LondonMetric Property Plc (LMP) Earnings Call Transcript & Summary

Good morning ladies and gentlemen. Welcome to LondonMetric's Full Year Results for the period ended March. Nice to see you all. As usual, I'll give you a run through over the highlights of the year, together with some of the financial numbers, conscious that I don't want to go through all of them. Otherwise, Martin's got very little to say. I am then going to just go through the detail of the recommended acquisition that we announced this morning. I'm going to go through it. It's not -- I can't deviate. We have a Rule of 2.7 that I -- with our lawyer, where's [ Christy ]? She's here somewhere -- front row. So I can't deviate off that too much. I'll then hand over to Martin, who will take you through a deeper dive into the financial review. I'll come back and give you some further color on the portfolio and its performances over the period with -- and then finally sharing our thoughts on the outlook for the sector and also for LondonMetric in the periods ahead. We'll open up then to Q&A, obviously, both in the room and I think we obviously got some -- hopefully, we'll have some on the iPad. So actually, the first thing to do is to welcome actually Alistair Elliott, who is due to replace Patrick Vaughan as our Chairman at our AGM in July. So those of you who haven't met Alistair, he'll be around later, and I'm sure he'd love to introduce himself to you all. So that's my first point of order. So right, let's -- so just an overview of the markets as we see them today. I think since certainly the beginning of the calendar year, we've seen the macro investment backdrop stabilizing. We -- the economy is showing resilience and we think the outlook is improving. There is no recession. We've got -- still got full employment. We have a very robust consumer as evidenced by today's inflation print. We've continued as a result, therefore, to continue to shape the portfolio, and that is being influenced by structural trends that we see taking place around consumer behavior. And that has strengthened our conviction around the logistics market, particularly the urban logistics, which continues to demonstrate attractive demand-supply dynamics. I'll come in to talk about that in more detail in a moment. That's allowed us, for the year ending at the end of March, to deliver like-for-like income growth at 5%, helped by lettings, but particularly by rent reviews. And again, I'll come in to talk about this in a bit more detail. Rent reviews overall are up 16% on previous passing, driven by our urban logistics reviews that are up by about 21%. However, we have seen the portfolio yields expand 107 basis points, which has seen the overall capital value fall just under 16%. So the outward yield shift has been compensated to a bit by ERV growth, as you can see there at 8.4%. But still, that showed a -- I think it's a 15.7% drop in valuation. And then rental growth over the next few years, again, I'll come in to talk about this in a bit more detail later. We think that we will capture over the next [ 2 ] years, another GBP 11 million worth of reversion through open market and contracted rent reviews, and Martin will go through how we think that, that will play out over the next couple of years and where it falls and what is guaranteed and what is open to negotiations. As you might expect, we've continued our disciplined approach to capital allocation this year with more sales than acquisitions, GBP 273 million worth that have been disposed of, and GBP 120 million worth of new acquisitions over the period. And that has allowed us to keep our LTV, I think, in a terrific place at 32.8%. And again, Martin will talk about the debt stack. And I think the fact that we're now in a -- got 93% of our debt is now hedged, which is up from 71% this time last year. So our exposure to rising interest rates has been greatly mitigated. So just a quick run through on some of the numbers, as I said, otherwise, Martin won't have much more to add. Net rental income is up 10.4%, Earnings were up 8.1%. EPRA earnings were up at 10.33p a share, that's up 2.9% on where they were last year. And that has allowed us to announce our final dividend for the period at 2.6p this morning, and that will be a final dividend for the year of 9.5p, and this would represent our eighth year of dividend progression, well on our way to dividend aristocracy, just another 17 years to go. And that dividend is 109% covered, okay? So it's progressive, and it's covered. It puts us in a rarified territory amongst some of the REITs. As I said, the valuation of the portfolio suffered a 107 basis point outward yield shift, partly mitigated by the 8.4% growth in ERVs. But as you can see there, that saw the NAV -- NTA, sorry, fall to 199p, which is a fall in portfolio valuation of around about -- I think it's roughly GBP 580 million. It's interesting that this time last year, I stood up to announce that the valuation had increased by GBP 632 million. So what we're effectively doing is giving back some of those gains -- a large proportion of those gains that we took last year. So then turning to the announcement that accompanied our results this morning, which is a recommended acquisition, GBP 198.6 million for CT Property Trust, which works out at 85.5p per share. It's 100% pay per offer. You can see the exchange ratios there. It reflects a 6.3% discount to their NTA as at the end of March and a 33.2% premium to their 3-month weighted average share price. It comes -- the transaction comes at a unanimous Board recommendation. We think that there is a compelling rationale for the portfolio. This is a space -- these corporate acquisitions, we've done this before. I stood up here 4 years ago, possibly in the same room to announce the acquisition of the A&J Mucklow PLC. So this is a relatively well-trodden route for us. So you would have expected us to have done a fair amount of due diligence on this portfolio. And we think that 78% of the portfolio is highly complementary with our own. I'll come on to show you a pie chart in a minute. We think it's the opportunity. We structured it so that we could -- we think we're acquiring it in a cost-efficient way. And we think that our intense asset management approach will allow us to capture not only the rental reversions embedded, but we would hope we might do a little bit better as well. And that's certainly been our experience with the Mucklow portfolio. When I look back at some of the assumptions that we made in terms of rent reviews, in terms of leasing, in terms of regearing, and in terms of cap rates, it's gone extremely well for us. And obviously, the merger of the 2 companies does improve scale and liquidity. You can see there the financial benefits will continue to support our progressive dividend. Our rental income will grow to GBP 163 million, and it will be earnings accretive through the economies of scale, cost synergies, but as I say, also hopefully through reversions. The company comes -- has a current LTV, which is below ours. So therefore, the overall group will drop -- LTV will drop. And it also comes with GBP 31 million of cash on their balance sheet, which obviously helps some of those metrics. So if you look at the pie chart here of the company and how their assets are split across the sectors and then what that means for -- to us, to the enlarged group, as you can see, there's an awful lot of synergies. I'm color blind, so I won't use the colors. Across the urban and long income portfolios, which accounts, as I said, for just about 78% offices, and high street retail make up the remainder. And I think it would be fair to assume that those are assets that will be monetized over the forthcoming period. Portfolio is 34 assets. They are operationally light, attractive net initial yield with a current embedded reversion to 6.5%, high occupancy, not as high as ours, but again, I would consider that to be an opportunity. And then importantly, really, is the chart on the bottom there, the 5 biggest assets, as you can see, are very well-located, distribution investments in parts of the United Kingdom that we feel happy with. I've talked about being geographically obsessed certainly since we came out of the GFC, and that's an important point for us and where our assets are located. It's not just about being in the right sectors, we want to be in the right sectors in the right places. So when you look across Colnbrook to Heathrow, you've got Banbury, Hemel, you've got Southampton Airport, you've got Bracknell. We feel comfortable in those places, and that is the 5 largest assets that make up the portfolio. So on the basis I'm not allowed to say any more than that, I'm not going to read the transaction structure and timetable. It's there for you all to read. It's set out clearly by our lawyers. And I will now pass on to Martin, who will take you through a deeper dive into the financial review. Martin?

Good morning all. Next year, [ Christy ], maybe you can say to him, he's not allowed to talk about the numbers either. Will be very helpful. So against the backdrop of volatile capital markets, rising costs and rising interest rates, our trading performance has been strong. We delivered significant earnings growth and dividend progression. So I'm pleased to report that our net rental income is GBP 146.8 million, an increase of 10.3% over last year and again supported by exceptionally strong rent collection stats in the year. We've collected 99.8% of rent during the year, up from 99.5% last year. We consider these levels of rent collection continue to reflect the strength of our occupier relationships and our focus on strong credits in the right sectors in strong trading locations. So despite operating in an inflationary environment, our administrative overhead for the year has increased by only 2.5% to GBP 16.5 million compared to GBP 16.1 million last year. As we continue to monitor our operational costs closely, our EPRA cost ratio has reduced by a further 80 basis points in the year to 11.7%, which is still one of the leading performances in the sector. Our net finance costs were GBP 29.9 million this year, an increase of GBP 5.2 million over last year. We've held higher average debt balances in the year, and we've seen our average interest rate increase over the year from 2.6% to 3.4% as the Central Bank interest rate increases have had a negative impact on the cost of our floating rate debt. Despite these increases in financing costs, our focus on cost control and our rental income growth has driven our EPRA profit to GBP 101.1 million or 10.33p per share. That's the first time our EPRA profit has exceeded GBP 100 million in the year. This supports the increase to our dividend for the year to 9.5p per share and provides very strong 109% dividend cover. But notwithstanding the strong trading performance, the effect that rising interest rates has had on property yields has recalibrated, as Andrew said, property valuations. So despite reporting record IFRS profits last year, predicated on a valuation uplift of GBP 632 million, we have effectively given that back due to the fall in the valuation of the portfolio of GBP 587.5 million, causing us to report an IFRS loss for this year of GBP 506 million. That decline in valuation has materially impacted the value of the portfolio, which has fallen by 16.6% in the year. The valuation is now at GBP 3 billion. Our gross debt of GBP 1.03 billion is broadly consistent with last year, although the split between fixed and floating rate debt has changed significantly. I'll come on to talk about that in a moment. The net liability position at year-end is GBP 22.8 million. The major component of that, as in previous years, is rent received in advance and is calculated after deduction of the noncontrolling interest in our Retail Park joint venture. In summary, therefore, our EPRA net tangible assets at the year-end were GBP 1.96 billion or 198.9p per share, a decrease of 23.8% over last year. The decrease in NTA in the year, together with the dividend paid, resulted in a negative total accounting return of 20.2%. Interestingly, despite the significant uncertainty, we have still delivered a positive accounting return over the last 3 years of 32.5%. In the light of the volatility in financial markets during the year, we've sought to ensure that our debt provides long-term certainty with flexibility and that our exposure to rising interest rates is mitigated. Consequently, as reported in November, we lengthened the maturity by 1 year on GBP 400 million of debt and then by a further 1 year in the post period-end period. Additionally, we entered into a new GBP 275 million RCF facility through to November 2025, with 2 1-year extension options. And we entered into a GBP 225 million interest rate swap to hedge our floating rate exposure. The new facility and our available headroom eliminates our refinancing risks until 2027. So although our debt repayments are more than adequately covered by available resources, we also retain the optionality to continue to crystallize cash from asset sales of noncore assets. The pricing on the new facility is consistent with our existing RCF facility, which eliminates for us the risk of bank credit spreads widening for any refinancings that might happen this year. The facility is also subject to ESG criteria, which generates a small margin benefit. So our debt maturity now stands at 6 years, down from 6.5 years despite the passing of 12 months, and we are 93% hedged against future interest rate rises compared to only 71% last year, the result of a very clear focus on the sales program, whilst also maintaining a comfortable LTV, which sits at 32.8% compared to 28.8% last year. As I mentioned earlier, we have reduced our exposure to floating rate debt significantly in the year, and that now stands at only GBP 70 million. Our current cost of debt is 3.4% compared to 2.6% last year, and we have unutilized facilities and cash of GBP 416.5 million. We have excellent cover for our banking covenants, and in particular, our interest cover ratio is 4.7x against the covenant level of 1.5x. And finally, given our low level of exposure to floating rate debt, a 25 basis point increase in interest rates would reduce our EPRA earnings by less than GBP 200,000. So our contracted rent roll is now GBP 145.2 million, a small increase on last year, given the loss of GBP 5.2 million of rent from net disposals, but it's forecast to grow to GBP 156.7 million. Andrew will talk later about the embedded reversion within the portfolio of GBP 10.9 million, a combination of over-market and contractual rent reviews, which will deliver this increase to the rent roll over the period to March 2025 and of which GBP 1.1 million has already been delivered in the year. The forecast increase to a rent roll of GBP 156.7 million will exceed the forecast increase to our finance cost in that period and will generate earnings growth. This supports our confidence that we will continue to be able to grow our dividend, which has increased by 2.7% this year and which we expect to increase in FY '24. And accordingly, we expect the increase to our first quarterly dividend for FY '24 of 4.3% to 2.4p. And finally, a brief look back, which puts the increase in rent roll into context and clearly demonstrates that in the 10 years since our merger in 2013, we'll be able to increase our net rental income and earnings per share by 2.5x. Our total profit return and our total shareholder return driven both by share price appreciation, but significantly most recently by dividends, equate to compound annual growth rates in excess of 10%. And on that note, I'll hand back to Andrew.

Thanks, Martin. So as you can see from the pie chart, the GBP 3 billion portfolio continue to be dominated by our investments within logistics space, accounting for 73% of the overall asset base. And the portfolio continues to be characterized, as you can see there, with high occupancy, just over 99%, long-weighted average unexpired lease terms with 63% of the rent subject to contractual uplifts. Turning then to the chart on the right, looking at the performance metrics over the last 12 months. You can see the distribution portfolio actually fell in value by 18% as cap rates expanded by 127 basis points, which was offset by 11.2% growth in ERV to give the overall -- an overall total property return of minus 14.7%. Our long income portfolio actually fared a little bit better, courtesy of higher starting yields with 57 basis points of outward yield shift. And as you can see there, our GBP 70 million worth of retail parks delivered a flat performance despite outward yield shift of 47 basis points. So diving deeper into the distribution portfolio. This is made up of 3 subsectors, which we characterize: urban, regional and mega. GBP 2.2 billion worth of investments, but the largest is our GBP 1.3 billion of investments in urban warehousing, which remains our strongest conviction call and that's simply through the demand and supply dynamics that we're seeing in the market. And I'll come on to talk about that in a bit more detail later on. As you can see from the data, strong operational performances, excellent ERV growth and some terrific rent review settlements across the urban portfolio in the year. Similarly, our regional warehousing delivered strong metrics with rent reviews settled at 17% above previous passing and 3-year ERV growth of 26%. A weaker performance across our mega investments over the period, only 1 rent review, which was up 8% on a 5-yearly equivalent basis with a total property return of 24 basis points, courtesy of a greater outward yield shift across the mega portfolio. But overall, the portfolio is still characterized, as you can see there, by some strong occupational metrics, lease lengths, but also geographical weightings of about 80% across London, the Southeast in Birmingham, which remains our favored geographical areas, an equivalent yield there up at 5.3%. Looking across our long income and retail park assets, nearly GBP 800 million worth of value, 100% occupancy, lease length at 13 years, as I touched on earlier, higher starting net initial yield at close to 5.5%, with now nearly 70% of that rent subject to contractual uplifts. And that allowed us, despite 57 basis points of outward yield shift, to deliver an overall total property return of only minus 3.5%. It's been a very, very strong performance as rental growth as well as the high occupancy and high starting yields allowed us to mitigate outward yield shift over the period. Looking at the investment market. I touched on it earlier. We've been a bigger seller than we have a buyer. I mean that -- there's very few periods I've been able to -- I've actually said that, but it means that we've been able to test our valuations in the open market. And as we announced, the GBP 273 million of the sales were done actually at a small premium to the underlying valuation. So it gives us great confidence that even in periods of what have been, by and large, illiquidity, we've been -- we're able to monetize the -- a number of the investments that we consider to be noncore. We consider that interest rates remain the most important yardstick in assessing asset pricing. We are seeing a polarization of sectorial performances, and we expect that to continue. There's been an increase, as we all know, in interest rates, and that must impact on real estate pricing. We have seen equity buyers return for some logistics assets. I think the transparency in that sector is probably further ahead than it is in a number of other sectors. And -- but we've seen very little activity coming from leverage buyers. Nearly all of the activity we've -- sales activity we've seen over the last probably 5 or 6 months since the turn of the year has -- nearly every single transaction has been an equity buyer. And the fact of the matter is it's harder to get leverage to work. I've said it before that until we start to see 5-year swaps drop down to 3% and possibly below 300 basis points, it will be difficult for there to be -- for proper liquidity to come back into the system. And what we do expect as the market settle down and we do expect that 5-year swap to drop down is we would expect investors to pivot into sectors with the strongest thematics. And the polarization of demand has rarely been wider. And as I said, whilst we've seen liquidity in the logistics market and some of our long income assets, there's very little activity going on in some of the more troubled sectors, shopping centers, regional offices, spaces where there's been very little print, which does beg the question of the validity of some of the theoretical desktop valuations that people have been printing. My view is that if the market -- if the property market is not going to give you price transparency in some of these troubled sectors, I'm pretty sure the debt market is going to assist over the coming periods. And you will see the true value of some of these troubled assets will come through as refinancings come to the fore. Looking at the occupational market. As I've already touched on, we think that demand continues to remain strong across all sectors: mega, regional and urban. We're still benefiting from structural tailwinds, whether or not it is ongoing pivot to online shopping, which obviously has come off its peak, but it's still well above trend over the last couple of years, localization, onshoring and the demand of occupiers that we're dealing with continues to widen. We're seeing an increasing granularity of new occupiers, whether or not it's not just 3PL retailers, manufacturers, health care, but also a number of new industries that are evolving, particularly around the urban space. I was looking at some of the deals that we've done over the last 8 months or so across our urban warehouse. We're doing warehouse deals with accident repair centers, with trade retailers, people like Screwfix, Howdens, we've got McDonald's, we've got coffee roasting houses, we've got yoga studios, we've got Deliveroo. It's just a very, very broad church of occupiers, particularly in the urban warehouse market. It isn't all -- it just really isn't about the online demand. And the supply remains incredibly constrained as development starts drop and cities convert and lose existing warehouse space. I used this stat before. The major cities across the U.K. are seeing a lot of urban space taken out of the system. Over the last 20 years, London has lost 24% of its warehouse space. Birmingham's lost 19%, Manchester's lost 20%. There's a lot of space coming out of the system. And that at a time when we're seeing a broadening church of demand is why we're getting ongoing rental growth. And our vacancy, our vacancy is [ 0.9 of 1% ]. I mean it's low. So that all, you put those together and not surprisingly, that tension leads to rental growth. And our rental growth over the period, our like-for-like income growth is 5%. Our rent review settlements across the portfolio at 16%, Urban led the way at 21%. And if you look at forward projections, the U.K. rental growth of warehousing is -- for '23 is expected to be 5%. But as you can see there on the right-hand side, some of the major cities will outperform that. The best located -- the best assets in the strongest cities look forward -- are expected to exceed those projections. And therefore, we expect to be able to stand here in 6 months' and 12 months ' time with, as Martin said or I've said already, the GBP 11 million of rental reversion, we see that as capturable without any -- without too many dramas. So looking, therefore, at the activity -- our own activity over the period that's delivered GBP 8 million worth of rental uplift across lettings, regears and rent reviews. You can see it there, GBP 3.8 million from lettings, average lease term of 10 years. Our regears added GBP 1.3 million to our rent roll. And those regears often accompanied by extended lease terms as you can see there by an average 5 years. And as I've already said, GBP 2.7 million of rental uplifts from reviews averaging 16% with urban leading the way, and GBP 11 million to be captured over the next 2 years. And as you can see, if you look to the far right hand of that bar chart, you can see that open market reviews will be GBP 4.9 million, GBP 6 million of that GBP 11 million will be coming from contractual uplifts with very little risk attached to that. Of the open market, of that GBP 4.9 million post period end, we've already agreed GBP 1.1 million of that uplift. So we feel very, very comfortable that, that will be delivered through to our income line. Our activity over the period, our asset management activity. It's part of our DNA, as most of you in the room know, and we've continued to derisk our developments by adding newer higher-quality income over the period, 900,000 square feet of developments completed or underway, which secure about GBP 8.6 million of new rental income. We're always looking to improve the quality of the estate, either through acquisitions or disposals, but more importantly, through asset management and improving the buildings that we already own. I mean the capital that we allocate, at a preference, I would much rather spend it on our existing buildings. We get a much better bump. On average, we're seeing a 10% return on our CapEx when we invest in our existing portfolio. The issue for us is we would just like more of this. And -- but it's delivering on 2 metrics, it's delivering ERV growth, but it's also delivering EPC improvements. You can see there on the right-hand side that 90% of our portfolio is now EPC-rated A to C. That is up from 74% 2 years ago and 5% this time last year. We're on a positive trajectory. We expect that to continue. What I would also, though, say is we are very, very good stewards, though, of poor buildings, all right? There may be the odd year that, that EPC number drops. And the reason it will drop is because we bought a building that requires some treatment. We have experience, we have the energy, the desire and we have the capital to bring old buildings, inefficient buildings back into economic use. We've been doing it across many sectors for very many years. We enjoy it, and we think it is incredibly rewarding, both personally but also financially. So there will be times when that number drops a bit, but we are excellent stewards of these buildings. The easiest way to improve that 90% is just to sell the 10% that don't qualify and give it to somebody else. But all we're doing is kicking that problem down the street to somebody else, I don't think we're improving the planet. So then looking at the outlook, finally, before we open up to Q&A. As we all know, we have a challenging macro environment. However, we expect that to settle. As I touched on already, we think the consumer is incredibly resilient. We have great savings ratios. We have full employment. It's almost impossible to have a deep recession with full employment. Inflation rates are falling, maybe not as quickly as some would like, but they are falling and that will lead to an inflection point for interest rates. This will bring confidence back and ultimately improve liquidity. And I come back to talk about the 5-year swap rate, which I think for real estate is much more important than the SONIA. In our preferred sectors, the demand and supply fundamentals remain incredibly strong. And that is really changing the macro trend of evolving consumer behavior. That's creating a tailwind with a broadening array of occupiers' demand representation within our space. Constrained supply continues to create conditions for ongoing rental growth for the best assets in the strongest geographies. However, just to touch on it, there are troubled sectors that are going to be increasingly exposed. And in this environment, it's going to be very, very difficult to paper over some of those structural cracks. If the property market won't deliver the price transparency, then the debt market surely will, and we actually think that, that market uncertainty will lead to more opportunities for us, whether or not it is motivated vendors, whether or not it is debt refinancing, whether or not it is higher borrowing forcing more vendors into the open market or whether or not it's corporate consolidations to try and capture attractive synergies, efficiencies and improve liquidities similar to the -- in the lines of the announcement that we've made this morning with regard to CT. We think there will be more of that available. So it is -- there will be motivated sellers. There will be debt refinancing throughout more opportunities and then may well be more M&A within the sector. So finally, before I finish up and open up to Q&A, I would just say it is Patrick's last results presentation, which is a very sad day for me personally. I've worked with Patrick for more years than I can remember in various different organizations. He has been a wonderful colleague, an incredible Chief Exec, in the old days, Chairman, but also a terrific mentor and friend to me. So I will miss him enormously, but he will remain -- obviously, he'll remain close to us as a major shareholder. So I'm going to have to be a lot nicer and the dividend will be going out, yes, the dividend will be going out. But thank you, Mr. Patrick, it's been an amazing journey. I wouldn't be here without you. So thank you very much. So on that note, before I get too emotional, let's open up the lines to some Q&A, either lines or in the room, I don't mind. I don't think we've got a preference.

Anybody want to kick off? Max?

Max Nimmo, Numis. I'm not going to ask any tough questions around the transaction this morning because I presume you can't answer much on that. But one of the things you mentioned was about 5-year swaps and we're closer to 4.5% than we are to 3% today. So yes, inflation might come off a little bit. But without that severe economic recession, it could be a long time before we get to that kind of level. I'm just kind of interested to see what you think that means for the transactional market. Yes, we'll have some -- the refis that kick deals and opportunities out there. But ultimately, other than that, it's mostly likely just to be equity buyers for considerable time. Is that fair?

Look, that's a rational assumption, Max. Although I would say there was a 3-day period at the beginning of February, where actually -- when the markets thought that interest -- that inflation had been tamed, we saw the 5-year swap drop back down to about 300 basis points. Like I said, it was for a very short period of time. The green on the screen didn't last for very long. I think our shares were up 80% in the day. So it can happen and it can happen quickly. It went up pretty quickly. I mean, this time last year, we were probably looking at 5-year swaps around about 120-ish. I can actually plot the 5-year swap for you over the last 12 months. I can assure you it's quite an important metric for me. So it could be. Markets have become -- I mean, I talked about it before, the liquidity in the logistics market and also in long income, lot of pension funds activity, a lot of the transactions that we've been -- or we announced a few weeks ago a portfolio of multi-let industrial that we sold to Blackstone. There was a deep pool of buyers for that. I mean we had 4 or 5 bidders on that market, all of them equity, Val?