Schroder European Real Estate Investment Trust Plc (SERE) Earnings Call Transcript & Summary

Good morning, everybody, and thank you for joining the Schroder European Real Estate Investment Trust Half Year Results for the 6 months ending 31 March, 2024. I'm Jeff O'Dwyer. I'm the Fund Manager of the trust and I'm joined by Rick Murphy, who's the Finance Manager. Just a bit of housekeeping first. You have the opportunity to download the presentation that I'll be giving together with the interim report. You can do that via the webinar. Also, we welcome any questions that you may have. You can also click on the little icon there. To provide any questions, we can go through those at the end of the presentation and then finally, we welcome any feedback. At the end, there's a survey that you can undertake and we welcome your thoughts. The plan is, I'll run through a business update. I'll give you an overview and a bit of flavor on markets, what we're doing to ensure not only that assets and income is growing and we're creating value and we've got the company in the strongest position possible, but also how we can and ways that we can grow the share price. After this, I'll hand over to Rick, who'll give an overview on the financial results. Overall, this should take about 30 minutes and that should leave us about 15 minutes to 20 minutes for questions at the end. So, what I wanted to do is just sort of remind people as to what we offer. Obviously, it's a unique proposition. It's the only U.K. listed company that provides a diversified exposure to real estate assets in growth cities in Continental Europe. I think one of the other points we're actually seeing a bit of a change in terms of -- we've seen a bit of a floor in terms of where values are, particularly for certain sectors. And I'll come on to that a bit later. Secondly, there's a real difference that Europe provides in terms of the underlying leases. Unlike the U.K., European leases face annual indexation. So, we're capturing sort of annual growth and then we get to ERV, typically at 5 years or 10 years. You may recall that about 12 months ago, the Management and Board made a decision to go quite conservative and we decided to maintain as much capital as possible, put the company in a really strong position from a gearing point of view and provide us with flexibility to move forward. So it's pleasing to be able to sit here today, to be running a vehicle that is set up to now grow and look at investing not only in the portfolio, but potentially in other initiatives to grow earnings and improve price. Obviously, for a new investor coming in today, it's extremely appealing. You're getting an 8% dividend yield from a dividend that's 109% covered. And Rick will talk in a bit more detail about that later. And really, the share price today is reflecting a 40% discount to NAV. And I'll give you some evidence later as to why we believe in the strength of the NAV and the realistic -- and how realistic that's been priced. And then finally, the strength of Schroder's expertise. We're not only sort of a global investment manager, but we have local, multi-sector expertise and we're thematic led. This is increasingly pertinent as we look to pivot the strategy to make sustainability central to the theme. This has been recently implemented in the U.K. trust with great success and well received by investors, particularly as a growing understanding. The better quality certified assets are outperforming not only in terms of returns, but liquidity to occupiers, lenders and investors. I'll now hand over to Rick to run through the financial results.

Thanks, Jeff, and good morning, everybody. Excuse me. So, turning to the financial highlights for the 6 months ended 31st of March, 2024. And focusing first of all on the income side of things of the company, so really pleasing to be able to say that EPRA earnings have moved along a further 3% over the 6 months. We have been at EUR 4.2 million and we now stand at EUR 4.3 million. And that increase has been underpinned by rental uplift with indexation, strong occupancy and strong rent collection. That in turn is fed into a dividend cover of 109% for the 6 months. And then just a reminder on the income side of things, that all of the income of the company is inflation-linked. Around 80% of that is annual indexation, and around 20% of that is linked to a hurdle. Then just onto the next bullet around rent collection. So, we announced at the last presentation that all rents have been received for the prior 6 months, excluding Seville, which we wrote our investment down to nil back in 2021. And again, that's been the case for these 6 months. So again, really pleasing to be able to say that all rents have been collected and reflective of that strong tenant base, those covenants and their ability to pay any indexations that come through in the period. Just with regard to the debt side of things. 2 successful refinancings in the 6 months. One was the office asset in Saint-Cloud, Paris, which was refinanced around Christmas. And then the other was the Rennes asset in France, which was refinanced in March 2024. From an LTV, net of cash perspective, the company is modestly levered at around 24% net LTV, 33% gross of cash. I just want to draw out here as well the strong balance sheet. So, as at 31st of March, available cash of around EUR 26 million, which we think provides very strong flexibility for accretive investment opportunities as we move into the second half of the year. And just finally, on the performance side, a NAV total return of minus 1.3% and that was driven by capital unrealized valuation falls in the 6 months as yields moved out during the period. On the next slide, we just got a bit of a breakdown of our EPRA earnings. So it's touched upon a 3% increase. And we can see here that we have been at EUR 4.20 million for the 6 months ended 30th of September. And this has increased to EUR 4.32 million for the 6 months to 31st of March. And that's been driven by -- we see in the top line, increases in rental income, driven by those indexations, a lowering of the cost base, increased interest received due to active treasury management and a small fall in taxes. And all in all, those drivers have more than offset the net finance costs, which also increased in the 6 months. And in the bottom line there, we can just see a reminder of dividend cover. So, dividend cover of 106% for the prior 6 months and 109% for this current financial period. Then on the next slide here, we just got a summary of the dividends. So, going into COVID -- during COVID and the aftermath after and again, just a reminder here that over the last 4 quarters, the company has declared dividends of EUR 1.48 per share. And we can see there again in the prior 6 months the 106% dividend cover, 109% dividend cover now, which we believe demonstrates good headroom and stability of that dividend base, should there be any changes in future such as increased finance costs. And then just on the next slide here, we've just set out a bar chart of SEREIT's and some other diversified listed, maybe not so peers, but other listed entities. And we can see that SEREIT's as a company has the second lowest LTV, net of cash, at only around 24%. And this combines with a share price dividend yield of around 8% and then that dividends cover and headroom, which we spoke about, we think makes SEREIT's an attractive investment proposition. And with that, I'll pass back to Jeff.

So, just sort of focusing a bit on the portfolio. Many of you have seen this slide before, those 15 assets, well diversified. We've got about 1/3 in offices. We've got around 1/3 in the industrial sector, around 17% in select retail, which is primarily grocery and a DIY unit. We have some alternatives, which is focused on a data center and a car showroom and we're sitting at around 11% cash. I mean, one of the key points I want to highlight here is just where we are exposed. And you can see here we've got exposure to Berlin, Hamburg, Stuttgart, Frankfurt, Paris, and then on the logistics side, in some very strong growth industrial areas, both from an urban industrial perspective, also from a pan-European perspective. The other point, I won't go into each asset, but what I want to highlight here is just the lot sizes that we have focused on. Most of the lot sizes are really in the sub EUR 30 million and that's where we're seeing most traction and most sort of investment volumes occurring. Just to sort of touch a little bit on offices because I think that is the one sector that still has a bit of a question mark over it. And it's the one sector where, particularly for the 2 German office assets, I feel really comfortable because we're in 2 cities here that have one of the lowest vacancy rates in the whole of Europe. In the case of Stuttgart, you've got vacancy at around 2%. We're coming off rents here of around EUR 15 per square meter per month. To put that into perspective, prime rents in Stuttgart are now EUR 36 per square meter. There's just no choice for occupiers. We've got the government in this particular building. They just don't have any choice to go anywhere. If there was a new building that was to be constructed, you'd need to be achieving rents of high-30s, if not 40, to justify construction. So, I feel really comfortable about holding an office asset where you have very tight supply and you've got a really strong understanding of where that supply can come from and the cost of that. And then equally, in Hamburg, we've got a fully leased asset, multi-tenanted asset. Again, off rents of mid EUR 13 per square meter per month. Prime rents in Central Hamburg, one stop away, are now EUR 35, EUR 36. So again, if you have an office building that is accessible and affordable, you're still going to hold up very well. And obviously, the office markets across Continental Europe have behaved very differently to what one has seen here in London and also particularly in the U.S., where most employees can get to their building a little bit more readily, given the transport connections and also the fact that people often live in the city, city center and we haven't seen the impact of work from home to the same degree. Obviously, on the retail side, I touched on 2 select assets. Again, parts of retail that have performed exceptionally well, one being the grocery asset in Frankfurt. It's an initiative at the moment that we're thinking of potentially selling that asset. We've just re-geared the main lease with LIDL and a couple other smaller specialties. That particular re-gearing still to come through the value, but again, it's an asset that is highly liquid and we're going to test the market from a value sense there. And then we're left with the DIY asset in Berlin, which is sitting on 4 hectares of land in a capital city and feel really comfortable about holding that particular retail. I touched on the lot sizes and again, this point around focusing and where we're seeing stronger investment volumes, it really is in that sub EUR 30 million ticket size. So if we needed to sell these assets, particularly given the city exposure that we have in the growth city that we're focused on, there is liquidity there and it's really the bigger assets, that's sort of EUR 100 million plus, where there's been a bit of balking, particularly from an office point of view. It's those sort of bigger assets where institutions are really shying away from making investments and waiting for pricing to move. On the right-hand side, you can see here just in terms of where values are. I did sort of touch on that. I have seen some draft numbers for June valuations. And actually, it's pleasing to say that the values will be flat. So, I think we have seen a bit of a floor now, particularly for the industrial sector and particularly for the select retail that we have. I mean, the other point here is just where our real estate is now priced. You're getting this premium to where the risk-free rate is. We've done this across an average, across Germany, France and the Netherlands, which is roughly 2.8%. And you can see here that our premium to that varies from roughly 2.5% through to 4.5%. I've excluded the data center because that's a fairly unique asset and I'll talk about that in a bit more detail in a minute. But in terms of pricing, traditionally, in the past, real estate has traded at around a 200 basis point premium. You can see here we've got more than that covered and feel that values are certainly representative, particularly where debt has now moved to. The debt still remains accretive to these sort of yields that we're valued off. Just a little bit on markets. I know we all sort of welcomed the interest rate movement 2 weeks ago from the ECB, where they cut rates by 25 bps. House view here is that we'll probably see another potential 1, if not 2, further falls in interest rates over 2024. I think that would be a real positive to sort of, I guess, investors coming back and really looking at real estate again, particularly around the lot sizes that we focused on. The sentiment across the sector and the different sectors is quite disparate. Obviously, I talked about offices. We're seeing really strong and central offices holding up really well and seeing good rental growth for that better quality offices in accessible locations. Obviously, secondary offices still remaining mixed and probably limited liquidity that goes with secondary offices. Across the retail side, grocery remaining very, very strong, and urban retail parks, again, a part of the retail sector that's holding up really well, both from occupier liquidity and investors. And on the secondary shopping center side, that continues to face challenges, particularly around trying to price or understand where a sustainable rental or net rental can be pegged for retailers to make money. On the industrial side, again, across Europe, we're seeing stronger rental growth. Feel very comfortable about having the exposure that we do there, particularly around urban, industrial and core logistics. In pan-European locations, we still see stronger rental growth, and that's starting to come through now in the valuations and what is upholding and allowing us to make the comment that we feel there's a floor in terms of where values are at the moment. Obviously, into alternatives, there's limited transaction evidence around alternatives, but we are seeing sort of continued focus for data centers, both from an occupation -- occupational and an investor perspective. And then, obviously, the living sector is really one of the big pluses. We don't have any exposure in the living sector, but investors are very much focused, particularly around multi-family, student accommodation and select hotels and co-living. So just to focus a little bit more on what have we done over the period. Obviously, we have been focused on re-gearing leases and trying to strengthen the income side and really move forward that indexation that I touched on, or Rick touched on in terms of helping with the earnings growth. We've got a little bit of vacancy that we're working on. That vacancy is about 4% across the whole portfolio and really is linked to Saint-Cloud. And that's the one asset that has the main vacancy. It's about 15%. There's potentially about EUR 570,000 of ERV potential there. So the teams are working hard to try and de-risk that. Frankfurt, I touched on, really strong and positive to come out with the lease re-gearing. We've had LIDL sign a new 15-year lease that will come through to June's valuation. But we're taking the opportunity to test the market here to see whether we can achieve a value that underpins current valuation. The thinking there is that we could use the proceeds to potentially repay a little bit of debt, but also possibly look at a small share buyback given the 40% discount that we have, or recycle that capital to a better use as well. Metromar, again, Rick touched on, we've written this to 0. We're in the process of working with the bank about potentially moving this on. That would remove or reduce our LTV by about 3%. So, a really positive story there. And then also what we've been able to do is really progress in terms of sustainability audits that I touched on at the full year. At the end of last year, we've done sort of 12 audits and net-zero carbon modeling. We're in the process of reviewing all those initiatives. We're trying to work out where are we going to get the best bang for our buck. It's a bit of a wish list that the consultants have come out with, and it's now up to us to really work out what are those initiatives that give us the best return on that capital allocation and helps with our wholesale analysis as well. But it really is a really strong way of how we see an opportunity to improve the quality of the portfolio and also grow earnings on the back of that as well. It's also helpful in terms of our re-gearing of leases and our relationships that we have with tenants, and being able to provide a solution to the tenants where we're giving them better quality accommodation. And on the back of that, we can secure longer leases and also drive rental growth on the back of that as well. So just a little bit on the sustainability. I've got to be a bit sort of open here that we still need to go through internal and external approvals. Obviously, our intention is to try and move the vehicle and evolve, and make sustainability a key part of the strategy. It's something that's been successfully presented with the U.K. sister trust and investors have given some very strong support to that. And we're looking to piggyback on what the U.K. REIT has done. And the reasons we're doing this is, obviously, it enhances asset liquidity, not only to occupiers, but also to lenders and investors. There is a proven -- particularly for officers, we're seeing a proven growth in terms of rents and a lowering of yields that go with better quality certified assets. We see this as a way of differentiating the company as well and having this thematic approach. It also is a way for us to potentially attract new investors, particularly those investors that will be looking at sustainability and have preferences for thematic investing as well. So being able to move this to and making sustainability key to our strategy will allow a broadening of that investor base, and that often attracts sort of smaller wealth managers and also retail investors. And obviously, with all this together, we hope that this will improve the share price and help grow shareholder performance. This is the best example of why we're thinking about the pivot. We had a really successful repositioning of an office asset in Paris. Many of you who have been shareholders of the trust for some years would have benefited from the profit that we've made here because we were able to make some special dividends. So, we effectively took a fairly tired grade C office building in a good submarket of Paris in Boulogne-Billancourt. It was an asset that was single tenanted to a company called Alten. They liked the location, but they wanted a better quality building. Obviously, us, with our expertise, not only in terms of our asset management and our ability to turn and create a better quality office building, we were able to turn this into a much more sort of more certified asset in terms of why it scored BREEAM In-Use certification. We invested EUR 30 million. So, we took the asset from EUR 40 million, invested EUR 30 million. And at the same time, we decided to sell the asset on a forward funding sale at roughly EUR 100 million. So, that crystallized about EUR 30 million of pre-tax profit and that allowed us to make these special dividends to shareholders. So, we don't have something of the same scale, but we've had a number of initiatives where we think we can do something similar. And a couple of assets that come to mind is the data center that we have in the Netherlands, the office building that we have in Stuttgart and to a lesser extent, some of the smaller industrial assets that we have across France and the Netherlands. So, we have a proven track record in being able to de-risk and turn fairly tired assets into institutional quality and actually see yields, rerate, move rents accordingly and capture that profit, which enhances shareholder value. We talked about sort of some of this growth that we're starting to see come through. Obviously, most of the leases are annually indexed. The only nuance is in Germany where typically there's roughly around 20%, subject to waiting for the compounding of the indexation. You still get the index, but you need to wait, typically, until that compounding reaches about 10%. Just looking through here, obviously, we all have welcomed the news of inflation coming back, and that's been helpful in terms of ECB being able to reduce rates. But forecasts for 2025 and '26 are roughly somewhere between 2% and 2.5% of indexation coming through. So, that's the kind of growth in the short term that we think we'll be able to deliver. Obviously, behind that, we're also in markets where there's supply constraints, where there's competing demands for uses, and where we're coming off relatively low rents. So, we naturally believe there's going to be ERV growth that will exceed that indexation. And that's the beauty of focusing and having a strategy fixed on really focusing on those sub-markets that are also going to benefit from transport, infrastructure changes as well, where you actually will see ERV growing faster than indexation. Just on the debt. I think we've done a really, really exceptional job here in terms of positioning the company and de-risking the debt that we had. You may recall that last year, we had sort of 3 or 4 refinancings that we had to do. And that was one of the reasons why wanting to retain the capital that we have. We've successfully, over the period, not only refinanced the office asset that we had in Saint-Cloud, when we extended that by another 4 years with the existing lender, the margin on that we secured is at about 1.9%. We also were able to refinance the logistics asset in Rennes. We did that with Saar LB, the existing lender as well. The margin on that went from 1.4% to 1.6%. We locked in the 5-year swap at around 2.7. So all-in cost there at 4.3. You may recall from the slide earlier that the logistics assets are valued off around a 6.5%. These particular assets are valued off around 6. So, you can understand why debt is accretive and why it suits sort of the assets and the yield profiles that we've focused on. So, we've done a really good job in terms of de-risking. Yes, the average cost of debt has slowly gone up, but we're in a position and hasn't impacted our dividend. The only other sort of next refinancing that we have is really to 2026. And that's the 2 retail assets that we have in Germany against the DIY asset and the grocery. And then in terms of Seville, obviously, I touched on that before that we are in discussions about potentially moving on that and moving that on, and that would reduce the gearing profile for the company by another 3%. So, just sort of moving forward then, just to sort of give a bit more color around that if we refinanced and we had the cap that we've got on Saint-Cloud, which rolls off at the end of this year, we then have another cap at 3.25%. The average cost of debt could go to 3.9%. So, what impact would that have on our interest expense? Therefore, it would mean about another EUR 111,000 a quarter. Now, given that we have 109% cover, the dividend is not going to be impacted by this potential increase in interest expense. The other positive, obviously, I touched on before about indexation, growing rents, that actually you're going to see rental growth covering this interest expense as well. So, that puts us in a really strong position. There's a lot of investment trusts out there that are still going to refinance their debt, and there's going to be a bigger impact on their ability to maintain dividends, whereas actually we have successfully mark-to-market our debt. And as I touched on, there's really only one sort of debt in 2026 that needs to be refinance. And obviously, as a house and as a company, we're a modest user of gearing. The maximum we can go to is 35%. And really, we have been keeping a very modest level and headroom against that. And hence, that 24% net of debt that we're running the vehicle at the moment. So just to sort of focus a little bit more on the priorities and what are we doing to try and grow not only share price performance, but also earnings and income. And I'm conscious that KPN is a very key part of the income. It represents about 17% of our overall income. They're a public listed telecoms company, market cap of about EUR 13 billion. They've been in this location for about 20 years. They currently run a data center, some offices, some high security part of their business there. We're in discussions, I mean, actually in the Netherlands on the 27th to see them. We're trying to sort of -- and our focus here is to try and re-gear this lease and have them extend. We think the data center is a pretty key part of their business. It is an asset that is depreciating in value and you would have seen over the months. And we're very open -- sorry, over the quarters, very open about that the valuers are pricing this asset as a depreciating asset. Until we can actually re-gear the lease with KPN, they're going to continue to take the remaining income and then the residual land value. So, that's another option that we have, is that we have the ability and we have zoning for medium density residential. There's opportunities for the land to be used for other uses as well. So that's in the back of our mind. But our primary focus is to try and re-gear the lease with KPN and have them extend on a longer term basis. It is over-rented and that's something that I'm conscious of. But it's up to us now to try and provide a solution to KPN where we can turn this building into a better quality asset that meets the sustainability requirements for them, but also secures their strategic needs, particularly from a data center perspective. Obviously, Frankfurt touched on really positive that we re-geared that lease again, securing LIDL there for the longer term. And on the back of that, we've been able to secure some of the specialties. We had some good success with another Schroder fund, where we sold some similar assets in Berlin. We were pleasantly surprised with having sort of 20 bids. So on the back of that, we're going to test the market and I think we will be successful in achieving a price there. And that allows us the ability to use that capital to a better way. And I touched on that. We may look at a bit of a share buyback if we are seeing the shares at such a deep discount that we currently have at the moment. Obviously, sustainability, I gave the health warming. We've still got a lot of internal approvals that we have to go through and obviously, FCA approval accordingly, but obviously, improving a portfolio for sustainability credentials. We believe in sort of enhancing asset quality and earnings potential and leveraging off Schroder's expertise is what really puts us into a strong position to now use the capital that we have in the best way. And then, obviously, investors, it's a really strong going concern. Yes, it's not a huge company this, but as a going concern, it's exceptional. We're targeting retail investors and smaller high net worths. And obviously, the viable income in the thematic investing that some of the investors are looking at will be appealing to them. And they're the sort of the main priorities that we're focused on in terms of trying to grow earnings and look at shareholder returns. I'm not going to go into detail on this slide. There's a lot on this slide. I appreciate that. And I'll let you sort of take this away. But I just want to say that we really do believe that this vehicle has been oversold. I appreciate that the whole listed sector has been oversold. I do think that we're at an inflection point at the moment, particularly where we're seeing a floor in values, particularly for the industrial, select retail, probably a little bit more downside in terms of some of the offices. But being in the cities that we have exposure to, I feel really comfortable about. And really having the cover that we have and having the earnings growth that we have, that gives investors a lot of comfort around the sustainability or the viability of this dividend going forward. And if you can buy that dividend today, that's delivering an 8% yield and you're buying the 40% discount, that to me is an extremely compelling investment case. We've just run over the 30 minutes, which is what I said we'd try and hit. I'm sure there's some questions that Rick has and happy to answer those.

Yes. Thank you, Jeff, and thank you to the audience for the questions that have come in so far. Jeff, one of the main ones we got is around the balance sheet. So, audience have pointed out that SEREIT's in a strong position and has that available cash of around EUR 26 million. And maybe just a little bit more color as to maybe how that might be invested in the next 6 months? You've obviously touched upon a potential small buyback, but maybe just a little bit more about any opportunities you're seeing maybe for the next 6 MONTHS to 12 months?

Yes. I mean, it's a really strong position that we are in, and we deliberately went conservative circa 9 months to 12 months ago. We did that to make sure we got through the refinancing risk, which we've now done. We also did it as a means to look at the sustainability audits that we've gone through and what capital do we need to improve the quality of the assets. Are we better off investing in the assets, growing earnings that way rather than running out and buying a new investment to grow earnings? And I think it's the former that we're focused on at the moment. I touched on earlier, we've got a lot of initiatives that we're going through and trying to work out where do we get the best bang for our buck to make that investment. We will potentially look at a new investment, but I think at the moment where we're trading at a 40% discount, it's very difficult to present a case. It would have to be extremely compelling investment case to go to the Board or go to our investment committee, given the shares are trading at that 40% discount. So, I think if we were to sell, for instance, Frankfurt, we might look at doing a very small share buyback. It's probably the best use of capital from a mathematics point of view. We know that share buybacks don't necessarily solve the discount question, but it is the best use of capital. But certainly, I think we will be in a position to potentially -- and if we do see the share price discount close, we will be in a potential opportunity to maybe look at a new smaller acquisition that would probably be more on the industrial side where we see stronger rental growth.

Great. And then just a quick question around LTV and maybe its trajectory over the next few quarters. We've touched upon this LTV, 24% net of cash, 33% gross and hopefully, with regards to sale of Seville and maybe where the market is. But next 6 months, 12 months, again, Jeff, maybe where the LTV might go to for the company?

Well, I think -- I mean, the big driver of the LTV is going to be valued in terms of the denominator. So, I think I touched on that. We're actually seeing a bit of a floor. So, I think that's really positive. We're not going to be doing a lot. There's no refinancing. Obviously, the positive is what can we do around moving Seville on, and that's extremely positive in terms of moving gearing even lower. So, unlike some other trusts out there that are sitting on sort of 50%, 60% leverage, I feel really comfortable about the direction of this vehicle at now and where we can actually spring to. Now, a good example is say, Apeldoorn, because we've got a few assets where the assets are not levered. So if we had a scenario where we went to KPN and said, okay, we're going to turn this into a BREEAM-rated, certified grade A building and it's going to require us to invest, I don't know, EUR 10 million to EUR 15 million, well, then I could gear that asset. So, maybe our gearing on the back of that would go up a little bit. But it would have to be an initiative like that for us to move the gearing and use that gearing as a way of creating value.