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

Good afternoon, and welcome to the Picton Property Income Preliminary Results Investor Presentation. [Operator Instructions] Before we begin, I'd like to submit the following poll. And I'd now like to hand you over to CEO, Michael Morris. Good afternoon, sir.

Good afternoon, and thank you to everyone for joining us this afternoon. My name is Michael Morris. I'm the Chief Executive of Picton, and I'm joined by Saira Johnston, our CFO. We've got about half an hour, and we're going to just give a very quick introduction to Picton for those that don't know us. We're going to talk to our financial results, give a view on property market and what we've been doing with our portfolio, some concluding slides and then an opportunity for Q&A as mentioned, using the [ INC ] Q&A button. So without further ado, Picton is a diversified REIT. We've been going nearly 20 years now. We've adapted and adjusted our portfolio through that 20 years as different market conditions dictate. Today, we sit here with a portfolio that's nearly 2/3 in the industrial sector, 1/4 in the office sector and the balance in retail and leisure. We're very proud of our long-term track record of property level outperformance against MSCI. And we run the business with not only a total return focus because that's really important to us, but also generating those returns through income as well. Looking at the year just gone, we've delivered, I think, strong financial results, certainly recognizing the sort of macroeconomic backdrop. We've outperformed at the property level now for the 12th consecutive year. We've reduced our office exposure through disposals of void assets by 1/5. We have used those monies to invest back into our portfolio and upgrade the assets. We've used the money to repay debt, and we've also used the money to take advantage of our current share price and buy back shares. So if I hand over to Saira to talk you through the financial results.

Thank you, Michael. So as Michael mentioned, we have a strong financial performance for the year ending 31st of March 2025, delivering positively across both income and capital values. For the year-end, we're reporting a profit of GBP 37 million and a total return of just over 8%. From an income perspective, we've seen EPRA earnings grow to GBP 23 million during the year, which equates to 4.1p per share. And from a balance sheet or net assets perspective, we closed at GBP 533 million at the end of March, and that equates to 100p per share. Over the year, we've paid just over GBP 20 million of dividends to our shareholders, and that equates to 3.7p per share. And overall, we've operated a well-covered dividend for the year of 113% and by way of further background, you'll recall that we increased our dividend by just under 6% in May last year and have recently announced a further 3% increase in our dividend. And really, the strong financial performance is underpinned by the value in our long-term debt structure. During the year, we repaid our floating rate debt and reduced our loan to value further to 24%. And now our interest rate at an average of 3.7% is fixed and well below the current financing rates. The maturities on our long-term loans are in 2031 and '32. So that gives us really good visibility about our financing costs and cost base going forward. And the value of that long-term debt isn't seen in the NAV per share, but adds about another 5p per share to 105p per share. The next couple of slides, I'll just talk through the key drivers for both NAV movements and earnings movements. So firstly, in terms of the net asset value movement, we saw an increase of 4% to 100p per share at the end of the year, and this is primarily due to the valuation gains on our industrial assets. We saw valuation gains of 3.8% over the course of the year. And we've invested in our portfolio, as Michael mentioned, and we'll come on to explain in a bit more detail later. But even net of that capital expenditure, we saw valuation gains of just over 2%, which compares positively to the MSCI index of 1.5%. We did see differences across the sectors, and we'll talk through those further in more detail later. Another point of note on disposals, we completed 3 opportunistic disposals in the year, totaling about GBP 50 million of proceeds, and they were all sold at a premium to the valuation at the end of March last year of just over 5%, realizing a gain of GBP 1.5 million during the year. Final point of note on this slide, share buybacks. So those share buybacks totaled GBP 7.5 million during the year. We bought back shares at an average price of 67p and a discount of 33%. And those have also been accretive in the period, not only from a net asset value, but also an earnings perspective. Moving on to the earnings for the year. So we've also seen growth in EPRA earnings for the year of 5% or 4.2p per share. And again, this is primarily due to our industrial exposure where we're starting to see the rental income increase and the repositioning and office disposals. So firstly, in terms of net rents, overall, disposals have resulted in a net reduction in net rents of GBP 0.4 million, but the underlying portfolio, excluding those disposals have seen rental income growth of just under GBP 1 million or about 2%. We're seeing reducing void costs on the underlying portfolio and an increased weighting to our industrial assets. So industrial assets for the year ending March 2025 comprised about 60% of our net rental income compared to 55% in the prior year. And again, this is showing the reversion on the underlying industrial assets coming through in our earnings numbers this year. Final point on here, reduced financing costs. We repaid our floating rate debt early on in the year, and that's resulted in a reduced interest expense for the period. Our next slide talks to capital allocation and our capital priorities. We've sought to reduce our void and focus on disposing of lower-yielding assets. And we've done that through 3 disposals of the year, and these were the 3 largest void at the end of last year. So Angel Gate, Charlotte Terrace and Longcross were disposals and they were all completed during the period at an average of 5% ahead of book value. And that GBP 51 million of proceeds has been used for the 4 sectors of capital priorities we've outlined on this slide. So firstly, we started the year repaying our floating rate debt. So we now sit in a really strong position with the GBP 210 million of our loans at fixed rates with long-term maturities. Secondly, we've invested back into our portfolio, just under GBP 12 million. We really believe that this is a good use of our capital. We see that reversion of about 16% in our portfolio and investing to unlock that reversion and maintain capital values has been an area of focus through the year. There's been one tactical acquisition during the year, something adjacent to an existing asset that we use. But otherwise, we've deprioritized asset acquisitions during the year. And finally, as Michael mentioned, we see good value in buying back our own shares, recognizing the discount and the disconnect between our share price and our net asset value. And in January this year, we announced our share buyback program. Those have been accretive to earnings at the discounts that we've purchased. And also, we've extended that buyback program post year-end.

Thank you, Saira. The next few slides just to give a broad introduction to the property market and how it's been performing in light of all that's been happening this year. So on the next slide, clearly, the budget at the end of last year sort of came a bit less field and some of the tax changes in there just took a little bit of time for business to absorb. And clearly, we've now had things like tariffs that again need a bit of understanding from business. But actually, we -- it's a word I've used before. We've seen the market really, I think, in quite a resilient place as a result of that. And the headline is that yields have come down a bit, base rates have come down as well. And I think I'd generally say that there's a bit more liquidity in the market now than certainly there was in the latter half of last year. The headline is and the chart show this, capital values broadly were rising in the last 12 months. The industrial sector saw the best growth. Offices for the reasons we'll come on to were more challenging. And rents actually across all 3 core sectors have risen. And that's a generalization. Clearly, better quality space is attracting higher rates of rental growth. Part of that is because demand has remained robust. Secondly, supply is quite tight. Now that's not fair reflection across the market when you start to think about sort of quality of space rather than space per se, there is a reasonably limited supply. And part of that is because the cost of construction has gone up, the cost of development finance has gone up, and there is definitely less speculative development today than there was a year or 2 ago when finance was more readily available. And all of these factors, the repricing that happened against the backdrop of rising interest rates mean that in lots of property sectors, current market pricing is below the cost of construction. And I'm not saying just because it's below the cost of construction, that means it's good value. But it is a real indicator and it is a reflection of what future supply will look like. If we turn the page and look at the occupational markets, I mean the headline is, and you can see from the chart, the industrial sector has seen generally higher growth rates in terms of rents across the whole year. We've seen a bit of a sort of step back into 2025 with all the sort of tariffs and that sort of view. And I think that's a view across all businesses, just people absorbing what all that means. But the reality is that rents are rising against this backdrop of sort of 90% plus occupancy. In the office sector, this really is the difference between best quality and not. We have seen rental growth, but part of that, in my view, has been driven by an upgrading of assets. But I think the challenge in the office sector today is just a much lower occupancy levels, and that creates more supply and really is more challenging in terms of capturing the demand that is out there. And this really reinforces the fact why we've, a, reduced office exposure through disposals for higher value alternative uses, but b, where we do have good quality assets, we're investing in them to make sure that we can attract occupiers and be at the top of people's list for new space. Retail and leisure, I mean that's gone through a big repricing. Rents today are still below where they were 5 years ago. But we do think that market has turned the corner. And we are starting to see a little bit of ERV growth even if that's not yet coming through into income growth. The stats show quite high occupancy for the retail sector. Personally, I don't believe the stats because I think the stats are quite skewed to a sample size that includes retail warehousing and supermarkets. And I'm sure most of you, if you go down most sort of regional or market towns, big towns, there's plenty of still floor space supply from a retail perspective, although without question, that's reducing as buildings are, again, in this sector being repositioned for other uses. Investment markets, again, the chart really tells the story. The repricing in the office sector has definitely moderated. And in the other 2 sectors, we're seeing not significant, but nevertheless positive capital growth. But with all of these things, the devil is in the detail. It's the type of assets that you own, the location of those assets, the quality of the space. If buildings are energy efficient, they meet today's occupational needs. The pricing is very different from buildings that require a lot of capital expenditure and without it might have far more limited occupational demand. Just talk to our own portfolio in the context of what I've said about the market. The chart on the left just shows the majority of our portfolio is biased towards the Southeast of the U.K. although we do own assets across the U.K. It's definitely more concentrated today in the industrial warehouse and logistics sector and our office exposure, which was up 30% a year ago, we've brought down to 24% with the disposals that Saira mentioned earlier. A good number of assets within the portfolio and a good number of occupiers, and that's really important as we think about diversifying the cash flow and the income stream to provide some stability to that. The initial yield on the portfolio is just over 5%. We have contractual rent increases where there have been either rent freeze or step rent takes it up to, I think it's 6.2% and the reversionary yield is just under 7%. In the last 12 months, our portfolio delivered a property level return of just over 7%, ahead of the wider market. That was better both in income and capital terms. And that improvement in occupancy principally down to the disposal of key voids also helped. 12th consecutive year that we've outperformed the wider market. And as we look back and benchmark against other real estate portfolios since launch in 2005, our portfolio at the property level ranks 8 out of 72 vehicles. So again, that's something we're quite proud of. This is just a breakdown of the valuation across the portfolio. And clearly, the impact of CapEx in the office sector has had a bearing on performance. But very much we see that as a sort of a future-proofing measure. And clearly, some of the upside of that will come through as we lease space in future. But the headline is that the industrial portfolio, which is the bulk of the portfolio and the retail and leisure drove returns and the office sector offset it, quite similar to the wider market. The headline being though that the offices that we sold, we sold at 5% premiums on average to book. So you can see the benefit of the disposal program that we undertook. Secondly, on this slide, it just talks about the change in value. One of the requirements of a public company is a rotation of valuers. That's something that we're having to do between March and June of this year. And it's unusual to have 2 companies look at a portfolio of assets at one moment in time. We did that with Knight Frank, our incoming valuer and also CBRE who are the outgoing valuer. And I think the headline, which is relevant for investors is the de minimis difference between those 2 firms. And I think that should be comforting to investors to sort of understand that valuation is not well understood. Valuation is an estimate of the price really. And secondly, we refinanced our RCF. This was following the year-end, but a second set of eyes went on a number of those assets that were part of that security package. And again, the valuation range across the 3 values is 2%. I mean this really is de minimis in property context. So in terms of our own portfolio activity, I mentioned previously, occupancy is up, the disposals, the investments, and that's really led to a near 4% increase in ERVs and a 3% increase in contracted rent. So again, against this sort of quite difficult market backdrop, we've still been able to grow some of these key metrics. And if you look in the blue box in the bottom right-hand corner, where we have taken or had rent reviews over the year. So we're generally on a 5-year rent review cycle, the fact that we've been getting on average rents 26% ahead of the previous rent just shows that reversion being captured and coming through. If we just look at the sectors in a little bit more detail, so the industrial portfolio, which, as I mentioned earlier, is just under 2/3 of the portfolio, 81% of our industrial exposure is through smaller, slightly more urban multi-let industrial units. And then the balance is in distribution units primarily located in and around the Midlands, which is a sort of well-recognized distribution hub. 70% in the Southeast and the balance across the U.K. So again, biased to those areas with sort of stronger demographics, tighter land supply, competing land uses, et cetera. Not much vacancy in the portfolio. We made one small acquisition, and this again reinforces that the ERV is ahead of the contracted rent, and we've seen like-for-like ERV growth of 3%. And the rent reviews here in the industrial sector just reinforcing that growth, the rent reviews here of 38% on average above the previous rent. We undertook a couple of transactions that we thought were worth highlighting in some of our sort of within the M25 assets and I'd just refer you to the settlements that we've achieved on some of these rent reviews, up closer to 50% rental increases as the rents have been reset at either lease events being rent reviews or actually on expiry of leases. So we've geared leases on lease renewals. The office portfolio is split really 3 ways between the offices we own in Central London, the offices we own in the Southeast and then the rest of the U.K. As I mentioned previously, more void in this part of the portfolio, which is not unexpected. But our occupancy of 86% is well ahead of the market. And as we've mentioned previously, we've been investing specifically around asset transactions, i.e., to facilitate re-leasing at higher rents or indeed to ensure that we get good occupier retention going forward. And that's the output of it this year is 4% ERV growth across our office portfolio, which is, I think, quite a good number, all things considered. Just some examples of this. So in Bristol, we refurbished space. Part of that refurbishment was tied in with an existing occupier expanding. So that was sort of derisked in terms of the CapEx spend. But some of the space we've refurbished speculatively. It's not yet signed up, but we've definitely got interest, and we're sort of progressing through [ legals ] on that. In Milton Keynes, we structured it slightly differently there. We had conversations with occupiers in advance of CapEx works. And so we're on site at the minute upgrading M&E, but we've done that on the basis of occupiers pre-committing to stay if we do work. And again, here, the new rent that we've got here is 1/3 higher than ERV. And it just proves that point, I think, that occupiers will pay for the right quality space. If it's the right space, people will pay. If it's not the right space in this market with the degree of oversupply, you'll struggle. And then Farringdon is just another interesting example. So the 3 assets we sold last year, we've secured planning on for alternative uses. Planning in Farringdon is not converting the offices to residential, but actually, we've got planning to put residential on the roof of the building. So if you just sort of think it through previously, there's no value ascribed to roof space. Literally, in the last few weeks, we've got planning permission to put 13 flats. And so as we sort of look at that asset today, there's a residual value now ascribed to the development value of those parts, and that's something that we're working through at the minute as to how we take that scheme forward. In terms of retail and leisure, it's a relatively small component part of the portfolio. It's an area that we've been heavily underweight as we've seen the disruption from online and seen the disruption from COVID. But we are more positive about this sector going forward. The devil is in the detail in terms of the towns and the locations you're in. And this is borne out really by the ERV growth we've seen in our own portfolio, of which, again, slightly skewed because 2/3 of it is in retail warehousing, which has seen better rental growth, better levels of occupancy. The comment I would make about the sector is even though in the short term, we're seeing rental growth, we are in a place where the contracted rent is still slightly higher than ERV, and that goes back to my point earlier that rents are below levels in [ 2000.] Gloucester and Sheffield lease regears, again where we've got higher rents relative to ERV. But like I say, that's not meaning income growth. It's just simply getting rents ahead of the market and that's had a valuation impact.

So moving on to just talk about a couple more points on the CapEx projects. I think it's fair to say we've invested significantly to upgrade the overall portfolio. But during the year, we've really focused on 6 projects where we've been looking to improve the occupier appeal and also alongside that, improve energy efficiencies across the portfolio. And you'll see from the -- on the slide that we've been focusing our spend on the office assets. We've explained why it's really to improve ERVs improve the rents that we're achieving on those and also trying as best we can to link that spend to lease events. And for 4 of the 6 projects that we've outlined there, we've achieved that. So we're linking our spend. We're trying to make sure that we achieve the best return on cost for our spend across our portfolio. So thinking about the timing of the lease events, thinking about retention and reletting is really key when we think about capital investment. And alongside that, we've been looking at how we best achieve our net zero pathway and thinking about practical solutions for that across the portfolio. And that involves key themes such as improving the fabric of our buildings, that's mainly on our industrial assets through roof upgrades, installation. And for our office assets, it's removing gas upgrading heating and cooling systems. But the key point of note here is looking at the improvement of the EPCs over a longer period of time, and we're pleased that at the end of the year, we've increased the proportion of A-C ratings at 83%.

Thank you, Saira. In terms of the portfolio vacancy, I touched on this a little bit as we went through the sector slides, but we've got GBP 3.4 million of void currently across the portfolio. Just to be clear, last year, that number was GBP 5.3 million. So you can see the reduction that we've made over the year through both re-leasing and our disposal strategy. Probably not unsurprisingly, we've got more vacancy in the office sector. I think what's important to note though is quite a bit of the void in that office sector is not where we've got whole buildings vacant. It just might be where we have a floor vacant within a wider building. So we know there's good occupational demand. We know tenants are staying and renewing. We just now have to lease the remaining space. We've got about GBP 0.3 million of that under offer at the minute. And in Milton Keynes, we're on site to refurbish and upgrade and that will bring that through also.

Just thinking about our reversion, so really bridging the gap between the 5.2% initial yield on the portfolio and the 6.8% reversionary yield. We see that in a number of parts that's the first chart on the slide. So rent free and set rents effectively already contracted and in our earnings numbers. And then we look at vacancy, which Michael has talked about where we're investing in our buildings to maximize their appeal to our occupiers. And the final part of that is the reversion in the underlying leases that we have with our occupiers. And when we think about reversion, we think about 2 things. We think about the timing. So when the lease events occur in order for us to unlock or crystallize that reversion. And that's typically sort of rent reviews or lease expiries or breaks. And we think about what sectors that reversion is in. So where do we see those ERVs growing to and at that point in time. So as of today, we see we've got 38% of that reversion linked to lease events in the next year and then 23% and 15% for the year after. So the chart, the second chart is showing the income at risk effectively breaks and expiries in the next 12 months, 24 months, 36 months and looking at what sector that is and the reversionary potential within that. And the key point of note there is the timing and the sectors that those are coming through in the next 12 months, we see as a real opportunity. Obviously, we're here trying to balance the time between the contracted rent and the income at risk and then the new letting rent review or regearing coming in.

So really sort of in summary, we are -- just because we passed the year-end doesn't lead to a change in strategy, but it clearly we've had time to reflect. We have a new Chair join us this year and looked at a number of factors. We are going to continue to capture the reversion. There's definite income growth within the portfolio. And we're absolutely clear that we want to continue to deliver sort of higher quality income going forward. And certainly in the listed market, there's probably a higher rating attached to higher distributions rather than just a pure total return play. So we want to continue to do that, investing into the portfolio to capture and drive rental growth and valuation growth is key. And there is, however, a balance between optimizing income and value. So some transactions that we'll undertake are going to be income focused and some value creation. And I spoke earlier about Farringdon and the upside there. Opportunistic disposals. Well, yes, we made disposals last year. Those have clearly improved earnings through debt repayment and share buybacks, but we're going to continue with that. And there's a focus for us, particularly on some of the lower-yielding assets. And if we can reinvest and recycle those to grow income further, I think that's attractive. We've got this very strong debt book. Saira mentioned that it puts us in a good place just following the quarter or year-end rather, we refinanced our RCF. That's currently undrawn. The cost of debt there is more expensive than the balance is there and available both operationally and clearly dependent upon opportunities that might arise in the market moving forward. In terms of capital allocation, we're clearly mentioned the buybacks. Over the year, we bought back GBP 7.5 million between the March year-end and yesterday, I think it was, we bought back GBP 4 million. And we are going to continue with that program, this disconnect in the share price, although it's narrowed and to be fair, there's a disconnect across the wider real estate sector, we're really keen to try and take advantage of that and start to narrow that discount so shareholders see the benefits of that. So I think that's the end of the presentation. It's now time for Q&A. I'm going to quickly tug in my pants. So alright.

Perfect. Thank you very much for your presentation. [Operator Instructions] We have received questions throughout today's presentation. And what I'll do is I'll hand back to you to run through the Q&A, and I'll pick up from you at the end.

Thank you. So we've had a couple of questions and let me try and summarize them. So the first question is, well, with shares repurchased at a 33% discount to NAV, how does management view this persistent disconnect between the share price and the NAV and what's the long-term strategy to close the gap? Well, that's a valid point. The shares that we bought back during the year we bought back at a 33% discount. The shares that we bought back post year-end have been bought back at a 25% discount. So we've seen clear share price appreciation since the buyback was initiated. I don't think you can solely use a share buyback program to reduce discounts to 0, but it does have, in my view, a positive impact. And as I mentioned just a minute ago, we're going to continue with that. We have surplus proceeds from disposals and our view is that the discounts in the sector will generally narrow Picton's will. And if we can keep delivering at a property level, the debt book is strong. And if we can use that buyback program, we will start to -- and indeed, we already have started to narrow that discount to what is an acceptable level. The next question is around sort of how do we feel about a diversified strategy. There have been a number of REITs that have left the sector that have had a diversified approach. And equally, there's a number of REITs [ have done ] clear sector strategies. I mean I think I've mentioned a couple of things to that. Although we're a diversified REIT, I think we're quite opportunistic in our approach. So we don't run a diversified REIT purely to be diversified. We run a diversified REIT that allows us to adapt and change these to market conditions. And the slide right at the beginning talks to how that portfolio composition has changed over time. And there are clearly times in the market where certain sectors deliver very strong performance. Equally, there are times in the market where returns are less about sectors but more about what owner of real estate you are doing to those assets, be it planning permission, be it lease restructuring, be it asset refurbishment and upgrade. So we're comfortable with the idea of being opportunistic and being able to adapt the business for the long term. What one sometimes doesn't see looking at the listed market today is all the businesses that over the last 19 years that we've been running are no longer here. And there are plenty of sector specialist businesses that are no longer in the listed market for a multitude of reasons. There's another question here on sustainability of occupancy, which I think is a good question. Occupancy today is 94%. A year ago, it was 91%. I think in the 20 years nearly that Picton has been running, we've never had occupancy above 97%. So we will always have a structural void within the portfolio. But I think what -- the way we look at it is occupancy is likely to move up and down, up and down, up and down as we get space back, we re-lease and we have that total churn within the business. But I firmly believe that occupancy between maybe 93% to 97% is a good acceptable range. It very much depends on lease events. But our own experience is if you're in the right sectors, which we've thankfully been for quite a period of time, space will release pretty quickly. And that's the key is having space that you can find occupiers for quickly. And you can see that with our current portfolio vacancy, there's very little void in the industrial sector, and that's where 2/3 of our assets are located. And then I think this might be the final question, but there's a question about capital expenditure and how do we think about required returns for CapEx? Sorry, the screen disappeared. So hopefully, you can still hear us about required returns for CapEx and share buybacks. So I think there's 2 discrete questions there. But to my mind, they're slightly interlinked because actually required returns for CapEx to my mind, is a property decision, and we need to think about the upside of doing those works or equally the downside of not doing those works. And as we've demonstrated, I think, through the slide show, quite a number of the CapEx projects that we've been doing have been linked with occupier transactions. So that clearly derisks the CapEx spend because it's generating a return through those lease regears and restructuring and Saira said broadly, we'd be looking at a 10% plus return on cost. But what we've been doing in the year is not only investing that money, but also doing share buybacks. So it's not an either or, it's a both. And clearly, the returns that are generated from buying shares back at a discount to NAV look very attractive on the face of it, [ we call that 25% ] discount. But what we want to continue to do is invest in and maintain or indeed, as this year, we've done again, grow the NAV so that you're buying through the buybacks in a proper discount as opposed to something that might be [ lusory ] or under pressure. So I think those are the questions. Thank you, and I'll hand back to Investor Meet Company.

That's great. Thank you very much for answering those questions from investors. Of course, the company can review all the questions submitted today, and we will publish those responses on the Investor Meet Company platform. Just before redirecting investors to provide you their feedback, which is particularly important to the company, Michael, could I just ask you for a few closing comments?

Yes. Just to say, I think we've demonstrated, I think, this year with these results success across multiple layers within the business. So in terms of the buyback program, I think, is really important as we think across shareholder value. I think what we've done on our debt book and reducing financing costs shows corporately that we're thinking about leverage and ensuring that we're in a good place at a property level. I think there's been lots of good things and indeed investment for the future going forward. So I'd urge anyone that hasn't to take a look on our website, our annual report will be on there, and there's a lot more detail in there. And equally, sort of happy to take any questions if we've missed anything on this presentation. So thank you all for your time.

That's great. Thank you once again for updating investors today. Can I please ask investors not to close the session as you'll now be automatically redirected to provide your feedback in order the management team can better understand your views and expectations. On behalf of the management team of Picton Property Income, we'd like to thank you for attending today's presentation, and good afternoon to you all.