Entra ASA

OSE:ENTRA

Earnings Call Transcript 2024-Q1

[Sonja Horn, executive]

Hello and welcome to Entra's first quarter presentation here in Oslo. Let me start by a few words on what you can see on the picture here. This is our building in [indiscernible], where we, in the quarter, have signed a huge contract with Yara International. So starting with the highlights in the quarter. We have rental income of. NOK 878 million in the quarter. That is a 1% rental growth compared to same quarter last year. The underlying rental growth is 6.5% when adjusting for divestments and one-off effects from the first quarter last year.

Our net income from property management is affected by higher interest costs and was NOK 325 million in the quarter. And our net value changes came in with a negative of NOK 1.624 -- sorry, NOK 1,627 million in the quarter, [indiscernible] by the increase of the discount rates from our mall appraisers with an average of 10 basis points, leaving us then with a loss before tax of NOK 1,313 million. We were pleased to see that we have had letting activity in the quarter leaving us with a solid net letting NOK 2 million in the quarter and also pleased to see that we [indiscernible] agreement for the sale of the Thonheim portfolio, in line with the terms of

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of the letter of intent and closing of that transaction will take place on May 31.

So move on to operations. Strong operations in the quarter. We are pleased to see that we have also the first quarter following an active fourth quarter very high activity in respect of letting. We signed new and renewed leases with a total rental income, annual rental income of NOK 162 million or approximately 52,000 square meters. At the same time, contracts with an annual rental income of NOK 115 million were terminated. However, as much as 92% of that has been resigned within the Entra portfolio, leaving us then with a positive net letting of NOK 28 million.

If you take a look at the largest contracts in the table below, as mentioned, Yara International signed 16,000 square meters with us. They are today a tenant in one of our existing buildings in the same cluster. They had expanded out of their current office into 2 neighboring buildings. And they have now chosen to colocate in Verkstedveien and where we will work with them for the next 12 months to define their future workplace solution, and they also have an option to increase with some more space if they should need more. So this clearly

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demonstrates also the value for our tenants in having Entra as a strong partner with a large presence in our clusters.

In this building in n Biskop Gunnerus gate for 14, BankID has signed 4,000 square meters, taking up 2 whole floors in this building. And at the same time, we have then also signed a lease buy-out agreement with one of our tenants to free up one of these floors, which will be shown as a one-off effect in our first quarter numbers.

Universal Music, new tenant to us moving into Akersgata. And in Bergen also, we have signed 2 large contracts showing that we also are having high letting activity in the Bergen market currently.

So all in all, occupancy remains stable at 95.3%, and our average lease duration is currently at 6.4 years, including the project, and we have 57% of our rental income from public tenants currently.

In Trondheim, we have now signed the final agreement with the buyer for the sale of these 13 assets or 187 square meters, which will be then handed over to the buyer on May 31. This is a huge transaction for Entra, total value of NOK 6.45 billion, which was signed 1% of our Q4 book values.

The agreement also includes the forward sale of our ongoing project development in Trondheim the where Entra will complete the project and the building will be handed over to the buyer upon completion. The proceeds from this transaction will be used to strengthen our balance sheet and should then improve our debt metrics with 4% on the loan-to-value or 4 percentage points on the loan-to-value, and our ICR should improve with 20, 30 basis points following the transaction. And as I said, we will be closing this transaction on May 31.

So our of ongoing projects is currently rather short. That is intentional from our part as part of our disciplined approach on improving debt metrics. Currently, we have around NOK 549 million of CapEx left on these ongoing projects. And the [indiscernible] of that, NOK 383 million is related to the project in Trondheim which has already been forward sold at a good project margin in addition to the project cost here.

There's no changes in the table of reporting this quarter other than that we have taken out the yield on cost occupancy on the forward sold assets. The other projects are also progressing according to plan.

We are now also preparing to start 3 refurbishment projects in Entra following lease contracts, which have been signed on 1 asset in Bergen, a smaller asset in Sandvika and also on asset here in Oslo, and we will get back more details on that in the next quarter.

So a few words on the market situation. First of all, it seems to be a consensus both amongst the businesses and consumers that the economy is heading for a soft landing. We can see that the expected GDP growth is 1.1% for 2024 and employment has remained stable in Norway, and the Norwegian bank increased the key policy rate to 4.5% in September. And they have now also communicated or signaled that we should be at the top in respect of interest rates. They are, however, still holding back on cuts to ensure that they have control over inflation.

Inflation is on a downward trend. And for March, it came in at 3.9%.

If we dive into the property market, we can see that the letting activity has been high also in the first quarter. We have had a very strong market rental growth in 2023 and 2022. Expectations now is that rental growth will take a slight breather in the short term particularly in the city center where you've seen even stronger market rental growth than the graph here for the overall market of Oslo indicates.

And if we dive into the market data now from the first quarter, what we can see is that there are indications of rather strong rental growth in the fringes of Oslo, where we have seen that currently, the breakeven rents for new projects in these markets is quite a lot above the market rents.

If you look at the bottom-right graph there, you can see that there has been very limited new build volumes feeding into the Oslo market for the last couple of years and also expected this year. 2025 stands out with a rather high volume. That is explained by 2 large projects being completed. One is the first part of the new government offices. That is, of course, fully let.

Secondly is the construction city, which is a huge project, where 80% of the volume has also been pre-let. So these tenants will move out and vacate buildings, which will need some 18 to 24 months of refurbishment before they come back into the market. So we are not very concerned about that volume coming into the market in '25.

Now seeing that we have low vacancies in Oslo, around 6.5%. And the fact that there is very limited new supply coming in and also the current situation where breakeven rents for new build volumes still is quite a lot above-market rents gives rather favorable market conditions for renegotiations from a landlord's perspective. This also was under -- or supported by the fact that we saw in 2023 that around or more than actually 80% of the large contracts above 5,000 square meters were actually renegotiated in the Oslo market.

If you dive into the segment slightly below down to 2,000 square meters, 65% were actually renegotiated.

So in a scenario with a soft landing and continued employment growth, combined also then with the low new build volumes and low vacancies, we do believe that we have good prospects of long-term market rental growth in the Oslo markets.

A few words also on the transaction market. First of all, transaction activity was very low in 2023. What we've seen in the first quarter is that volumes have picked up around NOK 20 billion. And the clarity we now are getting, more clarity on both the inflation and also interest rates having peaked expected to see cuts by the end of the year and continuing into 2025 is also providing good fundaments for the transaction market. So we do expect to see activity pick up through 2024 also, of course, supported by financing markets having opened more up and the tightest spreads we have seen in the bond market.

Prime yields are currently around 4.7% in the Oslo market. That has been supported by some transactions we have seen in the market. And as you can see from our consensus report price, we -- consensus is that we have peaked in respect to prime yields and that we should be seeing some compression maybe when we move into 2025.

So before I give the floor to my colleague here, I would like to take the opportunity to thank [indiscernible], seeing that his last week in Entra, we -- he has been with us and served with us for a long time, 35 quarters, including this one. It's been a great pleasure to work shoulder with shoulder with Anders. There's been some challenging times. And for me, it's been really great to have you as my professional partner. But I think that we will clearly miss you for your professional side but even more so for the person you are. So thank you, Anders, for your service for Entra, and our new CFO, Ole Gulsvik, will join us on the 1st of August.

In this interim period, our Head of Group Accounting, Knut will serve as acting CFO and also present with me here today and the next quarter. So Knut, the floor is yours.

[Knut Sørngård, executive]

Thank you. Operations and financing costs were quite as expected in the quarter. So I'll focus on 3 things in this presentation, the divestments of the Trondheim trona portfolio, the negative value changes and the financing situation.

Rental income came in at NOK 878 million, in line with expectations and 1% above Q1 last year. Finalized projects put into production and like-for-like growth accounted for an increase of NOK 42 billion and NOK 33 billion, respectively. Yes. Sorry. NOK 33 million, respectively, while properties vacated for redevelopment and divestments reduced income by NOK 21 million and NOK 4 million, respectively. Adjusting for a one-off effect of NOK 16 million in Q1 last year and divestments of NOK 33 million in the period, the underlying growth was a solid 6.5%.

Rental income was up 2% from Q4 last year, mainly driven by CPI adjustment for which the majority of Entra's contracts was 4.8%, with some offsetting effects from divestments and net letting.

Net income from property management was down 17% from Q1 last year, mainly due to higher financing costs compared to Q4 last year.

Net income from property management, however, increased by 10% due to the increase in rental income and lower financing costs due to lower outstanding debt following divestments of 3 assets in Q1.

Like for last few quarters, profit before tax is impacted by negative value changes in this quarter, driven by the discount rates increasing by 10 bps, and I'll come back to the negative value changes in the portfolio later.

This slide shows the effect of macro on the interest numbers with the effect of the increased interest rates on the P&L and the cash flows are represented by cash earnings, and the effect of increased discount rates on the asset values are represented by the NRV.

Cash earnings annualized 12 months rolling currently at NOK 7 per share, corresponding to a CAGR since 2015 of 6%. And EPRA NRV came in and then came in at NOK 158, down from NOK 235 at evaluations still a CAGR of 7% since 2015 or 10% when including dividends of NOK 37 in the period. And Entra NTA came in at 157. So we signed a binding contract for the sale of the Trondheim portfolio in March, and we will close the transaction on the 31st of May. This means that we will have income from the assets throughout -- we had income from the assets throughout Q1 and we'll have from the assets for the first 2 months in Q2. As we will sell an entire geographical segment, we have due to IFRS regulations, separated the results of the management properties in Trondheim in the P&L in the quarterly report, and included the net results from Trondheim after value changes and after taxes at the bottom of the P&L.

In this presentation, we have however, combined the P&L of the continuing operations and Trondheim to reflect the total underlying P&L of the whole portfolio. And this table is also a good indication of how our net operating income will be affected by the sale of the Trondheim portfolio. But however, in Q2, we will have those assets in 2 months.

The fact that this presentation doesn't show is the effect on the financing costs, but the repayment of over NOK 6 billion of our most expensive debt will lead to a significant reduction in financing costs and a significant improvement of our debt metrics. And as mentioned, rental income and operating costs came in as expected. OpEx slightly higher than Q1 last year due to timing of maintenance activities. Other revenues and other costs, so a significant increase in Q1 as we -- as part of the Trondheim transaction, we'll finalize the development of Phase 3 of Holtermanns 1-13 and deliver the property to the buyer upon completion of the project.

The change in accounting resulted in a NOK 72 million in both revenues and costs in Q1. And going forward, the revenue from the development will be booked in line with the costs incurred. Revenues and costs from this transaction will be presented gross but should be considered net, and we expect a positive effect of NOK 1 million to NOK 2 million per quarter from this development until project completion.

I mean costs came in at NOK 50 million in the quarter, pegging towards south of NOK 200 million for the full year.

Value changes on the derivatives were positive due to increased long-term interest rates. And I'll come back to the negative value changes in the investment properties later.

Rental income will -- based on reported events decreased by 3% in Q2, mainly due to the sale of the Trondheim portfolio in the which gives only 2 months of income from Trondheim in Q2. And we have other column that reflects a one-off due to a lease buy-out agreement, which Sonja mentioned, which will not be carried forward into Q3 decline from Q2 to Q3 is due to this one-off effect and NOK 67 million the divestment of Trondheim. And from Q1 '25, we have included a 3.5% CPI adjustment.

We have invested NOK 303 million in our property portfolio in the quarter, where of NOK 91 million in our 2 newbuild projects and 170 in the redevelopments and refurbishments. We divested 3 assets in the quarter, 1 in Bergen and 2 in Oslo, reducing the value of our property portfolio by NOK 973 million. And our property portfolio was written down by NOK 1.8 billion or 2.5% in Q1. The Trondheim portfolio was in Q1, sold 1% below book value as of Q4. So it was not unexpected that we -- that the appraisers reduced the value of our properties in Q1. However, it's fair to say that the write-downs was higher than we expected when we reported last quarter.

In Entra, we have a consistent approach to valuations. Each quarter, we have a thorough process with at least 2 external prices when that's the current value of all our properties, based on market data and updated information from Entra. And then we take the value estimated by the appraisals and include that in the balance sheet as the book values of our properties.

Prime yields were as mentioned by Sonja, flat in the quarter, but the discount rates were increased by an average 10% on several of interest assets and mainly on the secondary assets.

Currently, the portfolio net yield is 5.1%, up 124 bps since peak valuation in Q1 '22 or 150 bps when taking into account higher-than-expected CPI. And if the portfolio was fully let at market trends, the total net yield would be 5.7%. Isolated, this increase would imply a negative effect on property values of 28%, but good operations, a strong letting market and higher CPI has had an offsetting effect, and the like-for-like write-down for the period is 18%. However, based on the signals we currently see in the market, we believe that the property valuations are at or close to the bottom.

So over to the financing position. Following the closing of the sale of 3 assets in Q1, we repaid NOK 900 million in bonds and NOK 600 million in bank debt. And further, we issued commercial papers of NOK 500 million at attractive terms. So the net repayment of debt was NOK 1 billion, and the debt at the end of the quarter was NOK 38.5 billion.

Following quarter end, we issued 2 new commercial papers with a total outstanding amount of NOK 100 million. We did 1 month CP of NOK 200 million at 25 bps margin and one 8-month CP of NOK 300 million at a margin of 65 bps, and we are pleased to see that the CP market has opened up again.

The bond market is open, and Entra's enters spreads have come in 65 bps since the end of '23, significantly more than other Norwegian peers.

The bank market is open but selective. Good companies with long-lasting relationships with the banks, good assets and good tenants are able to obtain bank financing in the current market.

And we are working on improving our debt metrics. And we will see a significant improvement following the completion of the Trondheim transaction in May, where the LTV will be improved by approximately 4 percentage points and the ICR will be improved approximately 20 to 30 bps.

But bear in mind, the LTV will be improved immediately after closing of the transaction, but the ICR will, as we -- the reported ICR is based on the last 12 months, the ICR will gradually improve in the coming year, but we're definitely on a positive trajectory.

Interest average interest rates were stable from Q4 to Q1. And for this exhibit, we have taken the forward curve, NIBOR included existing hedges in terms of current loan agreements, and expected debt levels, that is assuming that the debt will be repaid after the Trondheim transaction and assuming refinancing upon expiry at today's market bank margins. And the NIBOR forward curve is higher than the forward curve we presented in the Q4 presentation. But our interest rates are expected to fall sharply in due to the repayment of the most expensive debt following the sale of the Trondheim portfolio, which will lead to a significant reduction in interest expenses and an increase in the ICR.

And the deleveraging will also have a positive effect on our hedge ratio from today's 60% to approximately 70%, which will give further predictability on future cash flows.

So we are finishing this financial update with our debt maturity schedule. In times with this, liquidity is key for asset having companies like Entra, and we are very happy with our liquidity position. We have very limited bond maturities of NOK 1.6 billion in the next 2 years, and we are continuously working on rolling forward and extending our bank debt and we have since Q1 '22 extended NOK 13 billion and raised new loans of NOK 5 billion. So to sum it up, we are very comfortable with our current debt maturity schedule, and we'll be even more comfortable after receiving proceeds from transaction of additional NOK 7 billion before the end of the year. And then to Sonja.

[Sonja Horn, executive]

Thank you, Knut. Okay. So a few closing remarks before we are ready for Q&A.

First of all, the activity in the letting market is holding up well, and the demand for centrally located assets has remained strong. So low vacancies and limited new supply for unlimited new supply of offices provide favorable conditions also going forward and also support prospects of continued rental growth in the long term.

We are getting more comfort on outlook, both in respect of inflation and interest rates. Cuts are now expected to come in the end of the year and continue into 2025. And financing markets are opening up with yields tightening in or credit margins tightening in, and we are seeing positive signs in the transaction market.

We have a solid balance sheet in Entra with ample liquidity. And with the closing of the Trondheim transaction, our debt metrics will improve, bringing down towards 50%. And also, our ICR should get above 2 sometime in the third quarter. So we believe also that we -- based on the signals we pick up in the market should now be at or close to the bottom in respect of valuations, as Knut mentioned, and the improving debt metrics will also start feeding into our results and our result margins going forward.

So I think that concludes us from this presentation and we'll just check with Tone if we have some questions.

[Tone Omsted, executive]

We do have some questions. So the first one being, how do you expect occupancy to evolve in the near to midterm?

[Sonja Horn, executive]

Okay. Based on the very high activity we have in our letting, we are working very hard to bring it up. And our target is to try to get above 96% in medium term. So we should see that it goes up in the months to come.

[Tone Omsted, executive]

What is the current level of reversion in the portfolio.

[Sonja Horn, executive]

If you look at our 12 months rolling rent relative to the market rent, we are currently at 12% below market rents in Oslo and some 11% on the portfolio as a whole.

[Tone Omsted, executive]

Including Trondheim, the Trondheim transaction, the total divestments accumulate now to NOK 11.1 billion. This is above the communicated targets. Are you now finished with the divesting program?

[Sonja Horn, executive]

We're very comfortable with the current situation, bringing our debt metrics more in line with our finance policy. However, we continue to work with the divestments of some nonstrategic assets. And if we see that we get interesting pricing on them, we will progress on those discussions. So potentially some NOK 2 billion, NOK 3 billion more. But assuming then that we see that we get the pricing we are looking for.

[Tone Omsted, executive]

Was this the final quarter with no changes in yields from the appraisers?

[Sonja Horn, executive]

Well, as Knut said, we were a bit surprised that it came in at such levels this quarter. And we do believe based on the signals we see in the market now that we should be close or at the bottom.

[Tone Omsted, executive]

What are your objectives in terms of LTV and ICR for the company?

[Sonja Horn, executive]

Well, our finance policy states that we, over time, should be below 50% loan to value and have an ICR above 1.8%.

Now if you take a little more long-term perspective, we do believe that the company like Entra with our profile of both long leases, high-quality tenants should move probably more towards somewhere around mid-50s -- sorry, mid-40s in respect of loan-to-value and ICR. I would be happy to see it above 2.5 in the more long term.

[Tone Omsted, executive]

Comparing rental income to the rental income bridge from Q4, what explains the deviation of the NOK 5 million lower rental income?

[Knut Sørngård, executive]

Yes. The rental income bridge is isn't an exact science. So it's, and it doesn't take into account all the effects that could be -- that will affect the quarter. So it's -- so we're a few million short than which we presented in the Q4 presentation, but that's more or less a minor timing effects. So no big effects. And we're quite -- there's no single item sticking out and it's -- moreover, it's the deviation is less than 1%, and it's more or less as we expected.

[Tone Omsted, executive]

Was the seller credit on [indiscernible] [ 6 ] of NOK 195 million paid down in the quarter.

[Sonja Horn, executive]

[indiscernible]

[Knut Sørngård, executive]

Yes, that will be paid in Q2, end of Q2.

[Tone Omsted, executive]

Thank you. That concludes the Q&A.

[Sonja Horn, executive]

Thank you very much.

[Knut Sørngård, executive]

Thank you.

[Sonja Horn, executive]

Thank you for joining, and we'll see you again in the second quarter. Bye.

[Knut Sørngård, executive]

Bye.