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

Thank you. Good morning, everyone. I would like to welcome you all to our Q3 '24 earnings call. Our CEO, Kruno Crepulja; and our CFO, David Dreyfus, will walk you through our presentation and give you an update on our current business performance and our outlook. As usual, this will be followed by a Q&A session. With this, I would like to hand over directly to Kruno.

Hello, everyone, thank you for joining our Q3 earnings call. Instone has once again delivered a very solid performance in the third quarter in what remains a challenging environment. The results also show that we are well on track to achieve our full year 2024 targets. The market recovery continues, and we are also seeing really encouraging momentum, especially after the summer break. The market is still showing a differentiated picture, but we have seen a noticeable pickup in demand in our retail business, especially since September. Investor sentiment is improving, which is certainly a result of the noticeable decline in interest rates from peak levels and the rising awareness that prices for new builds have bottomed out. Retail sales have already recovered quite significantly from the previous year's lows, driven in particular by buy-to-let investors, but the share of owner-occupiers has also started to rise again. Institutional investors, however, are generally still being cautious. Nevertheless, we are in talks on a number of deals, and we are confident that we will achieve the signing of at least one additional institutional deal by the end of the year. When we look at our business performance in the first 9 months, I would also like to highlight our strong cash generation. We achieved an operating cash flow of EUR 127.1 million, which helps to further strengthen our balance sheet. Our financial leverage is very low with an LTC of only 8.8%, and we have a substantial cash position of around EUR 270 million. This puts us in a very good position to invest in future growth at the trough of the market. Let's now take a brief look at our financial KPIs for the 9 months of 2024. Our adjusted revenues amounted to EUR 384.5 million, slightly below previous year's level, but fully in line with our expectations. Our gross margin remains at a high level of 24.2%, which is well within our budget. We continue to view our margin as per the best indicator of our operational excellence and leading profitability. We believe that we are a cost leader with our own in-house construction management. Also, our high level of discipline in property acquisition is reflected in this margin. Our adjusted earnings after tax amounted to EUR 29 million, which means that we have already almost reached the lower end of our full year guidance. Finally, our sales, which reached EUR 156.6 million, corresponding to an increase of more than 70% compared to the previous year. We expect a significant acceleration in the final quarter. Against the backdrop of our very solid business performance in the first 9 months, we are also reiterating our guidance for the full year 2024. We expect revenues to be more in the lower half of the forecast range. But adjusted earnings to be well within the range of EUR 30 million to EUR 40 million as we see a slight upside to our margin target of 22%. With our expectation of a strong fourth quarter, the sales target of EUR 300 million is also realistic. Moving on to Slide 4 in our presentation. As usual, the upper chart shows the development of our retail sales. The recovery in demand is gathering pace. While you can already see from the chart that our sales ratio has continuously improved in recent weeks, still does not give full picture. The accumulated number of reservations and notary appointments as the most important lead indicator is at its highest level since mid-2022. This is a good indicator for a very promising development of the sales ratio in the coming weeks, which already rose to 1.7% in the last week. Accordingly, we expect a strong Q4 in our retail business. By the end of the third quarter, our retail sales have already increased by more than 100% from previous year's trough levels to around EUR 89 million. We observed the investor sentiment has improved considerably over the past month. The decline in long-term interest rates from peak levels, the rising awareness that property prices especially for new builds in good quality locations have bottomed out in combination with the rising rents and wages are the key driver for this. The Growth Opportunities Act has created a very attractive support scheme for buy-to-let investors. The regulatory framework is quite complex and it has taken time for demand effects to materialize. And also the supply side needed time to bring products onto the market that benefit from the full subsidy with an initial tax depreciation of 10%, providing very attractive cost tax returns. We will start selling the first products that benefit from the maximum tax incentive in due course. However, we are already seeing the first positive effects in the sale of our current projects, which also benefit from the increased aggressive depreciation of 5%. Turning to our institutional business. The market remains challenging, although interest is clearly increasing. Nevertheless, as already mentioned, we are currently negotiating various projects, and we are confident that we will be able to close at least one additional transaction by the end of this year. Against this backdrop, we remain confident that we will achieve our sales target of at least EUR 300 million in 2024, which implies a strong seasonality in the fourth quarter. On the following Slides 5 and 6, we provide you with an overview of relevant macro indicators for our business. An important development in recent quarters has certainly been the stabilization of prices for new builds. There are clear indications that prices in metropolitan areas have already bottomed out. In addition to the fact the price, an important value driver for our business, the end of deflationary pressures also, as already mentioned, a generally very important factor for the uptick in demand. New build apartments remain the first choice for investors, also due to superior rental development. I'll come back to this in a minute. The chart at the bottom of the slide illustrates construction price inflation over time. The most recent data from the Federal Statistics Office confirmed a continuation of the trend of the last few quarters with a moderate CPI growth. However, we believe that the market is actually showing a more differentiated picture. According to our own on-the-ground experience, the cost increase is very low, if any. The demand for construction work is rather low right now, especially for larger projects and we clearly are benefiting from this. All of our construction projects are on budget. As already pointed out, the continuous dynamic rental growth in the German residential market, combined with the widening demand/supply gap is a key factor for the rising property yields and stabilization of residential house prices. With the combination of continued dynamic rental growth and the moderate price correction from peak levels has brought back property yields also for new builds close to their long-term average. The data from Bulwiengesa on the left-hand side of this slide, illustrates the very dynamic rent development for the top 7 cities in the past years with an additional acceleration as a shortage in the German housing market continues to rise. The scenario analysis on the right-hand side of this slide shows the change in affordability since the start of the crisis. Based on this analysis with the development of key input factors, we wanted to demonstrate that after the interest rate shock, the market has now adjusted in such a way that, firstly, buying is again cheaper than renting with rental yields exceeding mortgage rates. And secondly, affordability has not yet returned to the level of 2022, but the difference is not as large as it was 18 to 24 months ago. The mortgage ratio for new builds as a percentage of disposable income is lower than the rent ratio. This is due to a combination of a moderate price correction, i.e., a lower purchase price, a lower level of debt required and interest rates that have come down from the peak level as dynamic rent growth and some wage inflation. This includes an initial debt repayment of 2%. The monthly mortgage charge has increased in absolute terms, but taking into account the wage growth, the delta looks manageable for large parts of German households. This is a scenario analysis from the perspective of owner occupiers. Buy-to-let investors as the other important private customer group benefits substantially from the support provided by the Growth Opportunities Act, which is due to the possibility [Audio Gap] depreciation offers a very attractive double-digit post tax returns in the first years. While institutional market is still difficult overall, subsidized social housing has developed into an attractive product category also for institutional investors in some federal states thanks to improved support conditions. We are clearly benefiting from this. Moving on to Slide 7. As discussed in previous earnings calls, Instone has weathered the crisis very well based on its strong balance sheet, leading margins and a high presales ratio. The latter has provided a sound basis for earnings and cash flow visibility and has, therefore, clearly helped to derisk our business. To give you just a brief update on this, projects worth EUR 2.9 billion are currently under construction of which 91% have already been sold. This provides a stable source of future revenues of more than EUR 440 million as well as secure future cash flows of more than EUR 200 million. Over the past quarters, we have already generated substantial cash flows from the presold projects under construction, as David will highlight on the following slides. As soon as the market reopens more broadly, we will be able to accelerate our sales significantly with an existing land bank project with building rights of around EUR 1.7 billion. I would now like to hand over to David for the financial section of the presentation.

Thank you, Kruno. Let me now walk you through our Q3 financials in a bit more detail, starting on Page 9. As Kruno has already mentioned, we are pleased to have delivered another very solid set of results that puts us well on track to meet our full year targets. In line with our expectations, our adjusted revenues are slightly below previous year's level, mainly due to the expected lower construction outputs. We have continued to deliver high gross margins of 24.2% [Audio Gap] '24. As indicated in previous calls, the margin in the second half of 2024 is as expected, slightly lower than in H1, mainly due to a change in the revenue mix. Nevertheless, we are very much on track for the full year 2024, and the risk to our margin target is more on the upside. Compared to other listed companies with exposure to German residential developments, it is clear that we set the benchmark in our industry in terms of profitability. This is no coincidence, but rather the result of our structural competitive advantages, as Kruno has mentioned, such as our in-house construction management and our expertise as well as discipline in land purchasing. Additionally, we clearly also benefit from the fact that we do not suffer from any financial pressure. Our platform costs have increased, driven by onetime effects such as the share-based provisions for our management LTIP. Our underlying platform costs are in line with our full year target of around EUR 70 million. This is a result of our implemented cost-saving measures, including our staff costs which, for instance, have decreased by around 8% year-on-year. Further down in the income statement, we show a significant improvement of our interest results. This is mainly due to a higher share of project-related capitalization of financing and the substantial reduction in net debt. At the end of the third quarter, net debt was down by more than EUR 160 million year-on-year. We achieved an adjusted earnings after tax of EUR 29 million. While these results cannot be extrapolated, it should nevertheless provide comfort that we will ultimately be well within our forecast range of EUR 30 million to EUR 40 million for 2024. Over to Page 10. In the past, we have repeatedly highlighted our predictable cash flows from presold projects under construction as a particular strength of Instone, especially in the current environment. You can now see how these cash flows are actually materializing. With a high operating cash flow of EUR 127 million in the first 9 months, we were able to further strengthen our balance sheet. Our LTC dropped to a very low level of only 8.8% at the end of the quarter. Despite a lower earnings level in the current phase of the cycle, net debt-to-EBITDA is now only at 1.5x. This gives us ample headroom for acquisitions in an attractive competitive environment. Having signed the first 2 bargain transactions in the first half of the year, we are currently in negotiations for a number of additional land acquisitions. In the current market environment, transactions take time. As we have often said in the past, we actually expected 2025 to be an even better year for acquisitions with increasing supply of the markets, including an expected increase in distressed sellers. We are definitely well prepared to take advantage of these opportunities when they arise, and we are keeping our powder dry. We would also like to see a further improvement in demand in the institutional transaction markets before making acquisitions on a larger scale. We will not abandon our strategic strength of a strong balance sheet. This will remain a key pillar of our business strategy. Moving to the next slide. Our strong cash generation with an operating cash flow of EUR 127 million, as just mentioned, is shown in the table on the left-hand side. In addition to the strong cash inflows, especially from milestone payments, our continued selective approach to acquisitions is, of course, a key driver for this development. We have a very strong liquidity position of almost EUR 270 million and a significant net cash position at group level, i.e., if we would deduct outstanding corporate debt from our cash, we would still have substantial net cash available on group level. In addition, we have access to revolving credit facilities totaling around EUR 160 million. Furthermore, we also have contractually secured undrawn project finance lines of more than EUR 160 million for our projects under construction. Chart 12, gives us an overview of our financing structure. We have repaid liabilities of EUR 35 million due in 2024 from our existing liquidity. Overall, we have a very balanced remaining maturity profile with only low refinancing volumes in individual years, which also contributes to our strong financial profile. Finally, coming to our outlook on Page 13. As already mentioned, based on our very solid performance in the first 9 months of 2024 and the currently anticipated acceleration of our sales activities, we are convinced that we are well on track to achieve our full year targets, which are summarized in the table. To add somewhat more color to this, we actually expect revenues to be in the lower half of the guidance range, but we anticipate earnings to be well within the range as we see a slight upside to our margin targets. With this, I would like to conclude the presentation and move on to the Q&A session.

[Operator Instructions] Our first question comes from Thomas Rothaeusler from Deutsche Bank.

Yes. A couple of questions. The first one is actually on rather recently topic, the current government troubles. And any ideas about potential impacts on your side? That will be the first one.

Thomas, it's Kruno speaking. So from our perspective, when we talk to different parties regarding necessity to increase residential spaces in Germany, I think it's clear that all the parties see the necessity to it. Will there be any, let's say, significant change in behavior? I think that [ Chris ] Democrats will further push trying to increase our volume and, let's say, to increase the supply of flats from our perspective. So overall, I would say the situation could be positive for us. And I think it's minimally neutral. So that will be my personal first feeling on [ some of it. ] Maybe just to add, Thomas, I think overall, the economic pressure is due to nothing happening on the government level through a change in government will hopefully unveil that we will see some upside to the economy, which would be absolutely appreciated also from our end.

And any idea on like rent regulation? Or could there be any element for you relevant, just thinking -- roughly thinking about...

So regarding -- I think that due to the fact that we are expecting, let's say, a voting progress, I don't think that there will be relaxation on rent price regulation from my perspective. But you know that new builds properties are not part of the rent price regulation in, let's say, the mid-priced [ renter ] . So therefore, clearly, I think the appetite of investors is still focused on new builds due to the fact that rent price regulation is not really cutting through here. And I don't believe that Chris Democrats will put this on their agenda. That wouldn't be really popular, I would say.

Yes. Great. Great. And the second one is, I mean, just maybe roughly looking into next year, just wondering what's your view, especially with regards to sales activity I know it's very early. You don't provide a guidance yet, but just a rough, rough year. I mean I think you referred to a significant upside, what you said for sales should the market reopen more broadly. And also what is your expectation here for next year?

Yes. So let's try to maybe look at the years before the crisis. And there, we had sales volumes being above EUR 1 billion in the peak, mainly driven by institutional sales, roughly 60% to 70% of it. And when we look at 2025, I would say that owner occupier business is coming back to a level from a sales perspective from last weeks, on the level which we have seen before the crisis, the same for buy-to-let investors, and they will be additionally pushed by the Growth Opportunity Act because it's significantly more attractive today to buy a flat if you can benefit from both aggressive depreciation programs than in the past, also from a yield perspective, return on equity, et cetera. So therefore, this is still more attractive. But on the other hand, I think that the institutional market won't come fully back. So this was the strongest, if you -- the strongest sales channel in the past. So it's hard for us to predict today a detailed number. I think we have to wait a bit to see how the institutional market is coming back. What I can say is that we will have a significantly higher sales volume in '25 than this year. But to be more precise, we need some time and you have to wait for the guidance next year.

What would you say, what's the preconditions for the institutes to come back? I mean -- you saw one of your listed peers yesterday announcing to restart new projects basically. Yes. I mean, what do you think we need to get more demand from institutes?

So we are constantly in discussion with institutional buyers, and we are preparing the one or the other sale for this year, and we are very confident to get there. I think when we look at our portfolio and the multiples we have calculated, et cetera. I think these are in line with the expectation of institutional buyers. The institutional buyers have -- different groups of institutional buyers have different issues. The pension funds, for example, have invested a significant portion into offices in the past. They are currently struggling with overall write-off necessities. Then you have the funds like PATRIZIA, for example, they have suffered from outflows. Now we see that part of the money is coming back. But it will take time for them, not regarding the yield expectation more like cleaning up the portfolio. On one hand, getting the confidence of investors back that it's the right moment now to invest when the prices are going through the trough and there is potential HPI growth in the future. But all this will take time from our perspective. And the other thing which could, of course, accelerate the speed of a market rebound is -- are the interest rates, but it's now with the result we [Audio Gap] in U.S., it's difficult to forecast let's say, very sharp interest of cost decrease in the coming years. So we'll see. But this could be the driver that could significantly the [Audio Gap] back because then additionally to but the yields are quite attractive the investment alternatives investors have are decreasing massively then. So -- but it's hard, very hard for me to make a forecast today. But we clearly see that the appetite or the interest of investors has come back. And what we also see is that the price levels we are offering our product meets the expectation of investors. So these are 2 very positive things. But again, it will take time.

The next question comes from Andre Remke from Baader Bank AG.

And especially your comment on gross margins that there is upside pressure on your outlook. But maybe looking into the upcoming quarters beyond the fourth quarter where you potentially see a lower gross margin. Will the margin afterwards then stay on that lower level for the quarters come just probably as a kind of indication as you did not provide the guidance for next year, of course. Just to get a feeling on that.

Well, Andre, thank you for your question. It's David. We see that the margin -- the gross margin from our historic levels of 25% will come down a bit in the future due to the fact that in the future, we have more product, we expect more product to come from new, which has a lower gross margin as you're aware. So that mix will change. And number two, our pipeline that we have will also have a slightly lower gross margin than we have seen in the past due to the construction price inflation.

Maybe one additional comment from my side. So this, of course, is reflecting the current portfolio -- the projects we are adding to the current portfolio, and this also is, let's say, the same for the 2 projects we recently bought in Frankfurt and in Dusseldorf. They have significantly high margin. So looking at the existing portfolio, David, is absolutely right, but I also believe that in the next 2 years or 3 years of projects we are purchasing, they will have significantly higher margins due to the stress in the market where we can really benefit from the current market environment.

But also [ maybe ] as a curve, so in the short term, that means you will see the margin coming down a bit. And then medium term, it will increase again.

And a very difficult question because, first, you have to buy that. But from your current negotiation, if you are saying significantly higher margin would you come up and again within the range of 25% for the overall business?

So I have to say that through the cycle -- so through all the cycles, I would say, in average, the gross margin of Instone should be on a level of 23% roughly. And you will have time periods where we will be higher -- and in weaker scenarios, you could be a bit below that. But as David said, I think for the coming quarters where the influence of the high-margin projects in the distressed situation will have only a very limited impact, but of course, for the next 2, 3 years, there could be a benefit above the 23% of through-the-cycle gross margin.

Okay. That's clear. David, you in talks with a number of institutional deals you mentioned. Could you provide any occasion on the range of the project volumes?

Well, possibly to give you some idea of split between private and retail. You could assume somewhat for the last quarter, somewhere between 60% and 40%, so 60% institutional, 40% on the retail side. But this is a rough indication as we have obviously not full clarity if we do 1, 2 or 3 institutional deals and then the mix can change substantially.

Yes. What I meant was the -- especially the institutional deals, what is the range you are discussing at the moment starting this with only EUR 20 million up to EUR 100 million? Or is it more towards EUR 100 million. So just to give us a feeling, how the magnitude could be?

So it is within the lower range, it will be below EUR 100 million.

The next question comes from Thomas Neuhold from Kepler Cheuvreux.

Basically I have 2, firstly, coming back to the margin question, can you share with us your expectations about the construction cost development in the next couple of quarters?

Thomas. Sure. I think for, let's say, what we see currently on the ground is that we have a sidewards developments. And I also believe that this could be further the scenario for the coming quarters depending on, let's say, the overall situation in the Ukraine. The pressure on the construction companies on those who are not as diversified to also have industrial construction activities is further increasing because the number of orders coming in is still diluted by the overall market situation. So therefore, I think we have set up time that we expect for next year the cost price inflation of 3% to 4%. It could be a bit lower depending on the overall Ukrainian situation. What do I mean with that? If the war stops there, of course, then you have a lot of construction activities necessary and this will also have a big influence in capacities in Germany because we have many companies coming from the eastern part of Europe, working here. And therefore, I think there will be some competition here going forward.

Okay. Okay. And the second question would be on your potential acquisition pipeline. Can you provide some color there? And can you also give us some indication of kind of target acquisition volume are you looking at for the next 12 to 18 months?

So the acquisition pipeline we are currently working on is significant. So we are talking about EUR 5 billion to EUR 6 billion in different stages of -- and different sizes of projects. I think the current issue is that -- and this is not only, let's say, based on acquisition, it's also [Audio Gap] right of necessities of companies. We are still not, let's say, we are not still in the reality. So the people are still asking from our perspective, too much -- too high values, and they have to accept that the reality is different. But this takes time. The people, when you look at the influences we've seen. And now I think we have one famous developer from Leipzig, who is also going [ bus ]. Here, it's clear what is the reality. And for the other processes, the people are trying to, let's say, defend their really good projects, fighting to the end. But from our perspective, the pressure on these developers and land owners will further increase in the next 12 to 18 months. And we are staying here very disciplined. So we have bought 2 projects. We could buy more. But we are not still not, I would say, in our negotiations not on the right level. So if we reach the right level, we will further buy. And for the next 12 to 18 months, we -- our target is to purchase land in the GDV volume of EUR 1.52 billion. But we are not under pressure. So therefore, we will be very, very focused and pick out the right investment chances.

The next question comes from Manuel Martin from ODDO BHF.

Two questions from my side. A follow-up question on your pipeline insolvencies. How do you see the further evolvement of insolvencies in Germany? Do you think we found a trough and it's getting better? Or is it becoming worse? That would be the first question.

Yes. So what we are currently, let's say, in our discussion we have with the market participants, including the banks, we think that the next 6 to 12 months, there will be a necessity for landowners and developers to put in more equity, clearly, because the write-off necessity is not fully and transparently booked. So therefore, I think it's hard not to say will it be more a higher number, I believe that it will be still a higher number than what we have seen in the last 6 months to come. The stress is there, and it will further increase. The banks are obliged by not only Basel III but also by BaFin to ask for more equity and this will then put pressure, more pressure and this is the situations we are waiting for.

Okay. I see. My second question last question would be on construction costs. Have you -- it's a rather strategic question. Maybe if you talk about implementing also serial housing constructions to decrease costs. And therefore, maybe construction activity would become more active? Is it something which you are evaluating?

Yes, we do. To give you a feeling for -- so we -- with our affordable housing segment, the new business, we are currently also offering our products to [ Corps ], for example. And we are asking for a price to give you a feeling for, it's including -- it includes all the costs except of land costs. And we are offering a product for EUR 2,850 per square meter gross, including VAT but without a garage, which means we are already as Instone below EUR 3,000 per square meter, which is the target of many of the companies which try to bring in serial construction. So we are already there. And what we are doing currently is to check which scalability does it make sense to increase further the prefabrication. But the issue, the companies, I don't want to say it now, any names, but all the companies who are acting as a future serial producer, they are having problems to get the cost below EUR 3,000 per square meter. They are more at the level of EUR 4,000. So it's difficult for them. We are already there with a combination of prefabrication and classical construction. And we want to scale further, and we want to increase then the prefabrication part. But we have this clearly in focus and we are working here to also check, does it make sense for us to partner with the industry or to build up an own fabric. But these are things we would only do if it makes sense for us, and if it's profitable for us.

Okay. I see. So you just need the orders from [ Madam Gaivitz ] from the government, I suppose.

Yes. We have started to discuss with [ Corps ], and we have a very, very positive feedback. So the product is good, the price is excellent. So there is demand. What we have now checked is they are -- they have rules like they have to make a process, a tender process, et cetera, et cetera. So these are the hurdles we have to take. But the product itself is great, and we can offer it for a very, very attractive pricing.

[Operator Instructions] The next question comes from Philipp Kaiser from Warburg Research.

Yes. Congrats on a solid performance. Just a quick question left from my side. You mentioned already that you expect the sales volume to be significantly higher next year. Could you give us a guidance on the already sold -- the already fixed sales for next year.

Yes. I can give you a rough number for the revenues, which are coming from already sold projects in '25. It's roughly EUR 280 million. That's a rough number. And then, of course, the rest is coming from the sales in the last quarter [Audio Gap] guide.

The next question comes from Stephan Simmross from Simmross Capital GmbH.

Yes. Just one at -- on your own shares. You have around above 7% treasury shares, do you plan to increase this position? Or could you cancel these shares and then maybe go with the next AGM for another allowance to buy more own shares since you trade quite a bit below equity per share.

So thank you for your question. For the time being, we have no plans to further do any share buyback program. But we will monitor the market and we'll consider our options going forward.

Do you plan to cancel the shares?

No, not for the time being.

Do you have any further questions? Stephan, do you have any further questions?

No, that just was a point on the treasury shares.

Thank you. Ladies and gentlemen, that was the last question. I would now like to turn the conference back over to Burkhard Sawazki for any closing remarks.

Thank you for your participation. If you need further information, please do not hesitate to contact the IR team after the call. Thank you.

Thanks.

Thank you. Bye-bye.