Start Time: 09:00 January 1, 0000 9:46 AM ET
Warehouses De Pauw NV (OTCPK:WDPSF)
Q4 2022 Earnings Conference Call
January 27, 2023, 09:00 AM ET
Company Participants
Joost Uwents – CEO
Mickaël Van Den Hauwe – CFO
Alexander Makar – Corporate Finance Analyst
Conference Call Participants
Joost Uwents
Welcome, everybody. Wolvertem calling, like they say, in the newspapers. Let’s look together once for the last time shortly to ’22 and try to look forward to ’23 and further on. 2022 was the year with the biggest increase of the cost of capital, our beloved WACC in nearly 40 years as mentioned in a study by Citigroup, and this has had an enormous impact on the real estate sector. We had to rethink models and profitability. But yes, we adopted with team WDP, supported by structural demand for warehouse space as a part of the global supply chain. WDP is ready for the new reality. Let’s look into the details.
We made again a fantastic presentation with all the details. But, as usual, we will not go through in detail through the whole presentation, but we will focus first on some hot topics. And afterwards, you can ask all your questions on the presentation, and others by chat in the Q&A, which will be organized by Alexander. But first, let’s go back for the last time to ’22.
I think we can be proud that we realized a further growth of our earnings per share of 13%, up to €1.25, based on a very nice and very good balance sheet with a loan to value of 35% and a full house 99% occupancy rate together with the pipeline of realized and project in realization, we are again able to raise further our earnings per share up to €1.35 or 8%. So, let’s say very nice figures for ’22 and ’23.
But if you go back one year, exactly one year, we were together here to present you a new strategic plan. And that started with our slogan from external growth to external growth plus. Well, the way to that goal, the long-term goal of ’25 changed completely. But we still can realize the end goal, the €1.50 earnings per share by ’25. And we stated from external growth to external growth plus, but the plus had no time for a childhood.
We have now three drivers for growth instead of one and two in preparation for the next plan. It’s about structural external growth, which is still there. But we still will do the value of the existing portfolio and also our new business line, WDP Energy. All shoulder-to-shoulder are supporting together our growth and our profitability supported by a very strong and liquid balance sheet based on a brand new rating, BBB+ with stable outlook.
Mick, can you give us some details about the change profitability of each driver and also about the balance sheet?
Mickaël Van Den Hauwe
Yes. Thank you, Joost. So first to add further on our business plan which we started one year ago, as soon as we launched it, the war in Ukraine came, you had the inflation backdrop, the macro environment changed. And in fact all the parameters changed; some plus, some in minus. And then the critical thing is as a company, how do you react to this? And that is by adapting and taking into consideration the new parameters of the new operating environment.
And therefore, today, the main challenges to safeguard the profitability on new investments because of the strong increase in cost of capital, like Joost mentioned, and building costs, which continue to be elevated. But still, we adapted very quickly by changing first of all our hurdle rates for new developments and to take a step back. What we originally foresaw in the business plan was 5% yield on cost for new developments in Western Europe, 7% for Romania.
Then in Q1, Q2, the new business originations, the new deals were around those levels, even within a challenging context, but were also funded still at 1.5%. Then, in Q3, we changed to minimum 5 and 7 plus indexation during the construction period. And as from Q4, our new realizations are minimum 6 and 8 and that is achievable. But we think profitability should still be a bit higher today considering the cost of capital.
And we, therefore, would like to push for 7 and 9, I say, deliberately would like to push, because it’s not yet fully possible automatically on every project today, because of the fact that we would need to push rents even a bit further and do not yet see building costs decline. But we have a lot of in-house knowledge, good boots on the ground, and we need to be creative and selective. But what’s for sure is that in our view, the investments need to be calibrated on today’s parameters. And so we put profitability first.
And whereas, yes, the €500 million of new business volume, new developments per year was a target originally in the growth plan to achieve the €1.50 earnings per share target in ’25, that is no longer necessary and we can also live with, for example, 250 million new business developments per year, but focus on higher profitability. Because the good thing is that we have been — despite the fact that we have been 20 years reliant on solely external growth as a driver, we now have multiple drivers.
We have organic growth mainly through indexation, but also through upgrade opportunities within the existing portfolio at higher yield on cost, of course, and we have the accelerated deployment of our energy business for which we have already concretely identified €150 million of projects to be executed in ’23, ’24 at an IRR of 8% and targeted yield on cost of 10%, 15%. So what we’re trying to say here is yes, we will still continue to grow, but more balanced and with an utmost focus on profitability.
And we have always mentioned that there is no single path towards €1.50 per share. We are open for business, but we take into consideration the parameters of today and how do we think we can achieve the €1.50. We have a very strong development pipeline, profitable pipeline of €600 million, with €300 million cost to comp. To that, we will add new developments and be the focus on profitability. Then we have another layer of organic growth, mainly through indexation, which is higher than in the past. And then we had another layer of profitable energy projects.
So, yes, we will need to be more selective in deploying capital considering the higher cost of capital. But it’s not just about making the development gain. It’s about cash flow generation. That’s where our focus is. That’s what matters. And within this context, we can confirm our targets of EPRA earnings per share in ’25. Now, for the next topic, we go over towards property valuations and balance sheet.
When we look at property valuations; first, where do we stand? You can see that overall in ’22, we posted a 2% valuation decline in the portfolio, and that was actually being composed of a 50 bps upward yield shift. So the input discount rate applied by the property experts and some higher transfer taxes in the Netherlands and then partly offset by ERV growth of plus 11% and the development gains on our pre-let development schemes, and that was around a 20% development margin.
And of course, the valuation was positive during the first three quarters and then mainly the yield shift came in Q4. But overall, our portfolio is today valued at an EPRA net initial yield of 5.0; and excluding Romania, that’s 4.6%. And that is based on a value per square meter of around €900 euro, which is roughly where back of the envelope replacement costs would be.
Now, obviously, we have received many questions. What is your outlook for property values and for yields? We do not have a crystal ball, but based on what we see today in the market, the macro environment inflation rates and what we see in terms of potential deals and indicative pricing in the market, we believe the yields will go towards 5%, but that’s let’s say also excluding further other positive elements like further ERV growth and inflation, which are also forecasted.
But aside from that, I think what we can say is that we are, in any case, prepared for a new cycle. We have a very strong position, as you can see on Slide 40. And, yes, today, even with the valuation decline in Q4, we still have only an LTV of 35%. And even when we do a stress test, it would take another 13% hit or €800 million to even get to 40%.
And that is — the underlying reason for that is that we have never only focused on LTV, but we manage already for a long time, the capital structure based on true leverage on the business, through net debt to EBITDA, which comes in at 7x which we believe screens good in a wider European context. And as a result of focusing on that metric, we now have balance sheet room, we have a stress test at balance sheet, because we never leverage actually on portfolio revaluations. And we will continue to act like that as well.
And even more importantly, also our liquidity is very solid. We have 1.7 billion of undrawn confirmed credit lines, which largely cover all our committed investments plus refinancing. So over the next two years, plus leaving a buffer for any potential investment opportunity. And we can talk also about LTV, of course, but net debt to EBITDA matters. And what will also matter more in the future is your interest coverage ratio, because all costs of that have been based on very low base rates. So it’s important to judge how that will increase going forward.
And I think there we can say, today, our debt book is fully hedged. We have limited debt maturities in the next year. And even for the next five years, our hedge ratio stays on average 87%. And this allows us to really capture inflation, because indexation of rents, increasing your revenues is one thing, but your cost base also needs to be protected to be able to feed that true to the bottom line. And that is the case for us. And even if we would draw the next €500 million of debt on the existing credit facilities, then our cost of debt of today of 1.9% would only go to 2.1%. So think our cash flow is well protected from that. So that’s it on the details of the growth plan, property values and our balance sheet.
I would like to hand over back to Joost for comment on markets.
Joost Uwents
So indeed, we can have, let’s say, the best company and the best balance sheet, but we need, let’s say, a good real world. And there we can still [indiscernible] the supply chain is still very, very good. There is still a structural demand for warehouse space based on, let’s say, the same strategic points as last year. First of all, outbound. Yes, there is still e-commerce. Yes, e-commerce is still growing but, let’s say, in a more normalized way. The extreme growth of e-commerce has stopped, but we see further investments in the outbound strategy of every company. And it’s more about omni-channel today than just e-commerce.
And for example, there you see a lot of investments in the food e-commerce and more broad companies are investing in their omni-channel. Today, they have to deliver at home, tomorrow in the office, Saturday in a shop and on Monday, they have to be able to take it back. So their people and companies stay investing in; the same at the inbound side, strategically, even when today, it is a little bit more difficult, business cases are more difficult, there can be a little bit slowdown in decision making. But strategically, let’s say that deglobalization has to continue and people think about their strategic supply chain.
For example, the investment of Intel in Europe can be postponed a little bit, but they mentioned they will come. So we will not continue to make and produce chips only in Taiwan. We will make them in every continent. But that takes time. And yes, it can be postponed a little bit due to high construction costs, or scarcity of land. But it stays there. People are thinking about strategic stocks, about how they have to handle that by postponing a little bit production, doing it in a later phase in the production, doing it closer to house, or having a more strategic stock, even one that has a cost today.
So the strategic investments are the inbound side and the outbound side of our warehouses, stay there. And indeed, of course, you also have today new investments. You have to take care of the warehouse. You have — there are no possibilities, everything is full. So you have to take care of what you have. And then you will also adapt your buildings, make them better, make them more sustainable. Also, think about electricity. Is there enough electricity? Do we have to automate to make our warehouses more efficient? So there those structural trends stay there and make that, let’s say, there is almost no vacancy of warehouses in Europe.
Above that strategic demand, there was also a temporarily more short-term demand for warehouse space, due to let’s say the recession, too many goods were ordered and not sold. But that was within our warehouses, because in the financial crisis, there was empty space. And then we had, let’s say, 3%, 4% of extra short-term demand by which we could fill our warehouses. But now, the warehouses were already full before the recession.
And so our clients had to find solutions on their own by having a higher internal occupancy or putting and keeping goods into containers on the yard. But let’s say today, we have on our behalf, no temporarily demand. So let’s say one, this will flow away during ’23. The normal occupancy rate within our warehouse will go to more normal levels, but it will have no impact on our occupancy rate. So therefore, I think we are still positive about the structural demand for logistics space in the places where we are.
So then it’s time now for all your questions. I hoped that we discussed the hot topics. And now it’s up to you. And we give the floor to Alexander for the Q&A.
Question-and-Answer Session
Alexander Makar
To all participants, you can use the live chat to address your questions and we’ll take them one by one. We have a first question coming in. How is Ukraine today affecting the position in Romania?
Joost Uwents
Well, let’s say it’s making Romania a better place to invest. Romania is the safe haven of the region. It’s part of NATO. And it’s part of the EU. So it’s a safe place also, let’s say, protected by naval, but especially also strategically by the Americans. And so, let’s say, we see investments coming over from Ukraine or from even Russia to our warehouses, to our production units, and we see more investments than, let’s say, one year ago.
Alexander Makar
And then we have another question from Wim Lewi from KBC Securities on the high construction cost inflation. We now see that the material prices such as steel is declining and so are the order books. Is there any idea why the construction costs for logistics are not coming down?
Joost Uwents
Well, let’s say we hope that construction costs will and can come down in the near future. But there is also inflation and indexation of the wages and some materials are still high. And besides this, let’s say buildings were also becoming better with higher standards. So we hope that there will be a little distress and that prices will come down a little bit by midyear, we think, but we don’t calculate really big discounts in the construction prices for this year. But at least we have stabilization at the high level. And we can, again, fix fixed prices and a fixed timing.
Mickaël Van Den Hauwe
Yes. In a normal cycle, when you look at the cycle, they should come down. But we want to be cautious because we don’t see it yet because 50% of the construction costs is still made up of labor, and that is increasing also nowadays. So too early to judge.
Alexander Makar
Okay. And then another question, a follow up from Wim on the yield expansion, specifically in Q4. Interest rates have been very high since the start of the year. Is there any specific reason that you see why the yield shift has been moving since the fourth quarter and not in the second quarter or the third?
Mickaël Van Den Hauwe
Because of the fact that in the first two quarters, people were still finalizing deals from the old cycle because they initiated negotiations in the end of last year. And then as the war started, there was a stop in investments and not because there was no interest, there is still a lot of interest and also a lot of interest from equity buyers, but the markets needed to recalibrate. And in the equity markets, that happens immediately on a spot basis. But in the direct property markets, there is a lag in which markets adjust. And now we believe that over the next quarter, there should be a new equilibrium. And that’s the only reason.
Alexander Makar
And then we have another question from Rob Virdee of Green Street, specifically on the 300 million capital increase of October ’22. Have you deployed any of this capital for additional growth over and above the CapEx penciled in before the capital increase?
Joost Uwents
Well, we would not look at it like that. What we have said is that in the 300 million capital increase we did as we said, we have several reasons to ask for that capital to our shareholders. First of all, we had a very strong and profitable development pipeline. We added because we identify them concretely another material layer of energy projects of €150 million. And on top of that, we also want to be ready for new opportunities when they come. And the reason was also that in this type of markets, it would not be wise to first invest and then raise capital. You need to also not over leverage yourself and have a prudent stance on your balance sheet. But we have a good run rate of new investments, like were added in Q4. We had another volume of 100 million of new projects added. But the message we want to give is that we are open for business. We have good teams, boots on the ground, but we need to maintain the profitability on our project so that we have sufficient earnings per share accretion.
Alexander Makar
And then another question coming on the solar panels. Can you give a bit more insight on the profitability and the future of WDP Green?
Joost Uwents
Yes. On WDP Green and WDP Energy in itself, so there we believe that with our warehouses and our sites that we have 50 million square meters of land, we have 7 million square meters of buildings and so also of rooftops, and we believe we can play a material role with that in energy transition. But to do that, first of all, you need production capacity. So that is the first thing we need to do. We need to add production capacity. So we aim to go from 100 megawatt peak installed to 250 megawatt peak installed. So on the profitability, we target an internal rate of return on a project basis for those solar projects of around 8%. And the yield on cost will then be higher than 15%, a bit higher in the beginning, a bit lower towards the end. And that needs to be a bit higher, because it’s a bit more front loaded because of the fact that you don’t have a terminal value for the solar panels. So that’s something we need to do in the first instance. And that’s the start, because those are profitable investments. And then we can really start to do other nice things on our sites, for example, adding batteries to have a better management of the energy consumed locally, but also in combination with a further electrification not only of the buildings and the equipment inside, but of the electrification of the fleet of our clients really and that is decarbonizing and making the transport more efficient. And that is the real game changer, because our clients are now starting to look, obviously, towards electric vehicles for the cars, but the game changer will be the electrification of the trucks, and that is where our clients are looking at. And then that’s a whole new ballgame. Because then, for example, in the pilot, we are doing in Zellik the green mobility hub we are building there, so with a full rooftop solar plant, batteries, plus electric vehicle chargers for cars, vans and trucks there, the energy consumption of that site as a result of that, as a result of the electrification of the fleet will grow at least 3x. So there we believe there is sufficient potential for the years to come.
Alexander Makar
And maybe just to follow up on the profitability of new investments. Could you also elaborate on the assumptions taken into account to reach the 1.50 in terms of inflation and on new developments?
Mickaël Van Den Hauwe
Yes, on inflation, so we use organic growth of 5% for ’23 based on the outlook for inflation and thereafter, the 2.5% for inflation. And then on the assumptions for the investments is executing the 600 million development pipeline, of which 300 million still needs to be spent. €150 million of energy projects in execution in ’23, ’24 with full impact in ’25. And then per year another €250 million added to our development pipeline. Those are the main assumptions.
Alexander Makar
And then we have a few questions on the client payment behavior. Is there first any change in client payment behavior up till today? And do you expect it to come?
Mickaël Van Den Hauwe
Our client behavior is very good and follows a really stable pattern. We have around 15 day sales open, so that’s very good. And 99% of rents collected there. We believe that for the foreseeable future, it will remain stable. So we do not see any change in behavior on that. And that is also in the guidance, stable client behavior. What is always a risk that’s what we have always said already for 20 years, one of the most important operational risk is if a client falls bankrupt, because then you have abruptly and unforeseen temporary vacancy in your portfolio. So there in a recession and it’s still high energy prices what could be a risk there. We analyze that and the risk mainly sits in recession sensitive sectors, like industrial, non-food, retail, and wholesale. But the good thing is that most of our clients and all the clients having rent above €1 million versus rent below of almost €350 million. These are all big international companies. So when you really look at the weaker segments between brackets, that’s mainly the SME segment within those sectors and that’s around 5% of the portfolio where we need to be a bit more attentive but also these clients are being very well. And you could also see it as — let’s say, we would not like it, but you could also see it as an opportunity because the market is still strong. And when there would be a vacancy, it could have a temporary effect. But we could then also re-let the building at a higher price afterwards.
Alexander Makar
And do we see today any rental reversion potential on the portfolio?
Mickaël Van Den Hauwe
Well, today the portfolio is based on the ERVs we publish and based on which the property valuations are based versus our contractual rent, the portfolio still 5%, 6% under-rented. And there is still also upward pressure on ERVs.
Alexander Makar
And then we have a general question on the Netherlands. First of all, can you give any update on the future of the FV [ph] regime?
Joost Uwents
Well, there the Dutch Ministry of Finance has indicated that they would now — that the intent now to abolish the regime starting from January 1, 2025. And in our guidance and in our business plan, we take into consideration a provision as if we do not have the status. But for the short term, meaning for the years until they abolish it, meaning for ’21, ’22, ’23, ’24, we are still in discussion with the Dutch tax authorities to be able to maintain it, but it’s still in discussion.
Alexander Makar
And to stay in the Netherlands, there is another question with regards on the permitting, given the nitrogen regulation. Is this expected to cool down the investments or the new developments going forward?
Joost Uwents
Not specifically, let’s say, the nitrogen laws. But in general, I think in the Netherlands, there are — the scarcity of land is very important and there is still big demand for new warehouses, but there is no land. So there we can say that it’s not the permits even when it’s more difficult and when it takes longer. It is not the permits who are the problem, but it is the availability of land.
Alexander Makar
And then another question on the valuations. Is there any specific significant difference between the countries in terms of movements in the fair value?
Mickaël Van Den Hauwe
Yes, there have been some differences according to the valuators in the countries and the Netherlands has seen the biggest yield shift. So it ranged from plus 20 to plus 80 basis points and the most was in the Netherlands, where it’s our biggest and most liquid market.
Alexander Makar
And then there is another question coming from here from Francesca [ph] from ING regarding the 40% LTV guidance. What investments have been taken into account?
Mickaël Van Den Hauwe
The 40% is not the guidance. We say it will still stay below 40%. And as you will see in the detailed balance sheet we will publish in the annual report what is in there. It’s like over the years, it’s the execution of the committed investment pipeline. So the development pipeline plus the solar projects and both are scheduled in ’23, ’24. But for the path of this exit will be executed in ’23. That’s around €400 million and that will have an effect on the LTV of plus 1.5%, also taking into consideration that we have each year the retained earnings and the scrip dividend, of course.
Alexander Makar
And then another question coming from [indiscernible]. Do you see any developers that are getting into trouble in distress?
Joost Uwents
Well, I think you can say distress it’s probably too early but they are at least nervous I think because indeed they made projects based on a certain profitability. And now what is the exit value at which value will they be able to sell? So let’s say if it was possible, they postponed the projects and waiting to see where yields are going. But today — and the market is frozen. There are almost no activities in the investment market [indiscernible] cooling down speculative projects.
Alexander Makar
Then we have another question on Romania. CTP, your competitor, is very active in Romania just like WDP. Yesterday, they announced a large project. How is competition and yields looking like in Romania today?
Joost Uwents
Well, it’s indeed — it was a very nice project that CTP won. It was an existing client of us, LPP, very nice project of 60,000 square meters. But in the end, the client has chosen finally the price. And there we said, this is too low for us. Finally, it came at a net effective rent of €2.65 per square meter per month, which gives €32 per year, which gives us, let’s say, a profitability of around 5%. And there we say, no, thank you. And there we concentrate on quality and on profitability more than just on quantum.
Alexander Makar
And maybe just to stay in Romania, another question from Steven [ph]. Could you please elaborate how the current macro environment impacts Romania differently from the Western European markets? Do we see any specific difference in terms of demand and also the valuation in that market compared to the Western European portfolio?
Joost Uwents
I think demand is very strong. And I would say there is even — or there was even more demand than last year due to the fact that let’s say it was the safe haven, like I mentioned in the beginning, some projects that were first foreseen for Ukraine and for Russia, like the LPP project that we just mentioned [indiscernible] safe place to invest. So no. And we have seen also in our production units that production is driven up due to the fact that it is indeed a good place. It’s a big, stable country. So demand is very healthy. And on, let’s say, the valuations, I think there everybody was waiting for valuations going up. But it didn’t happen. So they did not have to come down too, because they stayed rather flat and stable.
Mickaël Van Den Hauwe
Because the market is more in fixed and the market is taken by the likes of CTP, WDP who are developers and the end investor. So there has not been a real downward yield shift, and now the upward yield shift is rather limited.
Joost Uwents
So it’s not an institutionalized market yet.
Mickaël Van Den Hauwe
Indeed.
Alexander Makar
And then another question from Rob. You mentioned that the investment market deteriorated during the second half of ’22 with large bid-ask spreads and the yields increased. Do you already see any signs of recovery or at least stabilization? And do you expect to see any distress in the market in the near future?
Joost Uwents
I think not yet. Probably, who knows? We have to wait for MIPIM within one month. But for the moment, we don’t see new deals yet. Some people are looking, trying let’s say if they would go or not. But yes, the spreads are still too high and market stays frozen for the moment. And we think it still can take a while. There is no pressure to sell with most of the investors, because the warehouses are full. They are generating cash flow. So even when they have high loans against it, the loans can be paid back, because there is cash flow. Our sector is generating cash flow. So there is most of the times no pressure. So we don’t see — we think it could take a while. And we, of course, hope that there will be opportunities, but we are not sure and we don’t think it will be before summer.
Alexander Makar
And then a question from Peter from Cantor [ph]. If you want to derive the yield on cost to 7% in the Netherlands or Belgium, what rents would you need or would anything need to move to obtain that 7%? And is that achievable today in the current environment?
Joost Uwents
That’s a difficult thing, indeed, because construction costs stayed high but stable, land prices also, cost of capital went up. So those are the three elements that went up. And so, indeed, if you want at that moment a higher profitability, then the rents have to go up. And then yes, today, you are I think between €70 per square meter per year; €70, €80 depending on the kind of building, on the location, on land price. And that’s the difficult thing today that markets and clients are not there or are almost not there.
Alexander Makar
And when you look at the investment markets, any assets coming up to sale in the market? What yields are you receiving or seeing?
Joost Uwents
Not yet. I think there are no real investment memorandums yet. I think I’ve read in some newsletters of the analysts today that Blackstone went with some portfolios to the market or will come with some portfolios to the market, but I’ve not seen any investment memorandum this year yet.
Alexander Makar
And then a final question. Currently on the solar panel strategy in the revenues, do you expect any increased regulatory risk?
Mickaël Van Den Hauwe
Yes. Well, the risk is already there, I would say, and identified. So what good is for all the new investments in solar panels is that we are profitable on an autonomous basis without green certificates. And in the most of the times, they do not exist even anymore. So that’s a very positive thing. And yes, there is a regulatory risk for the solar panels that the Flemish government is working on a plan on a draft legislation to abolish the green certificates on existing schemes, which were delivered between 2008 and 2012, which had a green certificate duration of 20 years. And they intend to cancel those certificates as from ’24 for the remaining six years. So that’s a risk that is something they are working on concretely. They have an agreement in the Flemish government. So they will likely push through and then we will need to see what legal actions we could take and our colleagues will also take. And that represents a risk of 2% of our revenue and 3% of our EPRA earnings.
Alexander Makar
And just looking if there are any other questions. There are a few detailed questions that will be taken offline and we will address them later. Maybe just one more question. Is there any update on Catena that you can give on the strategy?
Joost Uwents
For that you have to listen to the publication of the year results of Catena, I think 22 of February. But no, it’s a very good company in very good shape. And let’s say also with a low loan to value with possibilities to invest and to grow further. But for that, let’s say, wait and see and we hear you 22 of February.
Alexander Makar
And this currently concludes all the questions. And I would like to give the word back to you, Joost.
Joost Uwents
Thank you. Thank you all for the questions. If you have still questions later on, don’t hesitate. You can always call us. You know that we will answer as quick and as good as possible. So to conclude, I would say never waste a good crisis. It forced us to be creative and innovative. We call it to be and to work with warehouses with brains.
And finally, I should like to say thank you all and thank all our stakeholders and clients to support us. And especially a special thank you for team WDP for the fact that they have been so adaptive and the agility that they showed last year in order to be ready for the new reality. Thank you. Have a nice weekend.
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