Shaftesbury Capital PLC (SHC) Earnings Call Transcript & Summary

Good morning, and welcome to Capco's interim results presentation. Here's the agenda for today. I'll begin with an introduction and overview; Situl will then take you through the financial review; and Michelle will give an update on Covent Garden. After that, I'll wrap up with a summary and outlook, and then we'll take questions from analysts. Capco ranks among Central London's largest REITs, with a portfolio of investments valued at GBP 2.3 billion. Our strategy centers on value creation opportunities, aiming to deliver long-term superior returns through investing in prime Central London real estate. The landmark Covent Garden estate is our principal asset, accounting for over 70% of our total portfolio. Capco has built a strong track record of accretive investments and aggregating ownership in the West End, and we hold a 25% interest in Shaftesbury plc, owner of an exceptional mixed-use portfolio of over 600 buildings, many of them adjacent to the Covent Garden estate. As of the 30th of June 2021, our investment in Shaftesbury was valued at GBP 552 million, up GBP 51 million from the initial acquisition costs. That investment gives us strategic optionality and the chance to benefit from the recovery of the wider West End. This year has been marked by government restrictions and stop-start trading conditions for retail and hospitality.

With the vaccination program rolling out, footfall is gradually coming back to Covent Garden, and that's helping build confidence among consumers and businesses alike. Thanks to the aggressive actions we've taken on the management side and the strong financial position we've held over the last 18 months, the business is now positioned to benefit from a recovery and from future growth opportunities. We've reopened the game positively, keeping our world-class customer lineup intact. Covent Garden is the most vibrant district in Central London, with vacancy at just 3.4%, which is significantly less than what's been observed in Central London, where vacancy sits at just under 10%. That result is directly attributable to our strong management team and our proactive approach. Our strategy has focused on supporting our tenants so they can maintain the vibrant consumer offer and on supporting the long-term value of the estate. We continue to manage the estate creatively by implementing our consumer-focused marketing strategy. Our team recently launched a cultural program featuring public art installations, digital activity, cultural events, 800 alfresco dining seats and pop-up bars across the estate, which makes it London's most sought-after destination for customers and visitors. The enduring appeal of Covent Garden continues to show through the recovery in footfall and trade following the easing of COVID measures. Although customer sales data is limited and relates to a short period, the trajectory has been positive, which is very encouraging.

The addition of more pedestrian-only streets and our market-leading outdoor dining have gotten a really positive response, and that's improving the trading outlook for our hospitality tenants. Covent Garden's solid fundamentals and appeal keep driving a great level of leasing activity, with 29 deals signed in the period. Rent declines have eased off, since values now reflect recent market deals and the substantial demand that comes from better sentiment. With our strong balance sheet and inventive management team behind us, we have confidence in the long-term prospects for Prime Central London, and especially the West End. Now to the results. Total property value fell 5.1% like-for-like, to GBP 1.8 billion. NTA was down 6.1% to 199.2p per share, producing a total return of negative 6.1%. COVID is still weighing on income and earnings. Underlying net rental income came in flat versus June 2020, at GBP 25 million, which left underlying earnings at 0p per share. Our strategy stays clear, with a strong operational focus, disciplined capital allocation and cost management. Net debt to gross assets held steady at 28%, while the Covent Garden loan-to-value ratio dropped 1% to 18%. Despite the tough backdrop, and taking into account the better investment sentiment, the directors have brought back the dividend and proposed an interim dividend of 0.5p per share.

Over the year, the Covent Garden portfolio saw a like-for-like value drop of 4.9%, coming to GBP 1.7 billion. The biggest factor there was a 4.3% like-for-like fall in ERV, down to GBP 75.8 million. As I mentioned before, rental declines have been moderating, and the equivalent yield held steady at 3.94%. The initial yield stands at 2.98%. Also, in this period, we finished selling 2 properties on Southampton Street that are mainly residential, for GBP 50.2 million. We keep pushing forward with our broad environmental sustainability and community program, which a Board committee backs and which lays out clear actions. Sustainability runs throughout the business and matters more and more to our customers and to the Board of consumer, since meeting the climate change challenge demands action without delay. Capco has pledged to reach Net Zero Carbon by 2030, and a detailed pathway is expected out in the months ahead. We have also begun the customer engagement program to spot chances to cut carbon impacts throughout the estate. An employee survey was carried out recently, and we are glad to say our people remain highly engaged. That is a core strength and a differentiator for Capco. We stay committed to responsible stewardship, putting investment into high-quality public realm, and we keep supporting the broader Covent Garden community as part of our wide-ranging ESG agenda.

Now, Situl will walk us through the financial review.

Thank you, Ian, and good morning to everyone. I'll walk you through the financial review, beginning with the income statement and then continuing to the balance sheet, cash movements and where we stand on debt. As you can see, underlying net rental income came in at GBP 25.2 million, in line with the first half of last year. That reflects continuing disruption to income, since our customers faced significant restrictions for much of the period. We continue to provide rental support selectively and on a reducing basis after restrictions eased. Collection patterns have improved, and we would expect that trend to carry on over the months ahead. Underlying net rental income is stated after deducting GBP 1 million of bad debt expenses. And to arrive at the reported position, there are noncash movements amounting to a further GBP 4.2 million relating to the impairment of surrender premia and similar assets. Underlying admin costs fell to GBP 9.1 million, extending the downward trend of recent years from a run rate of over GBP 50 million towards our target of GBP 20 million per annum, notwithstanding certain upward pressures over the last 16 months. Net finance costs of GBP 16.2 million reflect the higher level of net debt following the Shaftesbury investment in 2020.

That figure covers commitment fees on facilities we haven't drawn down, plus GBP 2.5 million related to amortization of costs from issued debt. We still hold a considerable cash balance and can tap substantial extra liquidity via the RPS. Taken together, these movements left earnings neutral. After the period end, we received dividend income of GBP 2.3 million from our investments in Shaftesbury. We're pleased to be able to restart dividends, with proposed payments of 0.5p per share, split evenly between a pit and ordinary dividend. Subject to regulatory approval, a scrip alternative will be offered. This chart illustrates the bridge from gross income of GBP 61.8 million to ERV of GBP 75.8 million on the right. Thanks to ongoing leasing activity, the contracted and under offered position stood at GBP 70.6 million, and vacancy stayed low at 3.4%. Altogether, roughly GBP 14 million of reversion remains to be captured at present. Turning to the balance sheet. Total market value of property assets fell by 5% to GBP 1.8 billion. Like-for-like movements at Covent Garden were 5%. That was driven mainly by a 4.3% decline in ERV, with retail particularly emphasized.

Cap rates held steady at just under 4%, and the value adjustment, or assumed loss of income, has come down by GBP 16 million. Lillie Square's valuation, after adjusting for disposals and CapEx, fell 8% to GBP 108 million. Net debt is down to GBP 668 million, with group leverage rising to 28%, while Covent Garden LTV has stayed at a low 18%. The final cash payment sales cost — GBP 15 million — is expected to come in later this year. EPRA net assets stood at GBP 1.7 billion, or 199p per share, with substantially all of the movements attributable to property valuation. The Shaftesbury shares are held at the 30th of June share price of 569.5p; a 10p movement from the Shaftesbury share price at 1.1p affects our NTA. So, for example, using the average share price for the first half would give an NTA of 203p per share. This chart summarizes the main areas of cash movement over the first half. Net proceeds from disposals came to GBP 57 million, comprising the sale of Southampton Street properties and completions at Lillie Square. Financing cash flows related to repayment of outstanding balances on the Covent Garden RCF and the Lillie Square loan facility.

Considering additional movements, group cash stood at GBP 274 million, and the RCF was fully available, giving us access to substantial liquidity. Our capital and liquidity position is strong, and our capital commitments are modest. Group leverage overall is 28%. At Covent Garden, the loan-to-value position gives considerable headroom against the debt covenants, with valuations able to decline by another 70%. As previously announced, in light of the impact of reduced NRI, waivers are in place regarding the interest Covent covenants for all of 2021. That being said, the covenant was satisfied for the first half. There are no near-term maturities on loan debt. In view of the group's very strong liquidity position and the financial efficiency, we plan to refinance the RCF at a reduced size in the second half of this year. The company retains considerable financial flexibility, with significant liquidity and covenant headroom, supported by a disciplined approach to capital and cost management. With that, I will now hand over to Michelle.

Thanks, Situl, and good morning to everyone. Here at Covent Garden, our focus has been on getting the estate positioned for recovery. The leasing traction we're seeing across the estate is encouraging. During the period, we secured 29 transactions representing GBP 6 million of income, which came in on average 6% below the December 2020 ERV. We have a solid pipeline of GBP 3.1 million of income under offer as we keep targeting a world-class mix for the Covent Garden estate. The level of new store listings pleases us, with brands continuing to put money into this location for new concepts. Seven new openings took place across the estate, and 12 were expected over the course of 2021. Keeping occupancy filled with the right kind of tenants remains a focus area, with vacancy low at 3.4%. During the period, we sold 2 residential net blocks from Southampton Street for GBP 50.2 million. While the market backdrop has been challenging, we're pleased with the positive reopening of the estate and the activity levels we secured. As Ian mentioned, the Covent Garden valuation fell by 4.9% like-for-like to GBP 1.7 billion in June '21. ERVs have come down by 4.3% to GBP 75.8 million.

Most of the drop in rent comes from retail, and the valuer is still taking a cautious stance on big units when it comes to absolute rents. Their assumption for income loss went from 6 months down to 3 months, which gave us a positive adjustment of GBP 16 million for the period. Each unit gets looked at on its own, and they've factored in recent market transactions plus demand across the estate, which reflects better sentiment now that restrictions have eased. Over the last 18 months, we've concentrated on making Covent Garden competitive, owning our customer relationships, managing vacancy with the right brand, and bringing creativity and energy to the estate — those things matter a lot to us. As we reported at the year-end, rental support has been given case-by-case. That support carried into the first half of this year and should taper through the second half as restrictions come off. We've reopened successfully with a strong customer lineup, and tenant failures have been minimal. On top of that, a cohesive pedestrianization strategy, done in close partnership with our stakeholders, let us bring in 800 alfresco seats across 35 restaurants, which creates the setting to maximize trading prospects and drive footfall.

Even without international travel and with office occupancy low, the consumer in London and domestically is engaging well with Covent Garden. Footfall is tracking the Western benchmark, and a significant number of customers are reporting greater utilization, conversion rates and larger basket sizes, and sales are gradually improving. Although customer sales data covers a relatively short period, the trajectory has been encouraging, with certain categories such as F&B and luxury outperforming. As you can see from this slide, we have signed high-quality concepts to the estate. We are delighted to have signed 2 new flagship stores anchoring either side of King Street. Following last year's pop-ups, the digitally native beauty concept has now agreed terms for a long-term lease for their first London store. Reformation, another digital brand with a focus on sustainability, will also join our lineup. Vashi has opened its new London flagship store joining Bucherer which has now opened its larger concept. Sacred Gold have signed in the market building and Arc'tyrex will open shortly having signed earlier in the year. Following completion of our refurbishments to create a new destination restaurants, Ave Mario by Big Mamma Group, has now opened. And Mrs Riot, a new bar and restaurant, have signed and opened on Henrietta Street.

Work on 3 Henrietta Street is finished, and The Gentlemen Baristas is now fitting out its new flagship hospitality concept. Despite government restrictions on trade during the first half, the demand we're seeing has been encouraging: inquiries are up 50% versus the same period last year, and GBP 3.1 million of income is under offer. Our focus stays on driving content and animation. In our view, vibrant estates generate leasing activity, and that turns into value creation. We've kicked off an extensive cultural events series, working with a selection of bars and street food brands from across the estate, plus art commissions that drive content and digital engagement. Capco is presently partnering with the Royal Opera House on a festival of open-air performances on The Piazza, while Disney is launching at Summer Stage and selling out every performance — showing how much consumers want to connect with high-quality experiences. Active asset management and refurbishment work goes on across the estate, including refurbishments at 35 King Street and 5-6 Henrietta Street, both office refurbishments, which will be brought to market next year. Total current capital commitments across the Covent Garden estate stayed modest, at GBP 3.9 million. Following an assessment of forward returns, 2627 Southampton Street and 3032 Southampton Street, both predominantly residential buildings, were sold for GBP 50.2 million.

A bigger share of these properties consists of larger units, which will call for capital expenditure over the medium term. We keep monitoring the target investments in Covent Garden, and because our balance sheet is strong, we are well placed to act if such opportunities come up. To sum up, the steps we have taken have concentrated on making sure the estates reopen positively, and the transactional activity we have secured pleases us. We believe the measures taken and our vision for Covent Garden put it in a position to maximize market demand and gain from a recovery. I will now return the call to Ian. Thank you.

Thanks, Michelle. So a few points as I look forward. First, it's wonderful to see the West End bustling once more. Covent Garden is unquestionably Central London's liveliest district. My feeling is the worst is likely behind us, since the activity levels we're observing suggest recovery is underway. Near-term difficulties persist, yet the easing of restrictions, office staff coming back and the start of nighttime activities will each contribute to pushing the economy toward activity levels that are closer to normal. All through the COVID period, our team worked hard and managed to keep occupancy high despite having only a limited number of units available. That said, we are aware of elevated vacancy across Central London generally, which the market may need some time to absorb. We take particular pleasure in how resilient our world-class customer lineup has been, in the investment new customers are making to fit out space and in our robust leasing pipeline. Rental decline has decelerated and yields have stabilized, mirroring the valuer's take on better sentiment and the strength of demand across our prime Central London estate. We'll keep watching customer sales data, which is trending favorably with a positive trajectory so far.

Sustaining this through the remainder of the year matters, as we build toward the key trading period for the business. Our approach to allocating shareholder capital will stay disciplined, and we'll keep concentrating on response stewardship, delivering our ESC strategy, and striving to reach Net Zero Carbon by 2030. Thanks to our long-term vision, entrepreneurial culture and the way we put strategy into practice, we are positioning the business to compete well in the future. Capco enjoys a strong financial position, with considerable financial flexibility. We have confidence in the future of the West End especially, Covent Garden, and in the long-term value of our distinctive investment portfolio. That brings the formal presentation to a close. We will now take questions from analysts. Should you wish to ask something, please inform the operator. Thank you.

<<operator_script>> Miranda Cockburn from Panmure Gordon has our first question.

I’d like to ask a few things about rent. You pointed out that the leasing deals done in the first half came in 6% under the December ERVs. Could you say anything about how they compared with the previous passing rent? And you also mentioned GBP 3.1 million of income under offer. Was that at a comparable discount to ERVs? I’m mainly trying to figure out whether rents are bottoming out here. And could you also give us some detail on the sorts of lease structures you’re using — have those shifted much over the last year?

Miranda, thank you for that. The lease structures really haven’t changed in any material way from how they’ve always been at Covent Garden. We’ve always carried out a mix of different kinds of transactions. I think those 29 leases that are declared, so to speak, in the first half, as you mentioned, are roughly 6% below where they stood at the end of last year. That is more or less reflected in the ERV value assumptions, which are down 4.3%. So the second quarter is probably stronger than the first quarter. I think the main takeaway for me is that this is probably the highest level of genuine inquiries I’ve seen for the estate in the last 15 years, along with a good-quality brand. and they’re opening regularly now. So I think that’s a positive for the estate, and we’re starting to see competitive tension now around specific units. But perhaps Michelle would like to add to that.

Thanks, Miranda. Yes, we're fairly happy with how much activity we've locked in across the estate. I think one of my slides makes that clear — the caliber of the names has been a total priority for us. So we're quite happy with those brands and the ones we've drawn in. As for the deals themselves, value gets factored into the transactions we've completed, which is how you see deals being signed 6% under ERV, and that shows up in the valuation.

James Carswell from Peel Hunt has our next question.

I have a quick question about the investment market, and I suppose it has two parts. First, are you currently seeing any opportunities in terms of assets that might become available for purchase? Second, on the broader market, yields were flat during the period. We've obviously seen a fairly solid uptick in office volumes — have you noticed that across your estates as well, in terms of other parties looking at buildings? And where is that competition coming from, and how deep would you say it is?

So, we are tracking a handful of properties that we would very much like to acquire, though we aren't seeing any chances to move right away. One or 2 smaller buildings are, in a sense, changing hands. The bigger properties — at least those right in our immediate vicinity, Covent Garden — are typically in strong hands. We're therefore keeping an eye on a few buildings near Long Acre and so forth. It's possible there are 1 or 2 chances within the estate, acquiring into existing stakes and raising how much of those buildings we hold. Even so, right now we aren't spotting any particular bargains. Plenty of buyers are active at present. I'm certain others could speak about the office market in a better way than I have, yet there appears to be a great deal of appetite for modern office buildings that are well let at present. We're kind of witnessing that through people who may want to perhaps partner with us on things. Still, at present, what our company is focused on is really ensuring rents have stabilized, that vacancy stays at low levels, and that we get back to a position where, as soon as the market permits, we can be first out of the blocks for rental growth.