Warehouses De Pauw SA (WDP) Earnings Call Transcript

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 a year with the biggest increase of the cost of capital, our beloved WACC in nearly 40 years as mentioned in a study by Citigroup. This has had an enormous impact on the real estate sector. We had to rethink models and profitability. But yes, we adapted 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 EUR 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 EUR 1.35 or 8%. So let's say, very nice figures for '22 and '23. But if you go back 1 year, exactly 1 year, we were together here to present you a new strategic plan. And that started with our slogan, From External Growth to External Growth+. Well, the way to that goal, the long-term goal of '25 changed. We have now 3 drivers for growth instead of 1 and 2 in preparation for the next plan. It's about structural external growth, which is still there, which 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 changed profitability of each driver and also about the balance sheet.

Yes. Thank you, Joost. So first, to add further on our business plan, which we started 1 year ago, there, 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 the 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 challenge is 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 we're 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 EUR 500 million of new business volume, new developments per year was a target originally in the growth plan to achieve the EUR 1.50 earnings per share target in '25, that is no longer necessary, and we can also live with, for example, EUR 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 EUR 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 the EUR 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 EUR 1.50, we have a very strong development pipeline, profitable pipeline of EUR 600 million with EUR 300 million cost of comp. To that, we will add new developments and with a focus on profitability. Then we have another layer of organic growth, mainly through indexation, which is higher than in the past. And then we have 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, and 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 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, there was around a 20% development margin. And of course, the valuation was positive during the first 3 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 EUR 900, which is roughly where back of the envelope replacement cost 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 see 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 and would add -- it would take another 13% hit or EUR 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 managed 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 is good in a wider European context. And as a result of focusing on that metric, we now have a balance sheet room. We have a stress-tested 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 EUR 1.7 billion of undrawn confirmed credit lines, which largely covers all our committed investments plus refinancing, so over the next 2 years, plus leaving a buffer to -- 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 debt have been based on very low base rate. 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 5 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 through the bottom line, and that is the case for us. And even if we would draw the next EUR 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 I 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 a comment on markets.

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 say that the fundamentals of the logistics sector and more broad, 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 omnichannel today than just e-commerce. And for example, there you see a lot of investments in the food e-commerce, a more broad companies are investing in their omnichannel. 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 that 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, the 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 they will not -- 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 more strategic stock even one that has a cost today. So the strategic investments at 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 no or almost no vacancy of warehouses in Europe. Above that strategic demand, there was also a temporary 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 temporary demand. So let's say, when this will flow away during '23, the normal occupancy rate within our warehouses 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 hope that we discussed the hot topics and now it's up to you, and we give the floor to Alexander for the Q&A.

To all participants, you can use the live chat to address your questions, and we will take them one by one. We have a first question coming in. How is Ukraine today affecting the position in Romania?

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 by 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, 1 year ago.

And then we have another question from Wim Lewi, 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?

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. So -- and besides this, let's say, buildings are 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 a stabilization at a high level. And we can, again, fix prices in a fixed timing.

Yes. In the 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 cost is still made up of labor, and that is increasing also nowadays. So too early to judge.

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?

Because of the fact that in the first 2 quarters, people were still finalizing deals from the old cycle because there were initiated negotiations at end of last year. And then as the war started, there was a stop in investments 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 market, there is a lag in which markets adjust. And now we believe that should -- over the next quarter, there should be a new equilibrium, and that's the only reason.

And then we have another question from [ Redford Dee ] of [indiscernible]. Specifically on the EUR 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?

We would not look at it like that. What we have said is that in the EUR 300 million capital increase we did is 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 layer of -- material layer of energy projects of EUR 150 million. And on top of that, we also want to be ready for new opportunities when they come. And we -- the reason was also that in this type of market, it would not be wise to first invest and then raise capital. No, 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 EUR 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 projects so that we have sufficient earnings per share accretion.

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?

Yes, on WDP Green and on WDP Energy in itself. So there, we believe that with our warehouses and our sites, 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, 10%, 15%, a bit higher in the beginning, a bit lower towards the end. And also -- and that needs to be a bit higher because it's a bit 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 that's -- 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 in site, 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 at, 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 ball game because then, for example, in the pilots 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 x3. So there, we believe there is sufficient potential for the years to come.

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 EUR 1.50 in terms of inflation and on new developments.

Yes. On inflation, 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 EUR 600 million development pipeline, of which EUR 300 million still needs to be spent, EUR 150 million of energy projects in execution in '23, '24 with full impact in '25. And then per year, another EUR 250 million added to our development pipeline. Those are the main assumptions.

And then we have a few questions on the client payment behavior. Is there any change in client payment behavior up until today? And do you expect it to come?

Our client behavior is very good and follows a really stable pattern. And we have around 15 days sales over. So that's very, 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 table 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 an unforeseen temporary vacancy in your portfolio. So there, in a recession with still high energy prices, what could be a risk there, we analyze that, and the risk mainly sits in recession-sensitive sectors like industrial, nonfood retail and wholesale. But the good thing is that most of our clients and all the clients having a rent of above EUR 1 million versus rent of almost EUR 350 million, these are all big international companies. So when you really look at the weaker segment 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 paying very well. And you could also see it as, let's say, we don't -- 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 relet the building at a higher price afterwards.

And do we see today any rental reversion potential on the portfolio?

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 is still 5%, 6% under-rented. And there is still also upward pressure on ERVs.

And then we have a general question on the Netherlands. First of all, can you give any update on the future of the FDI regime?

Well, there, the Dutch Ministry of Finance has indicated that they would now -- that they intend now to abolish the regime starting from 1 January, 2025. So -- and in our guidance and in our business plan, we take into consideration a provision as if we were -- 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.

And to stay in the Netherlands, there is another question with regards on the permitting, given the nitrogen regulation, is there -- is this expected to pull down the investments or the new developments going forward?

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 the permits even when it's more difficult and when it takes longer, they are not the permits who are the problem, but it is the availability of land.

And then another question on the valuations. Is there any significant difference between the countries in terms of movements in the fair value?