Workspace Group Plc (WKP) Earnings Call Transcript & Summary

Good morning, and welcome to our full year results presentation from our Kennington Park Business Center. I hope you enjoyed that short video, which gave you a flavor hopefully of the refreshed brand messaging that we presented at our recent Capital Markets Day. Turning to the agenda for today. I'll do a brief introduction covering sort of summary of our financial performance, but also touching on some interesting aspects of customer activity in the year, which hopefully, you'll find interesting. Dave is then going to take you through the financial performance in more detail before coming back to me to give you a perspective on what I see as our priorities for the coming year and the opportunities ahead. We'll then finish with a Q&A session. And please, if you have got questions, either enter them online or use our conference call facility. Thank you. So moving on to Slide 4. Well, if ever there were also going to be a challenge for our business model, the last year with London shut for the majority of it, that was it. It's been a challenging year for our customers and indeed for us. We've tried to support our customers as best we can, but equally, unfortunately, we've lost a number of our customers, around 10% overall. The good news is, we've managed to navigate our way through, and actually, we ended the position in a relatively good financial position. The good news is that actually, in the last 3 months, we've begun to see quite a strong pickup in customer activity and demand, and that positions us, hopefully, in a much stronger position as we look to the year ahead. We've also made good progress on our ESG agenda, which I'll come back to a little later in the presentation. Looking first at the financial performance and on the left-hand side, our trading performance, you'll see that actually net income was significantly down, 33% down on last year. And this was a result of customers downsizing, unfortunately, customers leaving us as well as the rental discounts that we gave to customers, around GBP 20 million in total. As a result of that, we saw a 52% drop in trading profit. I'm pleased to say that we are paying a final dividend, but it is reduced in line with that reduction in trading profit. Looking at our balance sheet, our valuation for the year was down 10%. And that was driven by a reduction in estimated rental values with much weaker pricing that we've experienced through the year. Yields were broadly flat year-on-year. Overall, capital value per square foot is just under GBP 630 a square foot, which I think is really good value for the quality of portfolio we've got across London. The drop in valuation then followed -- flowed through to a reduction of 14% in our net tangible assets per share to GBP 9.38. You'll see we still are maintaining a prudent level of gearing with our LTV at 24%. On the bottom of this slide, you'll see I've also put 2 other charts, showing a 10-year history on both trading profit after interest and also net tangible assets per share. And this is really to show the progressive success of our business over the last 10 years, growing trading profits from just below GBP 20 million in 2012 to just over GBP 80 million in 2020. Now obviously, we've taken a backward step this year, but bear in mind, we've still got the same portfolio. We have the same quality operating platform. I do think it sets us a real opportunity to recover that lost profitability in the coming years and also to sort of recover that momentum in terms of growth story going forward. Moving on to the operating performance. On the left-hand side, I've set out details on our customer activity. And no surprise, it's much more muted than previous years, impacted by the 3 lockdowns we've experienced through the year. Having said that, we still managed to achieve just under 100 lettings per month. I think it's a great result given the circumstances. The chart at the bottom there on the monthly inquiries also shows that actually, we are seeing an uptick in inquiry level through the last quarter, despite the fact we're still in the third lockdown. And indeed, that momentum is carried into the new financial year. Looking to the right of this slide, you'll see the data for our like-for-like portfolio, and I'm afraid it doesn't make pretty reading. Occupancy was down through the year and actually ended the year 81.6%, certainly the lowest level since I've been at Workspace. Likewise, we saw a reduction in rent per square foot as well. Rent per square foot down 14% to GBP 36.57. That reflects really pricing to a very thin market through the year. The good news on both of these metrics is, we started to see stabilization through the fourth quarter as demand picked up. And certainly, the momentum is carried forward into the current financial year, and Dave will pick up on that later. I now wanted to give you a little bit more perspective around the customer activity through the year. First of all, in terms of customers joining and leaving us. I've broken this down by sector. And the first thing to highlight is actually the broad spread of sectors, both for joiners and for leavers. And that really does reflect the diversity of our customer base, equally, the diversity of our market across London. Having said that, you'll see within joiners, actually a very strong level of joiners from e-commerce businesses. No surprise there because they were probably one of the least impacted sectors through the last year. I guess a little bit more surprising is the second strongest number of joiners is in fashion design. We did see a strong take-up of space from niche fashion designs across our portfolio, really interesting. In terms of leavers, actually, unfortunately, there are some obvious casualties over the last year. So events companies, we did see in one of the largest sectors. Equally, unfortunately, also charities. But what you'll also see is a crossover between those who join and those that are leaving, and that is a natural churn that we see within our portfolio. So for example, business consultancy or the film and video production businesses. Also, what I thought would be interesting for you is to look at actually demand by region across London. And we've based this on our viewing statistics. And what I've showed on the left-hand side of this slide is the stats for the first 3 quarters of the year. What you'll see there is a very low level of demand in terms of viewings in Central London, which is really great, no great surprise, but actually a relatively strong level of viewings activity in both East and West London. When we move forward to the fourth quarter, you'll see that actually in Central London viewings numbers improved but still lagging the overall, but actually, viewings in the South have picked up quite substantially. If we look forward then to April, May and the recent numbers I've looked at, actually, a much more positive picture all over. Viewings actually are running at slightly ahead of pre-COVID levels compared to, say, 2019. And indeed, in Central London, we're now seeing viewings ahead of pre-COVID levels. So a substantial change from what we've seen over the last year and a much more significant interest now in Central London locations for our customers. And lastly, we also took the opportunity in April this year to ask our customers their views on a number of topics. I'm delighted to say that over 900 of our customers actually responded to this survey. And what I'll share with you now is the answer to 4 of those questions. The first was about the future of their business. And actually, over 80% of our customers were either confident or very confident about their future success, which is heartening to know. We then asked about working from home. Bear in mind, though, that a number of our customers have already had embraced working from home prior to COVID. But actually what their view was that they start working from home, 90% expected more working from home or the same in the future. And the consensus was that this would end up at around 2 days per week. So broadly in line with other commentators in the market. And lastly, and encouragingly for us, we also asked our customers about their future space requirements over the next year. Over 60% of them said that actually they thought they'd be taking about the same amount of space. 25% thought they'd be taking more space and actually, only 12% thought they would be taking less space. And on that positive note, I'd like to hand over to Dave. Thank you.

Thanks, Graham, and good morning, everyone. I'll first run through the financial performance for the year just ended before providing some thoughts on the outlook for the current financial year. Starting with our operating performance. Underlying net rental income before discounts, expected credit losses and disposals was down 12% to GBP 105.5 million as a result of the reduced rent roll following customers vacating or downsizing. As we announced at the half year, we gave GBP 19.9 million of discounts to customers, largely in respect of the first quarter. We're also reporting today a charge of GBP 4.2 million for expected credit losses or bad debts, which have increased significantly as a result of the government moratorium on rent collection. Admin expenses were up 7%, reflecting a full year of our increased investment in our sales and marketing capability, the executive appointments made during the year as well as the fact that the previous financial year benefited from a one-off cost saving following the previous Chief Executive stepping down in May 2019. As you would expect, we continue to keep tight control over discretionary costs and headcount. Net finance costs were up slightly, reflecting a lower level of capitalized interest due to the lower level of project activity during the year. And trading profit after interest was, therefore, down to GBP 38.7 million. Finally, we saw an underlying decrease of GBP 258 million in the property valuation. And this combined with one-off exceptional refinancing cost of GBP 16.4 million resulted in a loss before tax of GBP 235.7 million. I'll provide more detail on the property valuation movements and exceptional finance costs later. Slide 12 breaks down the reduction in net rental income. As expected, the main contributor was the fall in rental income due to reduced rent roll. The chart at the bottom of the slide shows the movement in total rent roll over the year, reflecting the number of customers leaving or downsizing. Although it is pleasing to note that despite the lockdowns in place during the year, we did manage to add GBP 7 million of rent from new customers. Unrecovered service charge costs actually reduced by GBP 1.2 million in the year due to our focus on cost control as well as reduced activity in our centers. We have, however, seen a slight increase in unrecovered -- other nonrecoverable costs and empty rates as a result of the lower average occupancy. The lower occupancy and reduced customers' numbers also impacted our ability to generate ancillary revenue, and sundry income was down GBP 2.2 million in the year. Turning to the balance sheet. The fall in the property valuation combined with a slight increase in net debt resulted in net assets decreasing to GBP 1.7 billion, and EPRA NTA per share down 13.8% to GBP 9.38. Slide 14 looks at the valuation movements in more detail. The property valuation at the end of March was GBP 2.3 billion, down GBP 258 million in the year and that was driven by a reduction in ERVs. You can see this in the like-for-like portfolio, where ERV was down 9.8% to just over GBP 42, reflecting price reductions on new lettings and renewals in the year. Equivalent yield was, however, unchanged at 5.8%. The movement in ERV also drove an GBP 8 million reduction in the value of our completed projects, including Mare Street Studios, which are still in the early stages of letting up following its launch last summer as well as a GBP 4 million reduction at Fleet Street. And looking at current refurbishments, as planned, we've now vacated Fitzroy Street ahead of our refurbishment project, resulting in GBP 9 million decrease in the valuation. And we've seen a similar picture at Westbourne Studios, where a large customer has vacated several units, having grown with Workspace for over 10 years. The Biscuit Factory also saw a fall of GBP 8 million, reflecting lower occupancy and pricing expectations. Moving on to cash flow and net debt. You can see that our cash conversion remains strong with operating cash flow of GBP 39 million, nearly offsetting the payment of the prior year final dividend. As planned, the GBP 28 million, CapEx in the year was significantly below recent years, but this is due to the timing of projects in our pipeline rather than COVID-related impact. CapEx was partly offset by GBP 11 million received on the completion of Bow Exchange. So overall, these movements resulted in year-end net debt of GBP 565 million. A key part of the strong cash conversion has been our robust rent collection. The chart on Slide 16 shows the consistent rent collection throughout the year as well as the impact of the 50% discount we gave to our customers. For the year as a whole, we've now collected 95% of rents due, net of discounts and deferrals. The outstanding balances are weighted towards those sectors most impacted by COVID, including travel, hospitality and leisure. And the outstanding amounts are largely covered by either provisions or rent deposits. Looking at the first quarter of the current financial year, we have to date collected 91% of the rents due, and this is ahead of the rent collection at the same point last quarter. As we've already outlined, net debt increased slightly to GBP 565 million. Despite this and the fall in the property valuation, LTV remained at a comfortable 24%. Slide 17 shows the impact of the increase on our available facilities and facilities maturities from the green bond, which we issued in March. The slide also shows the pro forma impact of the prepayment of GBP 148 million of private placement notes. We gave notice to prepay these notes in March, and the one-off cost is, therefore, accounted for in last financial year. The notes were actually repaid at the end of April. The notes bore interest at 5.6% and were due to mature in 2023. And on this slide, you can see the pro forma impact of that repayment with the average cost of debt decreasing to 3.1% and the average facility maturity increasing to 5.3 years. LTV remains unchanged, and we now have GBP 269 million of cash and available facilities. So moving on to the outlook for the current financial year. When considering the likely trajectory of our recovery, I think it's useful to look at the trends in customer activity. In the chart on the top left-hand side of Slide 18, you can see the monthly inquiries of lettings, and we've run that through until the end of May. You can see the marked pickup in Q4, which continues into April and May, although inquiries in the last 2 months due to a certain extent, reflect the impact of Easter and the May Bank holidays. Equally relevant is the number of customers leaving and downsizing. And the chart on the top right shows a steadily improving picture with the level of customers leaving or downsizing, now returning to near-normal levels. And together, this has resulted in stabilization of occupancy in the fourth quarter after the significant falls we saw previously in the year. And based on these trends, we would now expect to see occupancy starting to recover. Whilst it's difficult to predict the rate of recovery with any certainty, as shown in the chart on the bottom right, economists are forecasting a significant and strong recovery in GDP, which has previously been a good indicator of rent roll growth. So assuming the lifting of COVID restrictions remains on track, we would expect to see continued positive momentum. Our focus over the next year will be on rebuilding occupancy, and we will continue to price to the market until we see sustained improvement. Lower average occupancy across the year will mean we're also likely to see a drag on income from unrecovered service charge and void costs. The refinancing that we have done has left us with a strong balance sheet, significant liquidity and lower cost of debt. We continue to believe in our opportunity, and we'll see increased investment in our refurbishment and redevelopment pipeline this year with CapEx of between GBP 50 million and GBP 60 million. And I'll now hand back to Graham. Thank you.

Well, thanks, Dave, and I'd like to conclude with some thoughts around the opportunities I see ahead of us. First of all, in terms of the brand. Now at our recent Capital Markets Day, we highlighted the importance of both our brand and our marketing expertise and capturing demand. And actually, I do think that is really a hugely important part of our operating platform. Really, to be honest, I'd say, it's almost a distinguishing feature, which really makes us unique. And what we have said over the last year, a lot of time on that repositioning of the brand and the brand messaging and really aiming to differentiate us from others within that flexible office space market, which is a very confused market for customers when they're looking for the right offer. And I do think that actually, now have a very clear messaging. And alongside that, what we've launched recently is an advertising campaign to really capture the attention of businesses as they're thinking about returning to work. And you'll see on the right-hand side of this slide, an example of that, which is a billboard on the road side in Shoreditch that we just launched. Allied to our brand, of course, is actually our property portfolio. It really is a very distinctive feature of our business. The fact that we own properties in 58 locations spread across London. You'll see here the spread in Zone 1, 2 and 3 and beyond. It's a fantastic portfolio that we've built up over the last 30 years. And indeed, the buildings are distinctive, typically low rise, but large in size, 50,000 square foot plus. Often historic, but very, very much landmarks within their local areas. A fantastic set of buildings that we own across London. They also -- those buildings across London offers really rich potential for future redevelopment, refurbishment. And I've highlighted here an update on our pipeline of activity over the coming years. This identifies projects that already planned over the next 5 years. And if you add it together, it's about 1.4 million of new and upgraded space that we're expecting to deliver over the next 5 years. A majority of these have already got planning consent. It's only the 2 green bars that don't have planning concern. And actually, most recently, last week, we got planning consent here at Kennington Park for an additional 200,000 square feet of office space. A really exciting opportunity for us. And that actually makes a lettable area here once we've delivered that additional space, around 0.5 million square feet at Kennington Park. This highlights the rich potential we've got across this portfolio. I also wanted to touch on our recently completed project, the Lock Studios. It's a great example of our employment-led regeneration. By way of background on this site, we had a mixed planning consent. On a -- I would describe as a tired industrial workshop site in Bow East London, as you'll see in the top left of the slide. The consent was for 560 residential units as well as a new business center and some new industrial space. We sold the residential consent to a residential developer and, in return, received GBP 36 million in cash alongside the new business center. It's a great location. As you can see on the bottom left of the slide there, right next to Devons Road DLR Station, which is just north of Canary Wharf. The area has previously lacked good quality office space. And we've had a great response from local businesses. And indeed, we're over 50% let, having opened it last summer in the depth of the pandemic. We've also actually become a real hub of activity for the local community, and you can see in the local -- in the cafe there. And for me, this is a great example of what Workspace does best, delivering value to local communities alongside delivering value to our shareholders. And in terms of our ESG agenda that I mentioned earlier, I mean it very much sits for us under what we call Our Doing the Right Thing framework. The first pillar reflects the fact that we do take our environmental responsibilities very seriously. And you'll have seen earlier in the year, we actually set out our pathway to delivering a net-zero carbon business by 2030. Alongside that, as Dave mentioned earlier, we launched a green bond in March to finance and refinance a variety of green building projects. We also recently were named 17 out of 300 companies in Europe in terms of being able to reduce greenhouse gas emissions over the last 5 years as accolade from the FT. And it's really a great reflection of the achievements of our team over the last 5 years. So congratulations to them. But it's not just around the environment, the second pillar is focusing on actually looking after our people. And when I talk about our people, it's not just our staff, it's our customers and indeed, also our suppliers and partners. And a good example here is our commitment to actually paying a London living wage, and that includes our contractors. And so we are making sure that our cleaners and our security guards at our centers across London are going to be paid the London living wage. And lastly, the third pillar is around engagement with our local communities that we're based in. The Lock Studios' example, I think, is a great example of what we do well. But equally, there aren't any number of local initiatives. Most recent one is actually food bank collections launched by a number of our business centers across London in collaboration with our customers, and they've been a real success. So I'm really pleased with the progress we've made this year. There's plenty more to do. But given the challenges we've had over the last year, I'm delighted with the real progress we've made and the commitments our staff have made. So lastly, conclusion. I think London still offers us a huge opportunity. We have a very relevant product through an increasing number of those businesses across London, looking for a flexible offer. The priority for next year has got to be repairing the damage of the last year in terms of occupancy, but we do have a scalable operating platform. And as Dave highlighted, we've got a very sound financial backing for our business. And in terms of going forward, I think there's a huge opportunity for us to increase our footprint, both through delivering on our pipeline of activity, which I highlighted previously as well as through acquisition. So I do think we've really got a compelling story for the future. And on that point, I'd now like to move on to our Q&A session. So thank you very much for your time.

The first question is from Max Nimmo from Kempen.

Just a quick one from me. You talked about rents stabilizing, and I know some of your peers talk about give ERV guidance and this kind of stuff. But do you guys feel like the ERVs that there are representative? Or do you think that they have further to go, i.e. you've obviously got to fill up quite a lot of occupancy there. Is there -- what kind of incentives are you going to have to give to fill that up?

I'm -- actually, it's Graham here. I'll pick that one up and start with. I think you're right. I mean pricing has been a feature of the last year in terms of pricing to the market has meant that we've seen quite a big reduction, and that's been reflected both in the actual rent per square foot numbers you've seen as well as, as you say, the estimated rental values that CBRE have placed on our properties. We were pricing for the majority of last year into a very thin market. And as we've always said, we want to grab demand that's out there, and that has been, as a result, quite a significant reduction in pricing. What we've seen over the last quarter, as we come into this year, was that as demand picked up, that pricing started to stabilize. And certainly, since then, and April, May have been strong in terms of both inquiries, viewings and indeed lettings. I would expect the tone at the moment is that actually pricing is stabilized. Having said that, obviously, we're still assuming that restrictions are going to be loosened again in June. So it is predicated on the pathway that's currently planned for releasing those restrictions. I would say this year, we'll be focusing very much, as we say, on occupancy. And the element there around pricing is actually, I would hope, would be stable.

The next question is from Paul May with Barclays.

Just a couple of questions I have. You mentioned a couple of things on the net income guidance moving forward just around sort of empty rates and irrecoverable service charges offset by weighted average cost of debt. Just wondered if you could provide any additional color on that or just a more general overview of, are you expecting year-on-year trading profits to be flat, down or up over the next year, taking account of all those various things and what you know at the current time?

Dave, do you want to take that one?

Yes, sure. So as I said, I think we have seen over the last year a slight drag from empty rates over the last year. And that's really driven by the fact that we've had the lower occupancy. Last year, we did actually see that our unrecovered service charges were actually slightly lower, but that really was driven by the fact that we were able to manage costs quite tightly during the periods of lockdown. Now with customers coming back to centers as they are, the opportunity to keep those costs down as much will be more of a challenge this year and I think probably across the year. I mean we'll have to see where occupancy gets to, but certainly, given the starting point of occupancy, I think it's likely that we'll have a lower average occupancy across the year, which means there will be that continued drag as we go forward. And I think in terms of the overall picture for this year, we're starting at a lower occupancy point. As I said, I think the early signs are very encouraging. We do have a good -- very good customer demand coming back in terms of inquiries and lettings. And so we'll see how the trajectory pans out. I think it probably will see a recovery, and that probably will be certainly weighted in the second half, although we are starting to see recovery in occupancy already. So I think we'll have to see how it plays out a bit over the year.

A couple more, but you probably just do one at a time. You mentioned the 95% rent collection post deferrals and discounts. Just wondered what was the percentage if you were to sort of look at it on a normalized -- on a normal basis? And then secondly, within that, what's happening with that 5%? Is that something that you will be chasing? Or is there a risk that, that goes away once that sort of moratorium on rent collection sort of is removed and then actually potentially those tenants actually leave rather than paying the rents? Just wondered what that situation is.

Yes. So I mean on -- sure on a normalized basis, I mean, obviously, that takes into account the fact that we gave our customers GBP 20 million discount. So I don't think it's quite right to ignore that, but if you date -- if you look at the sort of headline numbers, we're probably more about 80% -- 75%, 80%. But if -- but that is almost exclusively in the first, and to certain extent, second quarter. In the second half of the year, we're well above the 90% mark. So I don't think looking at it across the year as a whole is the right thing to do. And the 5% outstanding, as I said, the majority of that is either covered by rent deposits, which we hold for the vast majority of our customers or we've provided against it. I do hope and expect that we will recover some of that as we move forward. Obviously, the government moratorium is still in place. As that ends, we would then hope that we will continue to recover more. And actually, as customers are coming back to centers, some of those that we've had limited engagement with over the last few months or last year even, they are not coming back and engaging, and we are starting to recover some of those amounts. So yes, and I think we've provided as we think is appropriate at the moment.

Okay. Great stuff. And then final one. Just you mentioned the detail on leavers and contractions. Just wondered, do you have detail on the customers' increasing space? And how has that sort of progressed over the various quarters just to get a sense of that sort of net contraction versus increasing space?

I think that's for you, Dave, that one? I think from your chart?

Yes. No, that's fine. So I mean the picture very -- I mean in a normal year, we would see more contractions than we -- sorry, more expansions than we do contractions. And I think if you look at the charts that I put out in the outlook, you can see the level of contractions increasing significantly during the year, but that is now tailing off. The level of expansions, I guess, has done the opposite. So we have had actually had expansions throughout the year, but actually, they've been at a relatively low level. We're really in line with the level of customer activity overall, but I thought that is also now reverting to a more normal level.