Q3 results – 14 February 2006 Analyst conference call transcript Stephen Hester
Good morning everyone, Stephen Hester here, Graham Roberts is with me as well. Welcome to our first ever quarterly report. Hopefully you will mostly have received an email from us, we are going to go through some slides, although if you can't get the slides it doesn’t matter, because we'll try and make it sensible just talking, but the slides are on our website that we're going through to illustrate our talk.
We'll try and be reasonably brief, because obviously it’s only quarterly results and we've tried to err on the side of giving you the information that you need, as opposed to too much for the first quarterly stab. But let me, in a sense, just lead off with the highlights and then pass to Graham. We are pleased to be celebrating our first quarterly report with what we believe are both good numbers and good activity level. You've seen the NAV per share up 11% in the quarter to 1390p and 23% for the nine months, underlying pre-tax profits up nicely on both measures as well and clearly headline pre-tax on the IFRS basis, 1.4 billion for the nine months.
Our valuation increase was 4.6%, obviously a significant acceleration on the pace of the first half, some of that I think is due to the market as a whole typically having a good fourth quarter, so I think it would be wrong to extrapolate from that into the rest of the year, but nonetheless we're pleased that we have now caught up with the IPD data, not withstanding the fact that yield compression is still making that hard for prime portfolios.
And as we'll talk about later, our two key portfolio concentrations leading the valuation increase. Lots of activity to talk about, and I’ll go through that in the slides under the headings that we promised earlier in the year, of portfolio reshaping, proactive asset management and I think the Pillar acquisition showing very clearly the benefits it’s brought to British Land’s shareholders. With that let me pass you to Graham.
Graham Roberts
Thank you and good morning, just turning to the second slide. As Stephen said, this is our first quarterly statement and because of the limited benefit of a valuation at the previous December, December 2004, we haven't produced a comparative which would look awkward under IFRS and therefore we have presented instead the three month and the nine month results for you.
The portfolio valuation increase drove an NAV increase of 11% to 1390 pence, that’s 23% over the nine month period. In the final quarter of the year, however, you should take into account that we have the interim, which under IFRS will then reduce NAV at 5.2 pence per share and also the recently announced re-financing of our superstore portfolio, where we're expecting an exceptional charge in the region of a £104 million, that’s 14 pence net of tax relief and just to remind you, that should yield us a £7 million interest savings prospectively.
Our total return for the three months therefore is 10.7% and 24.2% for the nine months, and we have net assets now of £7.3 billion. Moving on to the next slide, our underlying profit before tax for the three months period is £71 million, £173 million for the nine months. But in that third quarter
there are two items to draw to your attention, one is the Songbird dividend on the A&D shares, which were £16 million, and the dividend stream from Songbird is not regular, and we'll be reporting that accordingly as it comes through.
The second item is fund performance fees, and the third party performance fees payable to us have been estimated at £5 million in the quarter, however, this is just a cautious estimate at this stage, because the performance fees will be based on the IPD annual index and we have to await the publication of that at the end of February. So there’ll be further clarity on that after the fourth quarter when we present our results for the full year.
Underlying profit after tax was £60 million, because underlying tax charge was 15%, which is affected by the fact that the Songbird dividend was not taxable. The tax is significantly higher than the tax paid, as is usual, this is largely due to the amortisation of the deferred tax assets on the Broadgate refinancing last year, plus the tax on the revaluation movement.
We've had a lot of sales activity, as you're aware, but these have had a marginal impact on our underlying profits, both in respect of the sales in the six months to September and also the sales in the quarter, because the yield on our disposals in aggregate are broadly equivalent to the cost of the debt that we have repaid. Now profit before tax, the headline was 672 million for three months, 1.4 billion for the nine months, including valuation gain.
Moving on to the next slide, dealing with the balance sheet, we have continued with prudent financial ratios, our leases average 15 years, our vacancy rates are low. Our gearing is a matter of note, that we have peaked post acquisition of Pillar at a loan to value 59% on a proportion of consolidation basis. We are now back down to 50% as a result of the asset sales that we've undertaken and the valuation growth, and that is 46% on a group only basis, with an interest cover at 1.6 times.
Our average interest rate is 5.9% and following refinancing of the superstore portfolio, we're
expecting that to fall to the range of 5.75%. And our long term debt is 12.2 years and we've retained significant undrawn committed facilities. So with that positive outlook I’d like to hand back to
Stephen Hester
Thank you Graham, turning to the next slide 5, activity levels, as I mentioned two key themes that we promised, reshaping the portfolio, recycling capital and of course intensifying asset
management. So the programme has been going well, more than £900 million of disposals since September, some of which are not in these quarterly results, but were announced since the year end, and we have nearly a billion of assets currently in the market, of which the major ones are Plantation Place and residential, both of which I hope we will have positive news on during the fourth quarter.
The effect of the various disposals that we've been undertaking, as well as the acquisitions that preceded them, is to tighten our sectoral focus on the areas we believe there will be superior risk adjusted growth in the coming handful of years, namely open A1 out of town retail and prime London offices.
During the quarter, not that a quarter I think is very significant for these terms, our rental growth continued the same trend as the first half, with something like 2.8% annualised ERV growth driven by retail outperforming the market, office growth is not yet feeding through, given the over
rentedness, as you would expect.
Moving on to the asset intensity, or asset management, one of the underlying initiatives is an effect to become more customer driven, and we believe out of that both rental and occupancy trends are improved. However, the key activity is on the development programme. Our development programme, which, as you know, is not exclusively in the London, but concentrated in London offices, is on track and accelerating.
The next key building going up in the City is Lime Street, which should be up by the first quarter of ‘07, the York Building in the West End, part of which we'll occupy as our new head office, is also on track. As we announced at the half-year, but actually happened in the third quarter we're reporting on, we're commencing the Broadgate Tower and 201 Bishopsgate for delivery in the middle of ‘08, we continue to believe that that will represent excellent timing.
We are not currently seeking prelets, that’s not to say that we won't nearer the time, but for the time being we're producing the product and letting the rental tone harden. Importantly in the West End, at the end of last week we received resolution to grant planning from Camden Council for the next phase of our Regent’s Place office estate, 730,000 square feet gross for that one, of which about a third is residential and the balance is offices.
We've got further lettings in documentation at 10 Exchange and Plantation Place South, on terms that are broadly confirmatory where the office is going, but obviously since we have so little vacant space at the moment in the City, there's not a whole lot to talk about on that front.
As we move to the next slide six, that simply lists the disposals in the period, including those announced since the year end, and gives not only the gross value, but our share and the gain, a peculiarity of IFRS is that when we publish our year end results, the gain will be stated from the previous year end valuation, rather than from the most quarter uplift as it were, and so we're giving you those numbers here in order for you to get it right, as it were, in your models for the year end.
I suppose the most notable of the disposals clearly since the year end has been City Point, which you know we got £520 million for. Moving onto page seven, the valuation uplift, again a cautionary note, a quarter should not be extrapolated, it is only a quarter and just in the same way as I said at the half year, there are some things that are up more or less than you might expect. I think the same goes for this quarter, in addition to the fact that fourth quarters are normally better in calendar terms than thereafter.
But nonetheless we are pleased to note that our key sectoral concentrations in retail warehousing, now with a full Pillar period in it, and City, are performing very well, and we give for you at the bottom of this page the yields on the portfolio, net equivalent yield of 5.1%, gross initial yield of 4.7%, or if you take, add back rent free 5% and then the reversionary yield.
Moving then onto slide eight, a quick word on market conditions, and frankly I think you all know this, yield shift continued to dominate investment returns, we believe that is supported by the overall fundamentals, but also that the process seems likely to be in its later phases.
We do think that there is good value in some parts of the market, but there are other parts where property is at risk at being overpriced, particularly properties with income risk or without good growth, and we also feel that secondary yield compression versus prime is becoming vulnerable to setbacks, and you'll see in our disposal programme us, if you like, putting our money or not putting our money where our mouth is.
We are therefore approaching the time when the real economy becomes the key thing driving real estate values and rental rises and occupancy growth from the real economy, and that’s what all our positioning and activity is about at the moment. Out performance will require hard work,
nonetheless we believe that in that scenario we are positioned well, and if we move on to a couple of comments on our two key sectoral focuses on slide nine.
Clearly the retailing market did not turn out as bad last year as some were making out, there was positive sales growth, albeit less than before and that continues this year. Nevertheless in more challenging conditions property basics reassert themselves whether location, quality, planning regime or the supply demand, and all of that we believe continues to favour open A1 out of town retail.
Which on top of, if you like, the underlying trends, benefits from the ability to make extra money through intensive asset management. And we have by far the most distinctive portfolio in that sector, it’s interesting when you look at the Hercules return, which, as you know, is the largest part of the Pillar asset that we bought, and particularly interesting when we consider some of the fears people had about whether we were buying too expensively relative to the March valuation, of which we bought, Hercules units are up 26% in nine months.
If we look at the calendar year, up 35% geared and the underlying property return up 24% and ERV growth of 10% doubled the sector average, and interestingly the growth in rents and in total return, in absolute terms and relative to IPD and relative to competitors, has accelerated since we owned it. I don’t think that’s because we're magicians, but I just make that point.
London offices, again clearly the cycle is in the up phase and that’s for all the reasons you know about, falling Grade A vacancy because of lack of new supply and because of good take up, reflecting the healthy international trading conditions of the City. We do see rents and incentives hardening, but only modestly at present, we do believe that process will accelerate.
However, we also believe that supply will awaken, and although that’s likely to be 2010 and thereafter in terms of the main bulk of supply, we don’t see a leasing bonanza and we believe the product and timing will remain crucial and we would also note that the investment market is already pricing in quite a lot of recovery in rents. So we're positive on the City, but possibly not quite as positive as some of the more enthusiastic commentators.
As a result of that, while we have the largest City exposure and we believe the best, we are recycling capital within that exposure through sales of assets like City Point, the Fleet Place and Plantation coming up, together with rolling out the development programme that we've talked about and we think that that’s the right thing to do, given our outlook.
And finally page ten, all of what we are delivering today and the activity going on in the company, follows on from the strategy laid out at our year end results last year, and the promises we made in working our assets in the company harder in beefing up the culture and management team to make that happen, and then delivering it in a transparent and proactive fashion to our investors. And that’s what we're about going forward, and with that we'll end and hand over to questions. If you could possibly state your name company so we know who you are when you ask them. Operator. Remi Antonini – Goldman Sachs
I have two questions of detail, first of all in the revaluation of the developments of 16% over three months, could you tell us which were the biggest contributors in terms of individual projects. And the second question is, how much interest capitalised did you have for the first nine months? Stephen Hester
We only had two big developments that were ongoing development sites, Lime Street and 201, 201 was larger than Lime Street. And the interest capitalisation?
Graham Roberts £3 million. Stephen Hester £3 million.
Remi Antonini – Goldman Sachs For the nine months?
Stephen Hester
No, for the three months. Mark Young – Oriel Securities
I wonder if you could talk about Meadowhall briefly, giving perhaps a bit more detail on the ERV and giving us an update on any sort of partial disposal plans which you referred to at the interims?
Stephen Hester
Sure, well Meadowhall is going well in asset management terms, we had a pleasing increase in the ERV from £79 million to £81 million in the quarter, which is a faster rate of growth than we've been accomplishing of late, and that was as a result of a lot of the asset management initiatives in the current round. The major initiatives ongoing are the complete remodelling of the mall from the space we took back from Sainsburys and Alders and the letting up of that space, although that won't be trading until 2007, but we have high hopes of that, not only in terms of the game, which we spoke about at the half year from the letting, but also revitalising that end of the scheme. So that’s what’s going on, if you like, at the asset itself, at the same time it is going through, if you like, one of the shopping centres, periodic shopping centre capital expenditure peaks, and we're spending something £35 or £40 million over the next 2 years on just general improving of air conditioning, improving the look of the malls and so on, and 15 of that was in this quarter’s valuation, thereby, if you like, the 2% increase in valuation that we show was 3% on an underlying basis.
Nevertheless it remains the case that although Meadowhall we believe is doing very well for the type of asset it is, it probably represents quality and maturity as opposed to some of the other assets in our portfolio, and so it remains our plan to introduce third party capital to Meadowhall. However, we are not materially further advanced than three months ago, because we're really awaiting a clearer understanding of REITs environment, since a REITs structure would be one of the possibilities for Meadowhall if we wanted to make it truly liquid, and so we're sort of in a holding pattern on that, but in the meantime the asset is behaving reasonably well, as it were.
Mark Young – Oriel Securities
Can I just ask, on the ERV growth Stephen, is that prime, moving forward, are there new lettings, what was that £2 mill?
Stephen Hester
It’s a combination of all the above, we did achieve in the third quarter our highest ever letting, £440 per square foot, and although prime hasn’t yet moved to that, it’s probably moved to the high 300s, maybe a touch over 400, depending on your views, and there were a series of smaller lettings. Keith Crawford – Peel Hunt
I like the results, it’s great, and in relation to Broadgate, what will drive the rents off the plateau here, will it be Hamilton House lettings, is there anything from that direction?
Stephen Hester
Well I think the 10 Exchange Square is the only space we have available in Broadgate, and in fact the grey space of Lehman’s is pretty much all gone as well. And 10 Exchange is letting in the sort of £48, £49 kind of tone headline, which compares to, if you like, the valuers headline for the whole of Broadgate of around the range £40 to £45, so I think we're demonstrating with that, which is a nice building, but not flagship or anything, that that’s the kind of tone that we're getting.
And so I think that obviously Broadgate in aggregate is a mix of older and younger buildings, the ERV is moving forward with the market, the latest grey space that was let was let at better rates
than a year ago, but, as I say, I would caution, you know that we're at the start of the City cycle and we're not quite in the bonanza that I think some people are talking about yet, at any event. Keith Crawford – Peel Hunt
Right, also would you have scope in any of these buildings perhaps to seek to secure lease lengthening with the tenants?
I think over the next five years that is an important topic, as Broadgate’s leases are around 12 years on average, and so certainly over the next five years we will be seeking to lengthen leases on an opportunistic basis. At the moment though we're finishing the leasing of 10 Exchange and concentrating on 201 Bishopsgate, Broadgate Tower, which aside from its own merits as a
development, I think will have a rejuvenating effect for the whole of Broadgate, and obviously will be a good introduction to us deciding what to do with that asset later in the cycle.
Keith Crawford – Peel Hunt
Do you have scope to go for planning to enlarge some of the existing older buildings? Stephen Hester
Yes, but the exact scope is in a holding pattern until the Mayor finishes his views regulation, which I hope will be in the next quarter, and then we'll be able to talk more about it.
Harm Meijer – JP Morgan
I was just wondering, when you talk about London offices you have a bit more of a cautious outlook, can you please explain what your basically targeting then in terms of rental growth? That was my first question, second, basically you are quite positive about UK REITs, is that right?
Stephen Hester
Yes, well let me answer the questions in turn. On the City, we're actually not saying anything different, and I wouldn't put out any different forecasts than that that we put out in more detail three months ago, in terms of rental growth. But I think the point that I'm trying to make is a cyclical asset class, I think you would be a fool if you thought you could predict precisely the timing and trajectory of that kind of a cycle. And I do believe that it is a cycle and that in due course supply will choke off the up cycle, although I think not on the timing that our developments are aimed for. And the market is rising very strongly in anticipation of that, both in terms of yield and what people are thinking on rents. And I'm not sure that in every case people are risk adjusting those prospects. And so I simply wanted to explain why we are not holding on to every single City asset we've got, in addition to piling in to developments, but rather recycling capital, because we look on a risk adjusted basis at making the best of our shareholder’s money. So that’s really what I'm trying to say, obviously you see the surveys, like I think it was Jones Lang or Knight Frank or something, and I think we're not quite that bullish, albeit we're positive.
On REITs, and as to yields, well it’s very hard to predict yields, because that’s down to the vagaries of the investment market. Clearly I'm sure you'll all be watching what we get for Plantation, which I hope will be a fourth quarter event for us, fourth quarter our financial year, obviously that’s large, so you could say that there'll be other things that will be interesting as well, but we'll have to wait and
see. On REITs, we remain positive on the reasons for doing REITs, why it meets government’s objectives and why it would be good for the industry. And we are heartened by the consultative approach that the Treasury is taking with the industry in trying to get it right. However, it remains the case that we don’t know the final shape of the legislation or the tax bill that comes with it.
The initial draft in some areas was not workable, we're hopeful that that will be changed to workable form, but clearly there can be no guarantees and so at the moment we're positively engaged in the process, but if you like holding fire as to outcome. And I think it’s important, not just that the headline things like gearing and tax rate and so on are right, but that the REIT regime allows companies to compete and grow in the way that the property market provides opportunities and not to be too tight a straitjacket, as indeed is the case with other successful REIT markets.
It nevertheless remains our view that real estate is about just that, it’s about real estate, REITs don’t change your rent by a penny, they don’t change your occupancy by a square foot, and what we're doing is trying to maximise real estate value, whatever the tax structure we operate in, if you like, is a bonus or not a bonus on top of that, but the important thing is the real estate.
Harm Meijer – JP Morgan
That’s great, can I also ask you what is the current valuation and use of Plantation Place? Stephen Hester
I think that I would rather not tell you, since we're in the middle of trying to sell it. Harm Meijer – JP Morgan
I already thought so, but I tried it anyway, okay thank you very much for your comments. Carl Gough – Cazenove
Well done Stephen and Graham, I thought the maiden quarterly results were very well presented, everything was in there that we needed. My question is on the retail side of the business, we're all aware that trading is obviously getting tougher, but in your remaining portfolio have you had or seen any signs of rising vacancy, are you having to give greater incentives to tempt tenants into taking leases?
Stephen Hester
I would say the only place where that would be the case would be in the bulky goods end, which, as you know, we are underweight in relative to other people, where there are a few more vacancies and you've seen various bankruptcies and so on and stores handed back, including most recently in the news. So those for us are pretty marginal in financial terms, and I'm afraid I don’t have hard numbers. But if you like that’s why we've been changing, even our underweight position to more underweight in bulky goods type retailing.
But in the round I would say while the retailers are clearly having a tougher time, the strong retailers are getting through that well and we continue, it was the reason we gave in our statement, the fourth quarter rental growth in Hercules, fourth quarter rental growth or ERV growth, which is more up to date, than if you like, passing rents, was exactly in line with earlier in the year and in turn double the
rate of the market. So I don’t think we're doom and gloom, but it is a market which is, as I said in the statement, going back to fundamentals.
Quentin Freeman – UBS
Can I ask you a couple of small questions, Graham, on the tax charge, you talk about tax charge coming down from 22 to 15, with the Songbird impact, what kind of numbers should we use for Q4? Graham Roberts
I think for the nine month average is about 19% and that is based on an estimate for the full years, so that 19%. But that doesn’t take into account the impact in the final quarter of the exceptional item.
Quentin Freeman – UBS
Thank you, and then CAPEX in Q4? Graham Roberts
You're now getting a bit too precise, it depends how the development programme spends money, and we don’t have it easily to hand I'm afraid.
Quentin Freeman – UBS
Okay, sorry about that, and then Stephen a question for you, what kind of properties are you trying to buy at the moment?
Stephen Hester
Ones we can make money on, we're steadily increasing the European portfolio, which is again out of town retail, on the UK out of town retail where we see things to bid on, we do, it’s hard to find them, but the odd addition that we made there. And then on the office side I would say our accent is mainly on our development programme, but we continue to trawl both of potential developments and others, it ain’t easy to find value. Aside from, if you like, those what you might call fundamental sector picks, we remain opportunistic and we look at all sorts of things and I continue to believe that up to 10% of what we do can be, what I slightly rudely call, play money, where we think there is financial deals to be done and shorter term trading stock. And so we look at all sorts of stuff, haven't done anything in the last quarter, but that’s not to say we wouldn't do things outside the sector that we're concentrated in if we think there's money to be made.
Closing Comments
Well thank you very much for listening, as I say, I think we feel both the numbers and the activity are good, we're positive for the future, you definitely should not extrapolate third quarter growth to the fourth quarter, which we see as being a lot slower and we do think that British Land will be well positioned in the way that we can outperform in slower times, which we see is coming. Thanks for listening, obviously please feel free to call any of us with follow up questions, thank you.
