LondonMetric Property Plc (LMP) Earnings Call Transcript & Summary

Okay. Good morning, ladies and gentlemen, and welcome to LondonMetric's half year results presentation for the period ending 30th of September. The agenda is relatively self-explanatory and pretty familiar to you, albeit we continue to obviously operate in unprecedented circumstances. I'm going to give you a couple of slides on the highlights for these last 6 months before handing over to Martin, who will give you an update on the financial review. I'll then come back and talk about the portfolio and our performances over the period before giving you and sharing with you our thoughts on the outlook and the period ahead, and then obviously opening up the lines to any questions that you may have. So turning to Slide 3, Page 3, key half year highlights. Our sector calls, our asset selection, and, indeed, our focus on income has continued to allow us to deliver outperformance for the period. As we all know, COVID and lockdown too on the back of an unprecedented period of lockdown in the spring has continued to accelerate a number of trends in the economy, most notably, the growth in online shopping. You can see there in the box on the right-hand side, online shopping penetration has increased nearly 40% over the last 8 months to about 28%, and that is exposing both winning and losing strategies. I'll come on to talk about that in a bit more detail later on in the presentation. We continue to pivot the portfolio to make sure that we're investing in the best sectors. Today, more than 90% of our portfolio is invested in distribution and then long income, grocery and triple net retail. And again, I'll come on to talk about that in a lot more detail later on. But all of those sectors enjoy high occupancy, long leases, and as you can see there, helped deliver attractive like-for-like income growth of just under 3%. The portfolio continues to perform well. Net rental income, as you can see there, is up 12% at GBP 61 million. And we delivered a total property return over the 6-month period 4.9%, which is an outperformance against the MSCI index of 650 basis points. We've continued a disciplined capital allocation with nearly GBP 100 million worth of acquisitions predominantly in the urban and long-let grocery subsectors. And we've made nearly GBP 72 million of disposals of weaker assets located in poor geographies and on shorter leases. As you can see there, our investment activity has delivered a positive WAULT arbitrage of over 9 years. Turning then to the next slide, financial highlights. Most of these numbers are self-explanatory, but I'll try to give a little bit more color. Our net rental income is up -- GBP 61.3 million, that's up 12%. And importantly, our contracted rental income is up 2% to GBP 125.4 million. And Martin will give you a bit more color on that later on in the presentation and also the future trajectory of that number over the coming periods. Our EPRA earnings of GBP 42.3 million is up 20%, just helped us drive EPRA earnings per share of 4.75p, again, up 4% after taking account of the additional shares that were issued as part of our capital raising earlier in the year. We've continued our progressive dividend policy, which is up now -- the dividend after the announcement this morning of 4.2p is up 5% compared to this time last year. And our net tangible assets at 175.5p is up 3% from where it was in March, courtesy of a GBP 42.8 million valuation gain. And that's courtesy of not only rental growth, which, again, I'll talk about in a bit more detail later on in the presentation, but on average, 7 basis points of yield compression. All of that adds up to a total accounting return for the period of 5.6%. And on that note, I'll pass on to Martin, who can give you a bit more detail on some of the numbers. Thank you.

Thanks, Andrew. Good morning, everybody. So despite the challenges posed by COVID over the last 8 months, our financial results for the period are strong. As Andrew said, we've delivered both earnings and NAV progression. So I'm pleased to report that our focus on reliable, repetitive and growing income has delivered net rental income of GBP 61.3 million, as Andrew said, an increase of almost 12% over last year. This increase is driven by a full-period contribution from the Mucklow portfolio, which was acquired in June of 2019, and therefore, only contributed for 3 months for the same period last year. Our administrative overhead for the period is GBP 8 million compared with GBP 7.6 million last year. This increase, again, is due to absorbing a full 6 months of the enlarged group costs. It remains my view, as demonstrated by these numbers, that we will deliver cost savings on an annualized basis of over GBP 2 million against the Mucklow overhead, which was GBP 3.5 million, as our cost-saving measures are fully implemented. We continue to monitor our operational costs closely, and our EPRA cost ratio has reduced by 60 bps in the period to a low of 13.7%. And our gross to net property cost leakage remains extremely low at only 1.3%. Our finance costs are GBP 11.3 million, a decrease of almost 10% over last year, primarily due to the average interest rate payable over the period reducing following the cancellation at the start of the period of GBP 350 million of interest rate swaps. These significant cost savings, on top of our rental income growth, has driven our EPRA profit to GBP 42.3 million, an increase of more than 20% on last year or GBP 4.75 per share, which supports the increase to our dividend for the period to date to 4.2p per share, an increase of 5% and provides very strong 113% dividend cover. This strong profit growth on top of a valuation gain in the period of GBP 42.8 million allows us to report an overall profit for the period of GBP 85.1 million. For the same period last year, we reported a loss of GBP 10.2 million, but that was after deducting goodwill and acquisition costs on the Mucklow transaction of GBP 57.2 million. So adjusting for these -- last year's loss for these transaction costs, the underlying overall profit has actually increased by 81%. Having referred to the strength of our rental income growth, and before I move on to the balance sheet, can I just take the opportunity to dive more deeply into our rent collection experiences over the last 8 months of the pandemic. For each of the March, June and September quarters, our rent collection statistics have been very strong. Over March and June, we collected 96.5% of rents due, and recognizing tenant difficulties, deferred 0.6% of rents. We've undertaken accretive asset management initiatives on a further 2.1% of the portfolio. So less than 1% of the rent roll has not yet been recovered, and half of that outstanding amount, I still expect to recover. So only 0.4% of the rent roll has been forgiven. In September then, 97.7% of the rents due were collected, and we deferred 1.3% of the rents. And as earlier in the year, approximately 1% of the rents have not yet been recovered. But we expect the recovery of all deferred rents to be complete by the end of March 2021. We think these levels of rent collection demonstrate the reliability and resilience of our income and are a testament to the strength of our occupier relationships and our focus on strong credits in the right sectors in strong trading locations. Turning now to the balance sheet. The portfolio valuation of GBP 2.45 billion is ahead of the year-end. The increase in value is due to the combination of acquisitions of GBP 105 million, development expenditure and CapEx of GBP 18.5 million, all of which exceeds our disposals of GBP 73 million. And then on top of that, a significant valuation uplift in the period of GBP 42.8 million. And Andrew will come on to -- later to talk about the uplifts, particularly our uplifts in the logistics portfolio. And as of the period end, we had GBP 42.2 million of cash in our balance sheet and GBP 879 million of debt. In the period, we successfully raised new equity of GBP 120 million through a placing which was significantly oversubscribed and which has been utilized in large part during the period, most particularly on sale and leaseback portfolios of Waitrose stores and Kwik Fits, which Andrew will also come on to talk about later. The net liability position at the period end is GBP 16.1 million, and the major component of that, as in previous periods, is rent received in advance. As recommended by EPRA, we have disclosed EPRA net tangible assets on a fully diluted basis for this period and the previous period for the first time as our new performance measure. And our EPRA net tangible assets at the period end were almost GBP 1.6 billion or 175.5p per share, a significant increase of 3% over the year-end EPRA NTA of 170.3p per share. The increase in the net tangible assets in the period, together with the dividend paid, resulted in a total accounting return of 5.6%. The GBP 879 million of debt on our balance sheet at the period end is a reduction of GBP 96 million since the year-end. We've been active in the period in managing our capital structure with -- including the GBP 120 million equity raise previously mentioned and the swap cancellation and a GBP 50 million extension -- debt extension with Santander. The equity raise, supplemented by asset disposals in the period, has allowed us to reduce our debt. And consequently, our LTV now has fallen to 32%, net of deferred sales completion. And the equity raise also funded the acquisition program, allowing for these disposals to be deferred and, therefore, our income maximized. Our debt maturity has remained stable since the year-end at 4.7 years despite the passing of 6 months due to the reduced debt drawn on our RCF, which has a shorter term than our very long-dated private placement money. At the start of the period, as I said, we canceled GBP 350 million of interest rate swaps. So our only current hedging is by way of fixed coupon debt as we seek to take advantage of interest rates, which are so low and likely to stay low for some time. Consequently, our current cost of debt has fallen to 2.5%, a decrease from 2.9% at the year-end. This combination of strong income growth and interest cost reductions has driven our interest cover ratio from 4.3x at the year-end to 5.4x today. As Andrew mentioned at the start, our contracted rent roll has grown to GBP 125.4 million. This number increases to over GBP 130 million after adjustments to account for the busy post year-end period. Our contracted rent roll reduces in respect of lost income of GBP 4.2 million arising from the sales mostly completing prior to the year-end but then is offset by income on acquisitions in the pipeline of GBP 3 million. Further adjusted the contracted rent roll by GBP 6 million for the letting up of our near-term developments at Bedford and Tyseley over the next 2 years, and that CapEx will push our LTV to circa 35%. That rent roll of GBP 130 million, net of interest and overhead currently at circa GBP 40 million, will generate earnings over time of GBP 90 million or 9.9p per share. This significant level of growth in our rent roll supports our confidence that we will be able to continue to grow our earnings substantially and, therefore, progress our dividend. Finally, a brief look back, which puts the increase in rent roll into context and clearly demonstrates that since our merger way back in 2013, we've been able to double net rental income and earnings per share. Our earnings for this half year are actually now more than the full year earnings in the year after the merger. We have doubled our total property return, and our total shareholder return has trebled through share price appreciation and dividend returns assuming full reinvestment. That equates to a 20% compound annual growth rate. And on that note, I'll hand back to Andrew.

Thanks, Martin. So Slide 13 is just an update on strategy to remind you of what frames our investment decisions, and these continue to be impacted by the macro trends that we're seeing in the wider world and how they affect the real estate -- the various real estate sectors and the assets in which we look to allocate capital into. And as the world evolves, we continue to do so as well. And also worth reiterating that whilst we operate a total return model, we fully embrace the contribution that real estate can give you from a reliable, repetitive and growing income stream. As a result of our investment, asset management and development activity, we continue to build an all-weather portfolio that has shown over the period that it can withstand even the most challenging and unprecedented of conditions that we have all experienced over the last 9 months, and we will continue to look to improve it in the coming periods. So then turning to the portfolio drill-down in detail. As I've already mentioned, the distribution investments account for just over 68%; our long income investments, 26%. These 2 core sectors enjoy long leases, high occupancy, high rent collection and strengthening geographical focus. And as you can see there, over the 6-month period, they've delivered a total property return of 4.9% and capital value appreciation of 2.3%. Not surprisingly, our logistics investments have been a standout performance with an 8% total property return, with long income delivering a TPR of 2.3%. So then moving then to the right-hand side of that slide and drilling down into the individual performances in a bit more detail. As you can see, there have been strong performances across all 3 subsectors of the distribution market, with total property returns of 6.3% in urban, 12.8% in regional and 5.9% in mega. And that's the combination of attractive rent review settlements, which I can talk about in a minute, but also, on average, 11 basis points of yield compression. I would just say that the standout performance from regional was assisted by revaluation of our development assets in Bedford. In long income, grocery and roadside and also triple net retail and trade have delivered strong performances, with total property returns there of 5% and 4.1%, respectively. And not surprisingly, the weakest performance has been our 5 Odeon cinemas, which suffered 106 basis point outward yield movement, which contributed to a 12% negative return over the 6-month period. And again, I'll talk about that in a bit more detail later. And our retail parks delivered a resilient performance, benefiting from low rents, high occupancy, excellent credits, and increasingly, their role as click and collect and fulfillment centers. We saw a 44 basis point outward yield shift on those, on the valuation of those assets, which contributed to a negative total return of 1.7%. So turning to the distribution investments. As most of you already know, this sector continues to enjoy strong demand and supply dynamics, and that has delivered good rental growth against a backdrop of high occupancy. Our logistics assets are 98% occupied, and that rises to 99% if you include buildings that we have currently under offer. 2020 has been a record takeup so far, 33 million square feet so far taken up, including 10 million in the last 2 months or so, and that compares to, on average, an annual takeup of around about 27 million. Rental growth is strong. A look back in terms of the rental growth that we've enjoyed over the last 2 years across this portfolio shows that our urban rents have grown by, on average, 3.9%. Our regional investments have grown 2.5%. And our mega rent reviews have been settled at 1.6% per annum uplift. So very, very strong across all sectors. Before moving on to drill down into the long income portfolio, it's probably just worth mentioning that the valuations across our regional and mega portfolios are 4.4% and 4%, respectively, and that compares favorably to market evidence that is currently printing on 2 Sainsbury's distribution warehouses, one in Bedford, which is actually opposite the Argos that we own, and one up in Hams Hall, where the market is expecting those to conclude at yields of between 3.5% and 3.7%, which will provide excellent evidence for us for our next round of valuations in March. So then moving to Slide 16. We try to give you a bit more color on the makeup of our long income portfolio and split it down into the 4 main subsectors. Just to remind you, this portfolio is 100% occupied with average lease lengths of over 14 years and is valued off a net initial yield of 5.5%. The largest investment is in groceries, which continues to benefit not only from the defensive qualities, excellent credit, long leases, but also high percentage of contractual rental uplifts, is increasingly sought after. And our 5% total property return -- delivered a 5% property return over the period. Looking at triple net retail, a total property return of 2.8%. Our focus in this subsector is around the discounters, with investments let to B&M, The Range and Home Bargains, but also in home retailing, DFS, Dunelm. It's probably worth mentioning that we do not have any exposure to fashion or department stores. This portfolio is fully let on lease terms of around about 10 years. And as I said earlier, this sector continues to support not only the click and collect but also increasingly offers us more and more options for repurposing, and that is something that you will hear more from us in the coming periods. Our trade and DIY investments are dominated by our investments with Wickes and B&Q, in particular, delivered a total profit return of 5.7%. This sector, as most of you will know, has enjoyed a strong COVID performance as consumers have increased their home expenditure. The fact is the more time that we spend at home, the more money we spend on our home, and we expect that to continue in the coming periods. And as I mentioned previously, our weakest performance has been our 5 Odeon cinemas. We will continue to monitor their reopening when they're permitted and their ongoing performance. And we will continue to look at options for repurposing those either into retail parks, if necessary, or indeed, into residential opportunities, particularly in Lee Valley and Chelmsford. I've already touched on our investment activity over the period, and our acquisitions reflect our conviction calls, urban logistics and long income convenience. Our focus has been on strong credits, excellent geographies and long leases. We've made GBP 72 million of the disposals, and these generally reflect some of the poor assets, weaker geographies, shorter leases and some challenged subsectors. Post period end, you'll also see there on the far right, we've sold 2 Marks & Spencer's Simply Food, 15-year leases with inflation-linked rent reviews of capitalization rates of 4%, underscoring the almost desperate search for income that a number of real estate investors have. Turning to the next slide, highlighting our development activity. The majority of this is focused around our 2 sites: the one on the left in Bedford, which you will have seen before; and also the site that we acquired as part of the Mucklow transaction up in Tyseley in Birmingham. We're now on-site -- will be on-site shortly, delivering a further 635,000 square feet of warehouses across these 2 sites in 3 separate buildings, which will deliver us an average yield on cost of 7.2%. At Bedford, we've decided to proceed with the expectative build-out of both unit 2, and also this morning, we announced the start on-site of unit 1, which totaled just over 500,000 square feet. And this is a result of reduced competition that we're seeing in the vicinity as existing buildings will increasingly get let up. It's probably worth pointing out that when we finished the 3 buildings there on the right and form part of what we call Phase 1, there were 8 competing buildings in the vicinity. And as a result, we decided not to press ahead with unit 1 and unit 2. Six of those buildings have now been let, and the remaining 2 are currently under offer. So we think we'll be delivering these units into a receptive supply environment and against the backdrop of strong occupier demand. At Tyseley, we're proposing to build a single unit on Phase 2, totaling 120,000 square feet, where we have now received full planning consent. We hope to announce shortly the imminent pre-letting on a new 15-year lease with inflation-linked rent reviews. Worth pointing out that the completion of these 3 buildings alone will add another GBP 5.3 million to our rental income, and that's the vast majority of the GBP 6 million that Martin referred to in his income progression slide earlier on in the presentation. Slide 19 highlights the activity that we've undertaken as part of our active asset management, 75 deals generating GBP 2.8 million of additional income and securing 2.9% of like-for-like growth. We've done 47 lettings and regears that have secured GBP 1.7 million worth of new rent, secured against average unexpired lease terms of 14 years. We settled rent reviews across 28 of our buildings, delivering -- capturing GBP 1.1 million of additional rent, which is, on average, 11% ahead of passing. But as you can see on the bottom right chart, standout performance has been the excellent results from our distribution portfolio. Our contractual rent review settlements have delivered a 9% increase against previous passing, which is a result -- largely is a result of CPI and RPI and fixed uplifts. But our open market settlements have averaged 25%. And they vary, as you can see there, from 12% in Rugby to nearly 40% in Epsom. On average, our logistics portfolio has delivered 13% increases over previous passing rents. So turning then to our thoughts on the market outlook. This is a familiar slide. In fact, I don't think it's changed an awful lot from the slide we presented to you 6 months ago. The fact of the matter is structural trends continue to accelerate, and that is particularly apparent in the retail sector where we're seeing continual progression of online penetration. It took 10 years for online penetration to move from 7% to 19%. It's taken 8 months for it to climb to 28%. And the results from the grocery sector were even more dramatic, where online grocery penetration in February was 7%. And today, it has more than doubled, that 6.5 million new customers who are now shopping online that weren't back at the start of this year. These markets are exposing both winning and losing strategies. Without a doubt, the winners, sheds, meds and breads; the losers, high-rented shopping centers, high-rented shopping parks. And even a number of the safe haven sectors look more vulnerable today than they did back at the start of the year, offices, hotels, leisure and, obviously, student accommodation, not quite as secure as maybe we once thought they were. But the macro environment is -- continues to be highly supportive of the right real estate. Low growth, low interest rate environment arguably is perfect for the REITs. Secure, long-term income is being more highly valued today in a yield-hungry world of vanishing dividend returns, 0 interest rates and negligible bond yields. And as we see that, as we refer to there on the bottom of that slide, we refer to it as TINA, there is no alternative. So finally, before asking for Q&A, we're looking forward. History will show that the world has permanently altered. The tectonic plates have definitely shifted, and hope that we return to a pre-pandemic world and behavior is no longer a strategy. We will continue to allocate our capital in a disciplined way. We continue to pride ourselves on our process, our discipline and our rationality. We'll focus on the winning sectors and try and invest in the right assets as polarization across the subsectors continues. As Martin has touched on, our balance sheet has capacity and flexibility for more opportunities as and when they present themselves. And I think the result of the numbers that you see today has not happened in the last 6 months. This is the result of decisions that we made a number of years ago. Our long-term focus on income growth will ensure that we are able to progress our dividend and ensure that it is well covered. And that, in today's environment, is a rarity, indeed. And on that note, I thank you for your time, and we happily take any questions that you may have. Thank you very much.

[Operator Instructions] We will now take our first question from Sander Bunck from Barclays.

A couple of questions for me, please. The first one is on your acquisition and disposal strategy. I mean we get that everyone is very bullish on online sales penetration and how that's evolving going forward. Yet if we're looking at your acquisition and disposal profile over the last year, then acquisitions have all been concentrated around long income units such as Waitrose and service stations, while disposals have all been in the logistics area. So how are you squaring the trend that you're seeing in the market with the actual transaction activity that you're undertaking? And also, what does that mean for your future acquisition strategy and portfolio composition? That's my first question, please.

Thanks, Sander. I suppose I'll take that. Yes, it has. But look, real estate is not a screen-based trading opportunity. We don't just sit there and hit a few buttons and say, we want to buy a few urban logistics assets and up they pop. The fact of the matter is we have to react to opportunities. Obviously, we can be a bit more proactive than that. We obviously reacted to the acquisition of the 5 Waitroses, sale and leasebacks. We -- as I think I said at the time, they were of a quality that rarely becomes available in a normalized investment market. The logistics market is competitive, as you might imagine. And whilst that provides challenges in terms of finding new opportunities, it also gives us opportunities to get out of some buildings that we think that most of the fun has been had, and we will always do that. You should also think about our acquisition strategy also in tandem with our development commitments. We're making over GBP 50 million of commitment to the development pipeline over the period. And that is obviously money that has been allocated into that conviction sector. If I think about the deals that we have in hands today, I would say the vast majority of those will be in urban logistics. There will be some long income convenience in there as well. But as I say, we react to the opportunities as and when they present. But what we're not doing is looking at buying for the sake of it at yields that, in some cases, are eye watering.

Okay. And so that means that in terms of the portfolio composition, say, probably at the moment, approximately 70% logistics and the remainder in [ ops ].

Yes. We'd expect the 70% to trend up to 75% and long income, obviously, to trend at around about 20% to 25%. I keep reimagining that the retail part disappears as well.

Either actively or passively. The roadside acquisitions that you've done over the last year, like, is that -- does that have the potential to become a meaningful part of the portfolio? Or will that always be kind of a niche element?

Yes. It's probably difficult to -- I mean I like it. I like the convenience nature of it. All of our roadside assets are effectively secured either via a Marks & Spencers or a co-op or a Budgens or drive-through convenience offering, and that will continue. It's difficult to grow that into scale when the average lot size is about GBP 3 million or GBP 4 million, to be honest with you. So I think it's interesting. I think it's mispriced. And like you've seen with our M&S Simply Foods, when we're offered what we consider to be super prices, we'll take the money.

Okay. It makes sense. And then the very last one from my side is on Bedford. Obviously, you're now kicking off with 2 speculative developments there. Can you just give a bit more detail on what you're seeing on the ground? I know you mentioned some stuff in the presentation already, but in terms of occupier interest, what kind of occupiers are looking at that? What are you seeing in terms of rents? Is that positively evolving? Yes, so basically, what is giving you that additional confidence?

Yes. Look, I think -- I mean the confidence is that there is macro demand. We do believe -- not only in the period that we're all living through at the moment, but also the period we're going to live through post Brexit, we are seeing a move away from maybe just-in-time logistics strategies and increasingly towards just-in-case. That's definitely driven demand certainly through the COVID lockdown, and it may indeed continue to play out through Brexit uncertainty. So the list of potential occupiers is wide. It's not all Amazon. I think for us, the confidence was actually more on the supply side. For 8 buildings to go down to 6, to go down to possibly to 0, it feels like that's a window of opportunity to release the building into the market. And therefore, that, I think, was the driving factor. In terms of rents, when we underwrote Bedford, we were looking at rents on average GBP 6.60 a foot. At the moment, we're on target to exceed GBP 7.20. So our yield on cost on Bedford alone will increase to just over 7.5%. I mean, at the moment, we've got -- I suppose we see at the moment, there's one building out there, which is a first Panattoni Building. And I think they're quoting over GBP 9 a foot. So I think we feel pretty good. But development comes with risk. And again, I can't -- just because I think that the demand and our assessment of demand is out there, and as I say, I'm proud of our processes, I can't magic up exactly who it's going to let to at what terms and at what rent. But we've done a pretty thorough trawl of the market. I'm not -- we're not known as irresponsible developers. So I suppose take comfort of the fact that this is a rational decision.

No. Understood. So -- and you mentioned like initially GBP 6.6, now GBP 7.2, and others are asking GBP 9. That sounds like anywhere of market rental growth in that area of around 5% to 10% per annum...

We look good, yes.

Basically since you started underwriting Bedford. Is that approximately right?

Yes. Yes. Whether it is 2%, whether it's 3%, whether it's 4% or 5%, I mean, it's a first world debate, isn't it? I mean it's growth. I mean we're not -- I can't think of many other sectors that you're having this conversation on.

Well, [indiscernible] is quite meaningful. All right. That makes sense.

Well, it's -- Sander, it is meaningful. But at the same time, would I swap lower rent for a 20-year lease with -- to a Rockstar credit? Yes, of course, I would.

Yes. But truly, I mean, if rents grow by -- market rents grow by 2% versus 10%, that has a direct implication on the underlying valuation of the property as well.

Yes, yes, yes. I agree. I agree. I agree with that.