Warehouse REIT plc (WHR) Earnings Call Transcript & Summary

Good morning, and welcome to the Warehouse REIT's Half Year Results Presentation for the 6 months to September 2023. I'm Simon Hope, Joint Managing Director of Tilstone Partners and Co-Founder of the Warehouse REIT. I'm joined this morning by Paul Makin, our Investment Property Director; and Peter Greenslade, our Finance Director. We'll follow the usual running order. I will cover the highlights of the period and provide an overview of our markets, then Paul will then talk through the portfolio performance, and Peter will present the numbers. I'll wrap up with a conclusion, and we'll leave plenty of time for a Q&A. Okay. So today, there's a lot more clarity over the macro outlook than we saw 6 months ago. At the same time, we recognize that we're operating in an environment where interest rates are likely to stay higher for longer. In that context, we're pleased to operate an excellent operational performance and a much stronger financial position. NTA per share is up nearly 1% since March to 123.7p, driven by evaluation update of 1.3% on the investment portfolio. Yields have stabilized, and our strong leasing activity has supported ERV growth of 2.8%. We expect to maintain that run rate for the year. Our markets have been robust. So we've done 48 deals in the period, driving rental uplifts of over 30%. Like-for-like rental growth is 1.7%. In half 2, we've done nearly some really big deals, which have secured GBP 4.1 million worth of contracted rent, and that takes our like-for-like rental growth to 3.4% for the 7 months. This good performance, coupled with a firm control on costs, has delivered an increase in operating profits of 1.5%. However, with SONIA 300 bps higher today than last September, earnings have been impacted. As you know, we've taken swift and effective action. We have a highly liquid portfolio, so we've been able to sell GBP 40 million worth of assets in the last 6 months. That's over GBP 94 million over the last 12 months. And we've taken steps to actively manage our balance sheet. We completed a GBP 320 million debt refinancing, which Peter will talk about. And importantly, this month, we have taken out GBP 50 million worth of interest rate caps, effectively hedging our debt to nearly 90%. Now just turning to the progress versus our strategic priorities. On this slide, you can see the 4 priorities we set ourselves at the start of the year. Starting with reversion. We've captured GBP 0.4 million in the first half, a further GBP 0.5 million since the start of the second. There's another GBP 6.1 million of reversion to go for. So good progress, but also more opportunities. Next, on capital recycling. We've already mentioned GBP 40 million worth of sales. But most importantly, these have been achieved at 20% ahead of our book value. That crystallizes a profit on sale of GBP 5.4 million net of costs, adding another 1.3p to the earnings. Importantly, these assets are non-core or we've delivered the whole asset management plan to them. So we're not selling the crown jewels. What it also means is we're reshaping our portfolio to focus on higher-quality assets with larger units and a better lineup of tenants. Turning to Radway Green. There has been a shift in the economic outlook, so we're changing our stance on this. We won't be progressing the scheme alone, and we are now evaluating all opportunities to extract value from it in the near term. The higher for longer interest rate environment has driven that decision. It no longer makes sense to progress this development off our own balance sheet. It doesn't produce any income. Unlike everyone else, our RCF is expensive, so selling it is immediately accretive. We reduce our loan to value and we improve our earnings. So we've made a strategic decision to either sell it in its entirety or to bring in a majority partner. We firmly believe this is in the best interest of the shareholders. Secondly, the pre-let we talked about, the tenant has won further contracts and they have taken a nearby space which they need to activate in the short term. We can't accommodate them because we're not going to be finished until next summer. And it demonstrates why spec development often makes sense. And it's not something that we can do in this market. So we've launched a formal process for a sale of either part or whole, and we've really been encouraged by the interest so far. Finally, dividend coverage. Peter will provide a follow-up data in a moment. But in summary, the pathway we are following includes the following: the capturing of reversion, the making of further asset sales to reduce debt, and keeping our costs low. This will help us increase our coverage from our earnings over time. This has given us the confidence to pay an interim dividend of 1.6p, taking the half year dividend to 3.2p, in line with last year. Including profits from recent sales, the dividend is fully covered in the half. So market overview. Before I hand over to Paul, I'd like to make an update on the market. Our focus is on the multi-let industrial where units are much smaller than the big box market. And the dynamics can be quite different. A key feature of this market is that the rebuild cost is above the capital value per square foot. So it is rarely economic to build this type of space. On our portfolio, the capital value is GBP 92 per square foot, compared to a rebuild cost of at least GBP 110, and in most instances, GBP 120 to GBP 130 a foot. So the land is in for nothing in locations like Milton Keynes, Middlewich and Warrington. That's reflected in the pipeline statistics. While there's an estimated 27 million square feet planned, only 12% of that is actually under construction. With development finance hard to come by, a lot of that space in planning won't progress at all. Gerald Eve estimate that the space under construction is no more than 0.5 million square feet, so 500,000 feet in any one geographic area, and that would have no impact on vacancy. These facts are majorly supportive to rental growth. Setting industrial in the context of the wider sector. You can see that although rental growth has come off over the past year, it is stabilizing at a very attractive level. Across the market, the vacancy is circa 8.7%. That's ticked up a bit over the last 6 months. But it's only 4% on our portfolio, reflecting the quality of our assets and their locations. And as you can see from the chart on the right, aside from last year's correction, industrial has been the best performing part of real estate on a 3-, 5- and 10-year basis as well as in recent months. I'll now hand over to Paul to take you through the portfolio performance, and I will wrap up with an outlook at the end.

Thank you, Simon. To start with that, I'd just like to highlight some of the key numbers. The value of the portfolio now stands at GBP 811 million, and that's after GBP 40 million worth of sales, which is substantially offset by an uplift in value of 1% like-for-like. With yields now stabilizing, the increase has been driven by ERV growth, with the ERV of the portfolio now standing at GBP 52 million, reflecting more than GBP 6 million worth of reversion today, as Simon has said. Contracted rent is nearly GBP 44 million, up 1.7% like-for-like, benefiting from our continued leasing momentum, which I'll come on to shortly. And lastly, the weighted average unexpired lease term comfortably sits above 5 years, a bit lower than last year-end, but mainly due to the asset sales. Turning to our active asset management. We've maintained our leasing momentum with 48 lease events completed in the half, covering 0.5 million square feet of space. That's a similar run rate to last year and equates to around 2 deals a week. On average, new deals are 32% ahead of the prior rents. And this has helped generate GBP 1.2 million of additional income, and has driven the 1.7% increase on like-for-like. Some of the stand-alone deals -- standout deals are DS Smith in Avonmouth, where we signed a rent review 50% ahead of the previous rent at GBP 390,000 a year. And we've reviewed leases on 20,000 square foot in Edinburgh with Howdens, 30% ahead of the previous rents, and 5.5% ahead of ERV, securing over GBP 200,000 a year. This activity has delivered ERV growth of 2.8% and assumes the same in the second -- and assuming the same in the second half takes us to between 5% and 6% for the year, which does not look unreasonable where we sit today. That said, we're very mindful of the economic environment we're sitting in. Occupiers are very focused on managing their costs, so they're making more careful decisions and have -- but having the right footprint is key. In a lot of ways, this plays to our strengths. We have a well-located portfolio; offer a quality fit-for-purpose product, generally at a discount to new units; and our Southeast assets are seen as a viable low-cost solution to occupiers relocating from the wider London area, something we're looking to capitalize on in locations such as Milton Keynes and Luton. We also take a lot of comfort from a diversity of our occupier base, which you can see on this slide. As well as the big corporates like DHL, Amazon and Sainsbury's and the NHS, we have a number of smaller but successful local businesses. In fact, while 75% of our occupiers have turnover above GBP 10 million a year, 90% of our occupiers actually have a turnover above GBP 1 million, so these are decent-sized businesses. We also look closely at their credit quality. Our team regularly cross-reference credit score information from Dun & Bradstreet with occupiers' rental payments information to create a risk report, which alerts us early to any red flags. Looking at our rent collection, I'm pleased to say so far we have not seen an above-average delinquency. We continue to see 98% of rent collections during the period, and actually a higher-than-average occupier retention rate of circa 89% across lease expiries and breaks during the period. Turning to the valuation, and here our successful leasing activity has driven a revaluation gain. The value of the investment portfolio was up 1.3% like-for-like. The multi-let portfolio, which accounts for 70% of those assets, performed very well, and it was up 1.6%. Yields were fairly stable following the rapid decompression we saw last year. But encouragingly, we saw good ERV growth of 2.7% on the larger multi-let assets and 3% on the smaller multi-let assets. The value of our developments was down a bit, driven by macro factors, with higher interest rates making development less economic. However, the values were supported by ongoing asset management and planning successes, so we were only down 1.6% during the period. Overall, the investment portfolio is now valued at a net initial yield of 5.6% with a reversion yield of 6.6%. And remember, these are based on value as ERVs, which we continue to outperform. It's also worth noting that the portfolio is still very affordable, with the average passing rent of only GBP 5.87 per square foot and an ERV of only GBP 6.69 per square foot. That's very good value for a well-located space in key industrial hubs. And so there's even more potential to outperform and capture rental growth. Given our focus on multi-let space, I wanted to spend a few moments on one of the most attractive characteristics, the access to the reversion. As you know, the volume of lease events on multi-let estates means we have more opportunity to do transactions which raise the rental tone and means you're capturing the uplift quicker. It's also worth noting that only 9% of our leases are index linked, which in the market are typically capped and collared, and so the vast majority of our leases do not have caps on the rental increases. The diversity of our occupier base also means that the income is more secure, as I've already set out. Of course, there are costs involved in managing a multi-let estate. We typically repair and redecorate the space every time an occupier leaves, if they've not done so under the fully repair and [ assured ] lease already. But that's a relatively light touch because we buy assets with good bones, as they say, so there's very little obsolescence. There is some recovery of this CapEx through dilapidations receipts, and we continue to business plan CapEx of 0.75% of GAAP each year. There are reletting costs, typically 20% of the first year's rent. However, with an average occupancy, let's say, about 10 years, that's equivalent to just 2% per annum of rent. With most of the other asset management costs either covered in the investment advisory fee or paid by the occupier through the service charge, when we're fully let, and we're close to that, there's very little leakage. And importantly, these costs are more than offset by the uplift in rents that we're getting. Let me illustrate that with an example. Some of you will have kindly attended our recent tour at Bradwell Abbey in Milton Keynes. This is our newest acquisition, where rents were on average GBP 7.89 per square foot on acquisition, which was only last year. We spent around GBP 2.5 million on CapEx, and that's on relatively easy things like landscaping, minor roof repairs, redecorating inside and out, and also fitting LED lights. With these straightforward improvements, we're hitting rents of around GBP 10 per square foot on the large units, and we've reached GBP 19 per square foot on the small units, and this can be seen on the graph on the right-hand side. And if we continue to roll this out across the estate, more than compensating for the CapEx we spent and will help us secure a minimum return of 10% that we always target on capital expenditure. And this is just one example of many. We've secured a 40% uplift on passing rent at the Granby Industrial estate, also Milton Keynes, a 25% average on 2 lettings at our Maxwell Road estate in Peterborough, and we secured an average 60% uplift across 2 lettings at St James Mill in Northampton. Wrapping that up into a portfolio view, you can see on this slide that the full reversionary potential is now GBP 6.1 million a year. That's up from GBP 5.8 million at the full year, despite the asset sales that Simon has talked about. And on the chart here, you can see in orange, on the third and the fifth bars, the reversion we've captured so far this year. That's about GBP 400,000 in the first half, which has increased total contracted rent to GBP 43.8 million, but with transaction closed since the end of the half year with increased reversion capture to nearly GBP 1 million a year. For example, this includes a renewal at Kingsland Grange in Warrington to a thermoplastics business for nearly GBP 0.5 million a year, 43% ahead of the prior rent. And this is exactly how we capture reversion, one lease at a time, one renewal at a time, one review at a time. But ultimately, the reversion does come through. It does take a little bit of time, and it's -- while it's not always on the renewal date, but that's what we're demonstrating. And what's really encouraging is that we've got GBP 6.1 million still to come. And finally, I wanted to highlight the good progress we're making on EPCs. Today, 64% of our portfolio is A to C rated. That compared to 60% in March, and you can see here, we've delivered a significant swing from C to B rating units. That's because our refurbishment program targets a minimum B rating. Typically, we spend 0.75% of GAV on CapEx, and roughly 20% of that's on EPC-related work, and that comfortably covers the cost of taking the whole portfolio to a B by 2030. Timing is driven by lease events, and that makes sense both financially and it's less disruptive for occupiers. And environmentally, it's also not the right thing to do to replace good kit until it reaches the end of its life. Bradwell Abbey, again, is a good example of how we can progress this agenda when the timing is right, and it's now 70% A to C rated versus 38% on acquisition. On that note, I'll hand over to Peter.

Thank you very much, Paul. I don't propose going through the results line-by-line, but aim to pull out the salient numbers and ratios. But if you have any specific questions, I'll be only too happy to answer them at the end. If we look at the financial highlights, you'll see that EPRA NTA increased 1.1p to 123.7p at the end of September, reflecting the 1% like-for-like revaluation increase in the period, with other NTA movements broadly netting off. Adjusted earnings per share were 2.3p for the half year, down from 2.6p for the comparative period, with higher interest costs being the main driver. But importantly, we made a 1.3p profit on the disposal of assets, more than covering the dividend of 3.2p for the half year, and in line with our full year target dividend of 6.4p. We have a clear pathway to cover the dividend through earnings alone, which will grow steadily quarter-by-quarter, but it is not until the end of 2024 that we forecast that we would be fully covered. LTV increased marginally to 34% at the period end. I'll take you through a debt track later on to show the precise detail. This is below our self-imposed target of 35%, and our short-term target is to manage it lower to around 30% from asset disposals over the coming months, and we will exercise discipline on the allocation of capital until we see the market stabilizing. We have recently taken out a GBP 50 million interest rate cap at 2%. This replaces a GBP 30 million cap which expires shortly. The combined impact is that we are now hedged 88%, and this will increase as we continue to reduce the RCF through disposals. Our cost of debt was 4.7% in the 6 months, and this is expected to fall to approximately 4.3% with the new hedge and lower debt. In terms of the financial summary, IFRS profit increased to GBP 22 million from a loss a year ago, reflecting the revaluation gain combined with the earnings already mentioned. Adjusted EBITDA was 1.5% ahead at GBP 17.3 million, but adjusted earnings were GBP 9.8 million in the period against GBP 11.1 million a year ago, with the difference driven by interest costs. EPRA earnings of 1p increased to 2.3p of adjusted earnings when hedging income is included, EPRA rules simply don't allow us to include it, and the one-off costs of refinancing are excluded. I've already mentioned the EPRA NTA of 123.7p and the 34% LTV, but it's worth referencing the cost ratio, which has improved to 23.2%, some 5% lower, and reflects cost control and the impact of higher occupancy and therefore, lower void costs. In terms of an earnings bridge, the 2.6p of earnings for the 6 months to September '22 tracked at 2.3p this year through lower one-off dilapidation income and rental income of some 0.2p, combined with net finance costs 0.4p higher, and are offset by lower property management and other administrative expenses of 0.3p. As already mentioned, this 2.3p increased to 3.6p when the profit on sale of assets is included for the half year, which temporarily bridges the dividend shortfall, but with a clear pathway to full dividend coverage, we have identified 3 key levers. The first is the disposal of noncore and low earning assets at yields below the marginal cost of debt, which will be earnings accretive. Secondly, through focused leasing activity to capture reversion, every GBP 1 million of new rent adds 0.25p to earnings. And lastly, by maintaining our discipline on costs within the business. If you look at the NTA bridge from 122.6p to 123.7p, the adjusted earnings and profit on disposal of assets more than covered the 3.2p of dividend paid. There was a favorable fair value movement of 1.6p, largely driven by asset management, undertaken by the team driving ERVs. And there was a small 0.9p outflow due to the refinancing and to pay for interest rate caps. Just looking at our debt and hedging in more detail. It's worth emphasizing that we are now 88% hedged, with GBP 200 million of caps at 1.5%, half for a further 2 years and half for a further 4 years. There's also a cap of GBP 50 million at 2%, recently acquired, which replaces a GBP 30 million cap which expires shortly. The average cost of our debt was 4.7% in the period but will fall to 4.3% with the impact of the new hedge and a lower RCF. The new facility of GBP 320 million, which we announced in June, runs until 2028 and gives certainty of funding. And that facility also has the advantage of more favorable covenants over the facility it replaced. In terms of a debt track, this slide shows the movement from GBP 281 million of debt falling to GBP 276 million at the half year end. The main changes are the disposal proceeds of GBP 38.5 million, operating profit of $17.5 million in terms of income, offset by dividends paid of GBP 13.6 million, net finance costs of GBP 13.8 million, which includes GBP 4.2 million one-off refinancing cost. CapEx spend of GBP 14.3 million, largely related to one-off items. There was a deferred payment of GBP 4.5 million for our fully let Nottingham asset acquired in 2020 and GBP 6.6 million relating to Radway, which, as Simon has set out, we are looking to substantially exit. There is also an GBP 8.8 million working capital swing due simply to the September quarter day falling on Friday, the 29th of September. So quarterly rents were not received until early October. To date, as Paul has said, we are 98% collected for the quarter, and we fully expect the collection to reach 99%, in line with the previous 10, 12 previous quarters. Simon?

Thanks very much, Peter. Turning to outlook. Our performance in the half year and in recent months reinforces our conviction in our strategy. Focusing on Radway Green, we are going to deliver value, and it remains a key priority for the year. It's the right decision for the business and the shareholders. Our focus on multi-let industrial assets is an important advantage. Despite the economic headwinds, the dynamics for our market are favorable and supportive of rental growth. We operate at a price point that is attractive in today's environment. So we continue to expect ERV growth in our portfolio, based on our run rate, but being conservative, that would be around 5% to 6% this year. We have a diverse and robust occupier base. Our assets are well located. We have more than GBP 6 million worth of reversion to capture. Coupled with a strong financial position, that's a strong place to be. Thank you. We're now happy to take any questions.

Thanks very much for that. Going back to the sort of free land slide, as it was, that's just a function of higher recent construction costs. I mean over the cycles, is that a particular anomaly at this time in terms of the valuation of your portfolio versus replacement costs? And just on Radway, can you give us some idea how much equity is in Radway?

So let's take the first question first. Paul, do you just want to talk about construction costs and the capital value?

Yes. I think ever since we IPO-ed, and those being with us on the journey will remember us talking about the economic moat that we have around our assets, and this is because of the construction cost. In order to be able to build a new building and make it economic, you're going to have to get a rent which is higher than the market is currently paying. The market has been moving during that period, which actually look back to IPO, we thought might happen and we're capturing that ERV growth now. But the construction cost still is not -- it makes new buildings in most locations on a multi-let estate nonviable. And that's why, as Simon says -- I think Gerald Eve were actually saying, there's only 500,000 square foot in each region at the moment, which really doesn't impact hugely on those markets. In the big box market, as you've seen over the last few years, and you all know the economics have worked, yields have come in, rents have grown, and there has been some development in the big box market. But in our core sector, the -- we're still managing to buy assets when we were at below construction cost. So the land is still in for free.

On Radway Green, we've put the site together over the last 7 years. We've created liquidity around the site. We've taken it from preplanning to having outline planning and detailed planning, detailed on Phase 1 and outline on Phase 2. There's further expansion of the planning to be done. We're hopeful of taking it from 1.8 million square feet to 2 million square feet. We've sorted the transport. We've sorted the biodiversity. We've sorted the ecology. And it's a very liquid, very strategic asset in a geography that is performing very well. The Northwest has a heavy weighting of population and commerce. And it's at a strategic point on the M6, close to its confluence with the M56 and M62. There is significant occupier interest in the site in Phase 1. So yes, it was disappointing that the tenant that we've been talking to for the last 12 months has had to take a more recent and immediate space. But that's good for them, and relations are very good. All the contract agreements are agreed with them. We can't guarantee that we're going to do a deal with them, but we'd be pretty optimistic in the next 12 months that there is business to be done. They've done very well in the food distribution market. They've won a further 70,000 pallet contract. That was 3 contracts they've got, and they had to take immediate delivery of space. So they're located in the greater Crewe area and relations are very good with them today.

James from Peel Hunt. Maybe 2 quick questions. One on disposals, both the ones you've made to date and also future, I suppose not Radway, just kind of the more noncore stuff. Can you just talk about which buckets of the portfolio they are likely to sit in? Is it the more multi-let, is it the more single-let? And I guess just looking at Slide 13, you highlighted some of the benefits of multi-let capturing that reversion. It looks like the yield on the multi-lets is typically higher than the single-lets as well. So would it therefore make sense to expect sales more in the single-let units? Is that fair?

Your assumption is right in that way. Our disposal program has followed sort of good portfolio practice in that we've dropped the -- or sold the bottom 10% of the portfolio by way of lot size and distant geographies. We haven't got very much of that stock left to sell. What you can be sure of is we'll only sell stock that is accretive to us. As in, if our revolving credit facility is costing us, Peter, 7.5%?

7.5%.

We need to be selling it better than that. The market is less keen on capped and collared rents. When you're seeing sort of 5% to 6% rental growth, which we're seeing consistently across our portfolio, which is very well located in gateway locations, the likelihood is, yes, it will be single-let. And yes, it may well be something that's capped and collared.

And then maybe just another one on Radway Green. You talked obviously potentially selling the whole thing or potentially bringing in a majority capital partner. Just on the second, how would that work? In part, do you think you will sell a majority stake, so there will be a big kind of one-off cash inflow? Or could that also include kind of forward funding units unit by-unit as they build out?