million. The substantial increase in sales is driven by: one, the normalization of our retail sales ratio; second, incremental retail sales from 3 to 4 new H2 project launches; and third, substantially increased institutional sales where we see good progress in negotiating a number of potential sales. In summary, current trading is strong. Institutional sales are in concrete discussion and visibility is clearly normalized. I will come to our reinstated 2020 financial targets in a bit, but the above provides a high level of confidence in the relevant revenue and profit forecast. Over the page, we show our loan-to-cost and leverage ratio as of 30th June as well as pro forma. The pro forma column shows the impact of: first, the EUR 170 million net proceeds from the rights issue; and second, the refinancing of our term loan with a new EUR 100 million 5-year promissory note. With profitability temporarily impacted by COVID-19, our focus in monitoring leverage is on loan to cost, which we consider to be prudent, both pre the equity raise as well as pro forma for the capital increase. In the context of our LTC ratio, please note that our inventories are recognized at cost, and there is a substantial gap between the balance sheet figure and relevant fair values. Going forward and post investment of the rights issue proceeds, we are targeting net debt-to-EBITDA broadly around 3x and LTC of around 45%. Page 21 provides an overview of our project level and corporate level debt maturity schedule. By definition, project level finance is typically short term. Our corporate level weighted debt maturities are in excess of 3 years. I highlight our latest corporate level refinancing success. With a new EUR 100 million 5-year promissory note, we have repaid a 5% liability with a 4% instrument, substantially termed out our debt maturities and further diversified our debt investor base as we have now, for the first time, access the group of German pension funds. Our corporate level interest cost, excluding commitment fees payable on undrawn facility, has now been reduced to just above 3%. Our effective project level funding costs are more expensive and include bonding and guarantee costs. As a result, we do expect our overall cost of debt going forward to come out at around 4.5% as opposed to our previous guidance of 4.5% to 5%. Turning to Page 22. Our H1 operating cash flow amounts to negative EUR 37.8 million. However, adjusting for land investments of EUR 50 million, our H1 cash flow comes out at plus EUR 12.5 million. I would like to reiterate that even after new project investments, we do expect a positive operating cash flow for the full year. In fact, we expect substantial milestone payments based on already concluded customer contracts with both retail as well as in particular, institutional customers. These payments are, however, geared towards year-end and will mostly accrue in the fourth quarter. In addition, recovering new retail sales will provide for incremental cash inflows, in particular, in relation to those projects where construction is well progressed. As we embark on our new investment program and put the proceeds from the capital raise to work over the next 6 to 18 months, we do expect operating cash flow to be negative for fiscal year '21 as well as for fiscal year '22. Page 23 provides an overview of our liquidity position, both on an actual as well as pro forma basis, taking into account EUR 170 million net proceeds from the rights issue as well as our EUR 100 million debt refinancing. Our strong corporate and product level liquidity has obviously further improved on a pro forma basis. I would like to stress once again that our growth plans are fully funded and no further equity will be required to achieve our announced midterm revenue target of EUR 1.6 billion to EUR 1.7 billion. Over the page, we show our prospective NAV, both on an actual as well as pro forma basis per share. Please note that the pro forma figure is based on the capital raising, but pre any investment of the proceeds. On that basis, the capital raising would be slightly dilutive to NAV on a per share basis. However, we have also added a column for illustrative purposes to show the NAV figure, assuming investments in new land plots with EUR 1.5 billion GDV. On that basis, and assuming incremental expected project expenses equivalent to 60% of the GDV of these new land plots, we clearly expect the capital raise to be accretive to our NAV per share. The illustrative calculation points to an NAV per share post investment of EUR 39. As a reminder, our prospective NAV is the NAV our company would show, assuming all our projects would be developed to hold. Turning to Page 26. And as Kruno has already pointed out, we are reinstating our profit forecast for fiscal year 2020. We expect to achieve 2020 adjusted revenues of EUR 470 million to EUR 500 million with a gross margin of at least 28%. This will translate into adjusted [Audio Gap] EUR 5 million. Our expected volume of customer sales contracts amounts to at least EUR 450 million. Our guidance for 2021 and beyond remains unchanged. In particular, we remain highly confident to achieving a 2021 adjusted earnings after tax figure of at least EUR 90 million. Please also note, as previously communicated, all our revenue targets for 2020, 2021 and 2022 are covered based on existing projects. Also, for 2020 and 2021, 78% and 31% of revenues are covered based on already concluded sales contracts, assuming continued construction progress as planned. Finally, we remain fully committed to paying a first-time dividend of 30% of our adjusted [Audio Gap] by fiscal year 2020 to be paid out in 2021. We also anticipate to maintain our 30% payout ratio for the subsequent years, as we feel absolutely confident in our ability to deliver continued attractive growth and return cash to shareholders. With that, I would hand it over to Burkhard.

With that, we would like to kick off the Q&A session, sorry.

[Operator Instructions] Our first question will come from Bart Gysens with Morgan Stanley.

Thank you for providing that new midterm guidance of EUR 1.6 billion, EUR 1.7 billion, that's very useful. But can I just check how do you define midterm? Is that in 3 years' time? In 5 years' time? In 7 years' time? And secondly, when -- on Page 24, when you provide an illustrative post investment scenario, the net debt that you showed there of EUR 672 million, is that the net debt you expect to be at when you are at your run rate of EUR 1.6 billion, EUR 1.7 billion of revenues? Because I think then it's helpful to say, okay, if you make that type of revenue and if you apply certain EBIT margin to that, then we have an idea about what your debt cost will be, and therefore, we can have a proper understanding of what the bottom line economics will be. So that's my 2 questions.

Okay. On your first question, Bart, we think that we can achieve our target range by 2025, '26 at the latest. So midterm for us, I think, is within 5 years from now. On the pro forma or illustrative calculation, we are starting off the Q2 debt figure and assume that we're investing an incremental EUR 309 million into GDV projects worth EUR 1.5 billion. If we were to look forward to 2025, I would expect that our net debt figure would be quite a bit lower as we generate cash flows on the way to 2025.

Our next question comes from Pascal Boll with MainFirst.

I have a question, at your Capital Markets Day, you estimated there's additional sales revenue of EUR 400 million by 2025. Now you issued a new guidance of EUR 1.6 billion to EUR 1.7 billion per year in the midterm, but with a cap increase. This sounds against the backdrop of the first given outlook a little conservative. Can you elaborate why you are not more optimistic or planning more aggressively?

I think you're right. The number is conservative. If you run the numbers, what you'll see is that the proceeds -- the net proceeds on the capital raise, we could probably use a bit more leverage. And we are saying at least EUR 1.5 billion of GDV. So to the extent that this number will be exceeded, and I think there is a good chance of us getting above the EUR 1.5 billion, there is also upside to the revenue targets. But the other thing that we're also achieving is that we are accelerating the growth, so the trajectory to achieving the EUR 1.6 billion to EUR 1.7 billion will be steeper compared to what we would have been able to do organically. And lastly, and sort of in line with the previous statements, we feel quite strongly that the opportunity is now. So putting money to work now should allow us to generate enhanced returns versus our ambitious targets, considering what Kruno said about the market environment.

[Operator Instructions] Our next question will come from Thomas Rothaeusler with Jefferies.

Just one question actually on the sales activity. You said that's basically back to pre-COVID levels. I understand this is partly impacted by catch-up effects from a weak Q2. Can you comment on that? Or is this right? [indiscernible] -- actually, what I'm interested in is if the underlying sales activity, if you adjust for catch-up effect, is it also back to pre-COVID levels?

Thomas, the answer is yes. So the binding quality we have is back to level of pre-COVID. And we are currently in the premarketing phase of the one or the other project and also here the binding quality of people signing reservations. And this is, from our perspective, one of the main statistics, how many reservations we are signing week-by-week is back to normal.

I think to be clear, we don't think that this is just a catch-up of pent-up demand. This is a fundamental return to previous levels in terms of sales speed and discussions. And we can see this internally, not just by on a sales ratio basis, we will also see this on the level of interaction and reservations that we monitor as well.

Okay. That's helpful. Just one follow-up on the 2021 revenue guidance. Maybe we can get some more color on how visible is this and about confidence level on that?

So as usual, our -- the starting point for our guidance is a bottom-up analysis of the existing projects, as we said, that all of our revenues are covered by existing projects. We're clearly subject to changes here and there. Some projects go faster, some go slower. I think we have a really very high level of confidence to achieving both the revenue target as well as the net income target for 2021. It would take another severe external shock for us to feel uncomfortable with that figure.

Our next question comes from Philipp Kaiser with Warburg Research.

And just 2 questions. One, referring to the overview on Page 12. And you mentioned that there is a 50-50 split between valuehome and credit core and card business. Is that referring to your EUR 1.5 billion or to the EUR 4.3 billion of total GDV? And were there any corona-related insolvency cases in your network of subcontractors so that you have to replace a new -- so all partners or service providers, so then could be kind of a trouble in the construction area?

Okay. I'll start with the first one. So the 50-50 split is related to the EUR 4.3 billion. When we look at the short term, EUR 1.2 billion, thereof approximately EUR 700 million related to the core business and approximately EUR 500 million to valuehome. And your second question regarding subcontractors. So we haven't had any impact by corona or we haven't lost any capacities on the construction side. So we work with full workforce. What helps us here is additionally that we are well organized on the construction sites with all the necessary infrastructure. And additionally, we have already, before corona, installed a system of identifying every worker on the site. So if there would be a corona case, we could immediately react on the construction site, identifying the work, et cetera. So here, we are well prepared if something is coming up. But up to date, there was no impact.

[Operator Instructions] I'm currently showing no questions in the queue at this time. I'd now like to turn the call back over to Mr. Sawazki for closing remarks.

Yes. Thank you for your attention. If you have further questions, please do not hesitate to contact the IR team also after the call. Thank you, and goodbye.

Thank you, ladies and gentlemen. This concludes today's teleconference. You may now disconnect.