Picton Property Income Limited (PCTN) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen, and welcome to the Picton Property Income Limited post-AGM Investor presentation. [Operator Instructions] Before I start and before hand over to Chair Lena Wilson, I would like to play a short video prepared by the company, especially for those who are new to the company. [Presentation]

I would now like to hand over to Chair Lena Wilson. Good morning.

Thank you very much, and good morning, everyone. Thank you so much for joining us. I hope you find the video informative. And just to let you know, you can also find that on our website. So moving along this morning, we held our AGM, and we are delighted to take you through the presentation from our AGM and engage with you on any Q&A following that. First of all, I'd like to just make some introductions. Joined this morning and will be presenting to you this morning, our Chief Executive, Michael Morris, and our Financial Director, Andrew Dewhirst. I'm also joined by my 3 other nonexecutive colleagues, Mark Batten, who chairs our Audit and Risk Committee, and he's also our Senior Independent Director; Richard Jones, who Chairs our Portfolio and Valuations Committee; and Maria Bentley who chairs our Remuneration Committee. We really are all delighted to be here and for you all to join us this morning. And we'd also like to answer any questions you have after the presentation. But before that, I'd like to hand you over to Michael who will take you through our presentation for the next 50 minutes or so, and that will be followed by a Q&A session. Over to you, Michael.

Thank you, Lena. Good morning, everyone. So just very quickly, I'm going to give a brief overview, although you've seen the video, so we will talk briefly to that. I thought it would be useful to provide an up-to-date market overview. A lot has been happening in the last 12 months in the property market. Andrew and I are then going to talk through the annual results for last year at very high level, but obviously the AGM that we've just had relates to that set of results. We're going to talk through some of the ESG things we've been doing and then bringing things perhaps a little bit more up to date our annual results to March. But as a company, we report quarterly. So that was most recently done just before the start of the summer and we're going to provide a short update on that before we conclude. So in terms of Picton at a glance. Our property portfolio now is just under GBP 800 million. It's a diversified portfolio. It's a diversified approach. That diversified approach, we believe, is one of the reasons for our consistent outperformance against MSCI. And the presentation, looking at March is -- year to the March results, just to highlight against a really quite challenging backdrop, a resilient operational performance. The portfolio outperformed again. The fact that we have got a defensive capital structure in the way, our debt is positioned and Andrew will talk to that and also progress around adapting assets, specifically around sustainability issues, which are definitely coming more to the fore. On the next page, you'll see the portfolio is weighted to industrial warehouse and logistics. We've also got just under 1/3 in the office sector, and I'll talk specifically about some of the things we're doing in that sector later on. And then the smallest proportion of the portfolio is in retail, retail warehousing and leisure. As of today, sorry, [indiscernible] As of today, the net assets of the company are just over GBP 540 million and our market cap is well below that. And that's something that we're not comfortable with, but we do recognize that the sort of the changing interest rate environment has affected property stocks, discount to net asset value are prevalent, and we will talk through some of the initiatives we're working throughout the minute to try and unlock that. The other points I just mentioned on that slide is around the reversionary potential in the portfolio. That principally comes through vacancy and/or resetting rents that are being paid relative to market rents. And I'd also highlight the sort of diversity of cash flow through our occupier base, which again, I think, is important in the market that we're in. So if we [indiscernible] now just more generally to talk about the market as a whole and being blunt, it has been a tough year. A year ago, 10-year bonds were close to 3%, they're now closer to 4.5%. And that's clearly have an impact on asset pricing generally. And you can see here from the chart, the movement in yield -- in MSCI yield and indeed capital movements over the period. Some sectors were sharper to correct. And some sectors [ sellers ] have rebounded stronger and I'll talk in a minute about the individual sectors and how we've performed. So turning to page to the industrial sector. The first thing I think to note, which is the chart on the top right is the consistency still of rental growth in the industrial sector. And whilst I would say demand is slightly weaker than it was, nevertheless, it remains and rents are still moving forward. And I think it's against that backdrop that the industrial market has recovered from that sort of shock repricing that came through nearly a year ago. And you can see that on the bottom chart there, broadly seeing some stability in industrial capital values now. In the Office market, on the next slide, in the office market, rental growth has been more muted and less consistent. And I'm sure you will have seen and perhaps read in the press something in terms of polarization between occupiers as they're sort of coming back post COVID wanting better quality, more flexible space. So that's where the rental growth has been equally in more secondhand space, demand has been weaker. And the combination of that slightly weaker demand and ongoing costs, particularly as we've seen rising energy bills, void costs and capital expenditure, that's definitely added negative sentiment to the market, which is why you can see on the bottom chart, a more muted recovery from that pricing correction. And in fact, of the 3 sectors at the minute Office is the one that is struggling the most in terms of capital demand, capital growth. And what we've done which is in slide start, but I think the important factor as you think about real estate is not looking at it in a siloed way. And we will talk about it in a minute. The alternative uses that offices can be used for that can support values that can provide a way out where demand is weaker. And then finally to just talk to Retail and to some extent, Leisure. There are clearly build challenges in the retail market, and you can see the very wide dispersion of rental growth across subsectors over the last few quarters. Broadly, the trend has been trapped, but there have been pockets where we have seen some rental growth. But equally in other market, it's falling. And you will have heard headlines such as the administration of Wilko and that's going to lead to store closures, more supply of floor space in the High Street. And so this is a sector where we're still very cautious about rental growth prospects, especially against the sort of rising interest rate impact on disposable income position. Having said that, because retail as a sector repriced so heavily in the many years before COVID and in fact, during COVID. Actually, it hasn't been as badly affected from a capital perspective in the last 12 months. So yes, there was a correction, but actually the rebound or the correction wasn't as strong and the rebound has come a bit quicker, not perhaps similar to industrial but perhaps for different reasons. So I think it's fair to say that these are difficult markets. It's not straightforward and the interest rate environment is clearly key going forward. But there are things as an owner of real estate that one can do to mitigate the position, and we'll talk through those in a minute. So if I hand over to Andrew.

Thank you, Michael. We'll start with just some of the headline figures for the year ended 31st March 2023. Our net assets at the end of the year were GBP 548 million, which was equivalent to a 100 pence per share. We made an overall loss of GBP 90 million for the year, and that was very much driven by valuation [indiscernible] over the year. But as EPRA income, which is a EPRA earnings, sorry, which is the recurring income, net income from the portfolio was stable at GBP 21 million for the year. We paid dividends of GBP 19 million, which was 4% higher than 2022 and we have dividend covered for the whole year of 112%. Moving on to the capital structure. At the end of March, we had total debt of GBP 224 million, which was a loan to value of 27%, 95% of our debt was fixed with maturities in 2031 and 2032. The fair value of debt for the year-end was some GBP 23 million less than the book value and that gives rise to a higher EPRA net disposal value of 105 pence, so higher than the reported net assets. And at the year-end, we had GBP 38 million of undrawn facilities under our revolving credit facility. We'll move on now to the portfolio overview.

Yes. So just at a headline level, the portfolio performed well relative to the market, notwithstanding the market the whole -- as a whole, it was very difficult. The reason for that was less valuation impact than the market as a whole. And we were able to grow rental values, contracted rent and [ deposited rent ] and all these factors mitigated wider market declines. Occupancy has reduced. And in part, that's down to some of the specific asset management initiatives we're looking at in relation to alternative uses that I've already alluded to. A number of properties were acquired during the year, generally with a mixed use theme. Looking operationally back to last year. I think the key thing is that there's good activity despite what was going on in the capital market. So if we turn the page, you can see the lettings, the lease renewals, the rent reviews, all were above ERV, and that's really capturing and proving that rental growth that we alluded to initially. And at this point, that happens, I think, quite often is that the occupational markets can be more resilient than perhaps the investment markets give credit for. And we also continued this theme, which is not new, but the point that we see investing into assets as a really important long-term way to create value. And so upgrading assets using [ leased ] events to improve the quality of space not only protects assets for the future, but also provides a way in which we can enhance rental value and indeed capital value. Rent collection over the year was over 99%. So a very different picture to the preceding year where there was still the impact of COVID being felt. On the next slide, we touch on the vacancy in the portfolio. To be fair, most of our vacancy in the portfolio is in the Office sector. So that ties back to what I was saying about a [ particular ] market at the minute. And I think what's important certainly, in respect to that 3 current largest voids within the portfolio, we are actually pursuing alternative use strategies at all 3 of these assets not completely and not on all parts of those assets, but the fact that we're looking at alternative uses that are a -- in our view, easier way to unlock that reversion, feed that through a change of use be it through an asset disposal, reinvestment into other assets that's what we're looking at as opposed to just simply pursuing a pure office leasing strategy on those assets. I am really [indiscernible] in with the next slide where we put and have set out 3 sort of trends that we see. We set these out a couple of months ago, and they haven't changed. I think the way the market is at the minute, these themes still very much continue. So we've been through a year where we've seen quite high rises in energy costs, occupiers are increasingly realizing the cost of cooling and heating buildings. It's come to the fore with these rises in energy costs. So anything as a landlord you can do to improve the efficiency and by definition, reduce the occupiers' ongoing running costs is well received. So for us, focusing on that on our refurbishment is key. We brought someone specifically into the team this year to help manage that process and the workplace that we stopped going on. And Andrew will talk about some of the specifics we're doing in a bit. The point about occupational market and rental growth. And in the industrial sector, I think, is really important because that is a way in which we are going to continue to unlock value from the portfolio. And consistently, we have beaten valuer estimates on transactions we've done. And I think that is encouraging. And then finally, this point about the Office sector. We introduced something called SwiftSpace last year to offer a more flexible leasing solution, particularly on smaller suites in response to the market. But this point about alternative uses and where we're looking at it might be residential, it might be student, it might be hotel. There are a number of options available. We're not in a position today to unlock those. These things aren't done overnight. We've made announcements to the market around some of the residential [indiscernible] that we've got at Angel in particular. But I would hope as we move in to the -- towards the end of the year as a company, we will be able to announce further progress on these specific initiatives. So if I hand over now to Andrew, he you can just tie back to some of the responsible business we've been doing.

Thanks, Michael. First of all, just looking at sort of the environmental focus across the portfolio. We continue to seek to improve our EPC ratings. At the end of March, we had 76% rated A-C. We're continuing to decarbonize the portfolio. We've taken gas supplies out for -- from the 3 assets, and we are looking at installing solar, we've installed solar across 5 properties and got another 3 being implemented at the moment. The vast majority of our leases are green leases, now about 97% last year. And moving on to the next page. This gives a bit of a flavor of the occupier engagement or the stakeholder engagement that we carried out over the year. We carried out occupier surveys, particularly with an emphasis on the sustainability matters. We set up a Climate Action Working Group to oversee the progress against our net-zero pathway, and we carried out an assessment of climate-related risks across the portfolio, so we're able to report in line with TCFD. Moving on now to bring things a little bit more up to date with a quarterly update to the 30th of June. First of all, on the financial side, our net assets at the end of June were GBP 542 million. That was a decrease of 1.1% over the quarter to 99.4p. Total return for the quarter -- sorry, flat minus 0.2%. We maintained an interim dividend of 0.875p for the quarter. Dividend cover for the quarter was a little bit lower at 96%, but we fully expect that to be fully recovered going forward. Loan-to-value stayed very much same at 27%. And now, Michael is going to give a quick update on the portfolio.

Yes. But I think perhaps on the next slide, the valuation movement, although negative was the slowest negative movement we've seen really [indiscernible] [ trust debacle ] of last year. So there's definitely -- it feels like the worst of that repricing has happened, although it's clear that that we're not out of the woods yet, so to speak as a sector. And I think that came through in perhaps some of the comments I made about the market generally. With lease regears though, 18% ahead of the previous passing rent, 3% ahead of ERV, letting 5% ahead of ERV, rent reviews 24% above previous passing rents. So there's lots of good data points to prove this resilience in the occupational markets that I've referred to earlier. And we're always a bit nervous just about using 1 quarter of data and extrapolating from one. But I think what this quarter results show is more of the theme from the preceding year and that sort of leveling off around the price correction. Occupancy was 90, but this ties back, as I've just said, to the alternative use strategies we're looking at here. In order to deliver an alternative use, you've got to create the space to do it. And so you've surrendered the space, et cetera, and that ties in into that. So just really to end on an outlook slide before we go to Q&A. As I said, more generally, these are more difficult market. And certainly, in real estate, there is reduced investment trading activity and lower demand at the minute, primarily driven by higher interest rate and the wider macro picture. Certainly, we see in the short term, industrial and retail, perhaps being a little bit more resilient but I think it's quite difficult to generalize because there are clearly pockets as we think about retail exposure to specific retailers might lead to challenges going forward. So I think it's very much around such selection. And that's something that we've been very focused on. In terms of our own business, Andrew has referred to our conservative balance sheet and our long-term fixed rate debt. And that really, I think, is very helpful to provide some degree of earnings stability. We're not immune from inflation and rising costs. But certainly, the biggest line item, which is our debt cost is almost all fixed. The asset managers are very much focused on capturing this reversion that I alluded to at the beginning. The majority of that is coming through vacancy, but actually this resetting of rents to market rents is key as well. And you've seen that in the last quarter, and we will continue with that. The alternative use [ peaks ], I've mentioned, and we hope to be able to make some announcements later this year on that. And I think these things tie in with growing income and looking at trying to narrow our discounts. It's quite a challenge. The sector as a whole is on some very wide discount. So we're in a position where a lot of companies in real estate at the minute have a discount fees. But it's uppermost in our minds and our feeling is that the things we do within the portfolio will start to come to fruition and show investors that the strategy is working in terms of growing income, and we hope showing some stability on the capital side. We're very much focused on our diversified approach. We think that provides real strength to the business. And as a team, maintaining our long-term track record is absolutely key. So thank you.

Thank you, Michael. Thank you, Andrew, for the presentation. Much appreciated. We'll now open the floor to questions starting with the presubmitted questions on the platform and feel free to add in any other questions.

We've got Michael Andrew and also the rest of the Board to answer the [ last bit ]. So I can see that we have one already from Sam and Michael, you did cover some of this -- maybe if you go back to Sam's question for me, please. Thank you. And Sam says, can you give us your opinion on property market and interest rates over the next 6 months fiscal. You did cover some of that, Michael, but maybe just some additional comments.

Yes. So I mean I suppose really the way to answer that question is to start with interest rates because that leads to the property market. So really what happened with interest rates as being watched closely, I think, by everyone in the property sector and indeed, I assume in other capital markets as well. But I think the broad view is that we're likely to see quite a subdued property market. This point about limited liquidity. And clearly, debt costs have risen quite significantly in the last 12 months. So demand is weaker, volumes are less. And as a result, the data points around valuation are perhaps a little bit thinner. So what that, in my view leads to is probably more of the same, which is a sort of broadly flat market, but where you have specific lease events for both better and worse. So let's just come up with an example. You have a building that's let to Wilko, which we don't, but let's just use that as an example. You have a building let to Wilko. They go into administration, We're seeing values pull. You have a building where the occupier vacates. Again, you're seeing values on a downward trajectory. The counter is if there is the asset management activity leasing events, rent reviews, whatever that act in a positive direction, we may see some upside. So all eyes really are on interest rates and property financing. But I don't think -- I mean, if you ask me this question a year ago, who would have said that we would see the volatility that we did in the incoming -- coming weeks. But I think we're in for a more stable, slightly unexciting market on the capital side.

Thanks, Michael. I'm sticking with capital allocation and question from Chris about the -- the quality of [ impulsive ] assets in portfolio and the undervalued share price, would you consider share buybacks as part of the capital allocation policy. Maybe Andrew, if you could come in there?

Yes. Thank you, Lena. I think share buybacks is always something that we keep under review. And I think it's something that we would consider, but I think it's not something we would want to see as the only answer to looking at the discount.

Yes. As a [indiscernible] I would say that I completely agree to that. It's an option, but only one tool in the box. Actually, it's been an interesting change of use of something the Board has been discussing very recently. And Michael, we have a question on -- from Andrew on what valuation uplifts are possible arising from a change of use to residential?

Yes. Sorry, -- in terms of specifics, I'm not able in a presentation like this to talk about specific uplift on our assets. And I think that will be inappropriate at this stage. But what I think is worth just highlighting is that different assets in different sectors broadly have differing capital value rate per square foot. And in some markets, Residential is more valuable than Offices. In some markets, Retail might be more valuable than Offices. And in different cycles that may change. So we're looking at the alternative used strategies on our own assets, not all for the same alternative use. We're looking at different uses in different markets, reflecting demand, but we would expect those alternative uses to be accretive to the business. And if we can achieve those alternative uses, recycle the capital as Andrew has mentioned, buyback is an option, repaying debt is an option, reinvestment of proceeds is an option into income-producing assets. So there are a number of options available to us at the moment in time. What we need to do is deliver on those asset management activities first.

Great. Thank you very much. And seeing another question from Nicholas, what is the current contracted rate? What percentage of rents either breaks or expires over the next couple of years?

Let me just select numbers.

I think we did cover that in the presentation, certainly some of our apprentices.

Yes. So the rental income, and we'll add this Q&A subsequently. But the rental income from memory is around GBP 40 million per annum. And we have a sort of an average unexpired term on the portfolio of just under 5 years. So we have sort of steady stream. This is just part of how it works of space coming back every year. The majority of our portfolio is industrial as I explained in the sector allocation. And what we're seeing, particularly in that sector is we do get space back or lease expires, we're seeing rental uplift coming through rather than vacancy because occupiers are staying and there's embedded reversion. It's the space in the Office sector where the breaks in the expiries are perhaps a bit more and one needs to be more wary of, and that's why we're looking at that alternative uses. So the exact numbers will add on to the response, but we don't see anything in the next 2 years looking forward, anything outside of what I'd call ordinary course of what we had for the last sort of 15 years.

Thanks, Michael. A very interesting question from another, Michael. Are you seeing a greater number of potential reinvestment opportunities as a result of broader market conditions. So that's the first part of that. And secondly, would you consider investment outside the U.K.? Maybe I'll start with the latter part of that. I mean Andrew talked about relationships with our occupiers. That's easier to do when we can get to them in the U.K., where U.K. small but perfectly formed [ ousts ] the -- we do stay very close and that being much more difficult outside the U.K. So it isn't something that the Board has actively discussed as part of our strategy, but Michael, again, do you want to talk about reinvestment opportunities generally?

Yes. So I think there are more opportunities to come into the market. I think we are starting to see signs of certain property owners having refinancing issues and assets being brought forward as a result of that. I don't think it's anything like what happened in '08 or '09, but there's definitely -- we're hearing opportunities there. For us, it's the balance because as we're currently structured, more opportunities equals probably use of debt or recycling assets. And I think what we want to do is move forward with some of the opportunity, the asset management piece and deliver loans. And then clearly, at that point, we can look at reinvestments, but reinvestments doesn't just have to be real estate. There are other options available in terms of the balance sheet that we think can think about.

Thank you very much, Michael. Another question from Andrew. I think for Andrew, but staying on the financial side. Can you provide some details on why EPRA earnings fell in the quarter of 30th of June? You did cover some of that, Andrew. As you say, debt costs are relatively well hedged and the headline portfolio occupancy does not seem to have fallen significantly from 31st of March to 30th June. So just wondering what is driving the fall in earnings.

I think it's very difficult to read trends into a single quarter. There are one-off costs and income events each quarter, and these can contribute to EPRA earnings falling or rising within a particular quarter. So in the June quarter, there were 1 or 2 additional costs that we incur, which are not recurring, and so we don't expect them to come through in future quarters and occupancy did fall slightly from 91 to 90. So that had a consequential impact as well. But certainly, going forward, we don't expect to have an uncovered dividend.

Thank you. A question from another Andrew. I think you definitely get a question if your name is Andrew today. A number of [ marriages ] in the REIT sector designed to reduce discounts but also raise market cap, combined entities, which make them more attractive to wealth managers who are reducing cost per share. Is the current climate not an excellent opportunity to participate in this activity? Maybe I'll start with that. We have made no secret of the fact that we can see that, that kind of consolidation you're talking about, and we definitely have ambition for Picton to scale appropriately and scale in a way that creates value for our shareholders. So that is something still very much to the forefront of our mind and activity that we are constantly looking for opportunities but in a way that scales appropriately and is in the interest of creating value for our shareholders. Anyone like to add to that? Or is that pretty much covered?

I think that covers it.

Thank you.

The answer is sorry, the answer is yes, but it's about the right transactions that work for the company.

I mean, I think the final question that I can see, similarly, have you been engaging with peers about consolidation, and that's from Christopher. Obviously, we would never be able to talk about anything specific in a public forum like this, but I hope my previous answer gives you insight to the fact that this is an ambition we have to scale appropriately in the interest of creating right value for our shareholders. So I think I can't see any more on live screen. So I think with that, we thank you very much indeed for your attendance today. In fact, We hope you find the presentation useful. As I said at the beginning, it is up on our website. We thank you for your questions, and please feel free to contact Michael and the team and engage with us, with any further questions following today [indiscernible]. Thank you very much indeed.

That's great to the Board of Picton Property Income. Thank you very much indeed for your time this morning. Can I please ask investors not to close the session as we're now automatically redirect you for the opportunity to provide your feedback and also the Board can really better understand your views and expectations. This may take a few moments to complete, but I am sure will be greatly valued by the company. On behalf of the Board of Picton Property Income, we'd like to thank you very much indeed for attending this morning's presentation. Now, I wish you'll a very good morning. Thank you.