MRPRF - MERLIN Properties SOCIMI S.A. (MRPRF) Q3 2023 Earnings Call Transcript
2023-11-17 13:55:02 ET
MERLIN Properties SOCIMI, S.A. (MRPRF)
Q3 2023 Earnings Call Transcript
November 17, 2023 09:00 AM ET
Company Participants
Ines Arellano - Investor Relations
Ismael Clemente - Chief Executive Officer
Miguel Ollero - Chief Operating Officer
Conference Call Participants
Mariano Miguel - Banco Santander
Fernando Abril-Martorell - Alantra
Florent Laroche - ODDO
Jonathan Kownator - Goldman Sachs
Presentation
Ines Arellano
Good afternoon, ladies and gentlemen. Thank you for joining Nine Months '23 Trading Update Conference Call.
As we always view on quarterly results, our CEO, Ismael Clemente will provide you with the main highlights of the period and will thereafter open the lines for Q&A. [Operator Instructions]. With no further delay, I will pass the floor to Ismael. Thank you.
Ismael Clemente
Thank you, Ines. Good afternoon, everyone. We are here today to report on another Solid set of results of Merlin Properties in up to the third quarter of 2023. Many of you might remember that, during the full-year results presentation 2022, we commented that, our expectation for the year was a relatively strong first half on significant inertia from positive 2022 and a slightly softer second half.
Probably what we didn't have the opportunity to comment was the order of magnitude of that predicted softening, which has clearly been lower impact than we expected. While in 2022, as of today, we have renewed 74% of our contracts with a 6.2% inflation average, this year it has been 70% of the contracts with 5.7% inflation average. This is why, the second half is slightly a little tad softer than the first, but clearly well above our expectations. Particularly, offices where our asset management team has made a great effort in keeping occupancies stable and obtaining not only full pass-through on the rents and on the inflation but also in terms of achieving modest release spreads in the renewals.
Likewise, our logistics team covered a fantastic quarter. Occupancy is now reaching 99%, which is an all-time high for us. And it continues to underline the strength of the logistics business in Spain, for which we can subsequently comment during the Q&A. In shopping centers, we are amazed by the strength of consumer demand in Spain. Both like-for-like and release spreads have been significantly high. And we continue to see good performance through the Black Friday campaign and the Christmas campaign, if nothing goes wrong, specifically at the local level.
Occupancy overall of the company has reached a new high at 96%, which is remarkable, because it is no longer positively affected by the 100% occupancy of the BBVA portfolio. So, it is important to note. Regarding our data center, we have delivered our three data centers on time on the 30th of September in Madrid, Barcelona, and Bilbao to the anchor client and are currently working on a number of initiatives in order to continue furthering our pioneering effort in that line of business.
Our NTA per share with no revaluations in the period stands at 15.49%, whatever it means nowadays. But this is our NTA at present. Without further comment, I am happy to take your questions.
Question-And-Answer Session
A - Ines Arellano
[Operator Instructions]. And we already have a question. It comes from the line of Mariano Miguel from Banco Santander. Mariano, the line is yours.
Mariano Miguel
Good afternoon, everyone. Thank you for taking my questions. I have got a few questions on the mega plan, and then one on offices.
Ines Arellano
Mariano, sorry, but we cannot hear you very well.
Ismael Clemente
We hear you very little.
Mariano Miguel
Now is it better? Now can you hear me?
Ismael Clemente
Better.
Mariano Miguel
Okay. So first of all, thank you for taking my questions. I got a few on the mega plan and then one on offices. So first, we have seen recently different articles talking about a potential acceleration of the whole plan, pointing towards different options involving some of them corporate transactions. So, I was wondering if you could give us a bit of color on this. And then in the nine months, you have revised, of course, the expected cost on the first 58 next of the plan. So, on one side, it will be interesting to understand the reasons behind, on one side, the higher CapEx on the other, the much higher rental income for SIN. And also, how should we think about the next phase of the plan in terms of potential returns?
And finally, and operator, sorry for that long, it seems that the year will feel better than expected. We have been able to renew an important contract materially in 2024. So, if you could provide a little bit of color on the speculations for the next exercise and also on the release spread in that new contract, that would be welcome. Thank you very much.
Ismael Clemente
Okay. Look, first, regarding the press article on how we are planning to act on data centers. What I can comment is that, we have, as commented, finished and delivered on time our three structures fitted with three megawatts each. So, for a total of nine megawatts, clearly, we have been mistaken in the estimate of the demand that we will find in the market. We have been too prudent. In the general shareholders meeting, we already hinted to shareholders in April that, the first phase of technology demonstration of our data centers that we intended, in which we intended to reach 12 megawatts commercialized and three data centers opened by end of 2024, was to be construed as 15 megawatts to 18 megawatts by end of 2024.
Then in our results presentation in July, pertaining to the first half, we already commented that we were placing orders of equipment in light of the demand in order to reach approximately 33 megawatts equipped by the end of 2024. That's why when you see in our presentation the CapEx breakdown, you will see that there is CapEx till end of 2024, and then there is a little CapEx also to be incurred during 2025 in order to reach the 58 megawatt capacity, which is total in our three existing facilities.
What I can share with you now is that, we have activated an acceleration of orders so that those 33 megawatts can be fitted in our facilities up to 30th of June. So, we will probably be already and those with 33 megawatts as of the end of June, and we will continue fitting during the rest of the year and throughout 2025 up to reaching the maximum capacity of 58 megawatts. Although that might have, will accelerate depending on how we see not even demand, how we see the installation of our clients within our facilities, which, as you know, by nature in this world of data centers is relatively staggered.
At present, our order book more than covers all of our available capacity. So now, we are embarked in basically a next step, which is addition of capacity. This problem is farther slightly aggravated by the fact that we have had some problem with the staggered delivery of capacity in Madrid, but it will be significantly compensated with the fact that we might probably repower to a superior power in Barcelona.
So, we are doing things basically keeping track with our many times revised business plan. The demand we are encountering in the market, it is important to highlight that we have devised a business plan that was mainly intended for cloud services. The truth is that the reality we are finding is that we are signing between 10% and 20% of our capacity with cloud services and 80 or more with generative AI operators. So, the game changer clearly has been generative, uh, AI, which is also helpful because it brings cash flows slightly closer to moment zero, which is good. And you can achieve slightly better pricing than you can achieve in cloud. Hence, we have now shown our most recently recalculated yields on cost gross. Of course, then there is a gross to net that you need to take into account, which in data centers can be significant.
The other nuances that generative AI bring to the table are bigger orders in generally speaking, but those bigger orders come at the price of a much more significant scrutiny on the technical due diligence because of course they need to be fully operational on day one. And they check every [technical difficulty] aspect of your technical operation and that simply delays a little bit the moment between reservation and signature of contracts.
On our side, there is also the need for a more thorough credit analysis because we are talking about significant order, I mean significant backlogs. And we need to check that those backlogs are good enough. The contract negotiation, however, could be slightly easier always taking into account that converting an American work order made by email into a Spanish lease law 180-page contract is never easy. It is exactly the same, but you need to convince your counterparty that it is exactly the same. So, there is always some time lag in the middle. Hence why we have decided basically to go the route of playing with statistics and covering our order book more than one so that we can have replacement in case somebody, finally falls in the last minute.
Next steps which are important for our business is well, first, sign all leases and fill up to the maximum all of our capacity. As soon as this is achieved, start the second building in Arasur, which will be good for 48 megawatts IP power that is Arasur is past country, which is you might remember, is the landing station for Maria and for Grace Hopper. And at the end of next year ‘24, we will be also welcoming Anjana, the biggest subsea cable from the U.S. which is being laid out by meta as we speak.
The other next step, which is important for us, is obtaining the license in Lisbon, because we are seeing significant demand for that 100 megawatt generative AI campus. The location -- the Lisbon location is extremely attractive for engineers across the pond. So, this is basically, where we are in terms of development of our mega plan. And you have also your explanation of yield cost and next phases. Regarding speculation in the media about capital increases, et cetera.
First, let's do a recap of where these needs come from. Basically, we devised for our Board Directors a business plan that encompassed reding between 58 megawatts and 70 megawatts, whatever was good to reach approximately €75 million of income by end of 2027. That meant basically five years. The cost for this oscillated between €520 and €640 more or less million. We are good for those figures, but those figures were spread in five years. And what we have found is that we will probably need to incur in such CapEx in less than two years. While this means a certain stress to our P&L, it is not a stress that we cannot cope with.
So clearly, we are good and we can more or less easily cover that kind of CapEx. The problem lies with the remainder of the 178 megawatts of IP capacity that we have in our belly, which in our original business plan, if you look at what we explained to you during the analyst presentation, the Capital Market Day in Barcelona, those 178 megawatts spread to 2035 and beyond.
If, because of the market strength we need to bring those 178 megawatts to something closer, meaning '26, '27. That means the plus, we are not holding our horses. I mean, we continue working on a series of new projects in Spain and Portugal, trying to secure power in our existing land or buildings of ours, plus also looking at third-party assets. So, if we need to bring all that expense closer, that means, we need something between €1.6 billion to €2 billion CapEx in order to build the remainder, €170 million all at once.
And that although you might think this is a luxury problem, course, it is a luxury problem, but from a managerial standpoint, it is a problem. So, we need to tackle it. We need to have a course of action decided beforehand in the company in order to tackle that difference in -- numerical difference and acceleration of CapEx. The possibilities are varied. There will be one possibility, which is simply to deleverage the company. Many of you say, okay, you can do it because it is bottom of the cycle, and interest rates will go down, and you can do it safely.
Yes, but, I don't think a company like this with €11 billion in assets, we should go to the casino and play all of it on the 27th -- I believe we have to act a little bit more prudently than that. And I am sure that Miguel Ollero, who is by my side, our CFO, will sleep better if we do things on a more prudent way than simply deleveraging to the bones.
The other possibility clearly is bringing in capital. And that capital can be brought in downstairs, I mean, at the data center subsidiary level or upstairs. We have engaged in preliminary discussions with our BOD which have meant also a number of checks with some Spanish-based investment banks. And we have been looking at the different options that we have in front of us and if we need to raise capital for that, let's say, accelerated expansion in data centers.
As you know, 70% of the employees of this company are our shareholders. So, rest assured, as we have commented in many occasions that, we are not stupid and we are not going to provoke a capital raising at the top core level, at current share prices even if they have significantly improved and will probably continue improving, as compared to the moment in which we started discussions with the BOD regarding this possibility.
However, we have calculated returns for investors and we believe pretty interesting returns can be achieved by an investor at certain levels of entry price that will reflect a fair valuation of the company, hence a significant premium compared to current trading levels. What will end up happening? We don't know. We'll try to act in the best interest of existing shareholders because we are existing shareholders and all the R&D of this company towards having the promising data center activity that we are having today has been born since 2019 by the existing shareholders.
Therefore, our respect to the existing shareholder base is maximum and we'll do whatever we believe is best for the interest of shareholders. Of course, this is a two-way process. There will be a counterpart in front of us, which will argue in terms of pricing, and we will try to do our best to achieve a good solution for all parties involved. Recognizing that if we want to accelerate the data center expansion business plan, which is in the best interest of everybody, including existing shareholders, we will need to engage in such discussions with the capital provider. So that is all I can comment as of today on data centers.
Next?
Ines Arellano
There was a second question. Mariano, can you remind us? It was about offices could very well…
Miguel Ollero
It was simply -- sorry, because I mean it took really long. It's simply about color and expectations of offices and the religious spread on the contract with -- within your [indiscernible].
Ismael Clemente
Look, Mariano on release spread, I wish I had an idea. What I can tell you in -- the specific contract information we cannot provide to you, but I can tell you that the A1 has positive release spread. Okay, so, despite all the myths and legends, we have achieved positive release spread on A1 contracts, which is not only Indra, there are some others, but Indra is, let's say, big.
Expectations for 2024, look, I wish I had a crystal ball. I don't have it. Clearly as we have commented in many cases, there is, I would say a communication between CPI pass-through and risk spread. So, it is obvious that in a, in an environment of high inflation, you are always eating and eating on your reversionary potential vis-a-vis the market. And the clients that accept a full CPI pass-through sometimes protest a significant release spread, and vice versa, if they accept a release, a high release spread, they want you to cut at least the first year of inflation. So, it is up to our office teams to negotiate the best solution possible for the company. Knowing that both ingredients go anyway into, like, for like, so whether it is full pass through or it is really spread, they all go in offices.
Providing more color on the market, I can tell you that so far, the fears that come from the other side of the Atlantic are not pretty much at present, applicable to our market. As commented in other calls one equals behavior that we are seeing in our clients is that they normally mistakenly calculate their needs for space. We have recently had an anecdotal evidence with a very big client that contracted with us a number of square meters with fault. They were approximately 20% short of what they really needed and told them openly that they were wrong, but they of course, told us that their bosses in the U.S. expected them to reduce square meters for the sake of reducing.
The end result has been that we have finally ended up signing a contract with a 100% owned subsidiary. That takes us exactly to the same situation that we indicated to them at the very beginning. This is repeated all across the portfolio. We have other clients in also recently, inaugurated buildings in Castellana, which initially left one or two floors empty that we knew they will and they will end up occupying. So, what we did is temporarily we occupied them with loom coworking spaces, and at the end, they have been reclaimed back by the clients.
So, I see, people swimming in uncertainty, as probably everybody else in the world. But I don't see a significant weakening of the office demand. And if there is some weakening is again, more owing to uncertainty than it is to a softened economic activity, which at some point might come. But for the moment, employment in Spain remains good, and economic activity remains good. So, we would expect normally a pretty reasonable 2024. I cannot tell you whether super good year, super bad year, but I would expect a reasonable 2024.
Ines Arellano
Thank you, Mariano.
Mariano Miguel
Thank you very much for answers.
Ines Arellano
We have another question from Fernando Abril from Alantra.
Fernando Abril-Martorell
Thank you very much for the presentation. Have few questions. One feedback from Mariano’s, so it's about offices again. So, I don't know if you can comment on your current reversionary potential you'll have on your office for portfolio regarding prices. Then second is on sub incentives. So, trends continue super strong. But my question is on renewables again, still few renewables year-to-date, but you face a big amount in 2024. So, I was wondering if you can comment on your expectations based on the conversations you may be having with tenants and if you expect neutral or positive release spreads in 2024.
And third, data centers. I don't know, thank you very much, because you comment a lot on this topic. Just on your CapEx expectations and on your rental expectations for the next two to three years. I don't know if how this would change if you start working on the Lisbon data center. Thank you.
Ismael Clemente
Okay. Look, on offices, reversionary potential, I don't have it handy with me, the one that we internally calculate, but I tell you, for sure, it is now lower than 10%. So, let's leave it there. Although it is important to note that the market continues going up. So, note that, every lease we have been signing in with Picasso on trend has been at a higher rate than the previous one. And that trend is continuing and we know of particularly small leases which are being signed by some of the boutique specialists in the Madrid market like Nutlo, et cetera, at rent starting with a 500.
So that is very, very interesting and provide us with a very interesting comparable for our lease up activity. So, we don't really see a significant softening as is evident in some other places in the world, particularly in the U.S. and a little bit in London, which is where those fears are coming from basically. At some point, if there is an economic softening, everything is possible. But not for the moment.
Some interesting things which we are seeing in the market are as follows: One is new supply has never been a problem in Madrid and Lisbon. But what I can tell you is that at present, it is zero, means nonexistent. I mean, nobody is really now building anything in offices because that the wave of negativity on the asset class, which is coming from across the board has reached the capital sources and the debt sources, and it is not easy to finance or fund a office project.
And the second thing which is important is that, we are starting to see the first signs of some stock destruction as a consequence of office-to-resi re-conversions. We are protagonists in a number of them here and there, small things, but everything counts. But we are seeing that as a widespread trend in the market, which is also helped by the more pro-business regulation, which is starting to be applied in a number of Spanish cities barring probably Barcelona.
So that is what we see. And this will, of course, contribute to the market finding new balance and really quantifying itself at some point in the future, because at present, as commented on many occasions, the investment market is mainly now down to transactions with family offices in the 30 million to 60 million ticket maximum, and there is, at present, no institutional capital chasing office assets in the market.
Regarding shopping centers and our expectations for renewals in 2024, I can tell you that at present, our stance is positive. I have here with me Luis Lazaro, who is The Head of Retail and Logistics in the company, and he is giving me his thumps up. So basically, that means that, the role of renewals that you are eventually seeing in our presentations, you need to know that a significant part of it is the one-year revolving renewals pertaining to one or two big clients, namely one big client, which also always operates on a one-year revolving basis.
But as you might know that big client has left us completely aside from the significant closure program that they have conducted in the past. Well, so, and the rest is, I would say, ordinary renewals that will be tackled in due time with no specific concern about whether the client will renew or not. Of course, I can provide more color during the full-year results, depending on how we see the Black Friday and Christmas campaign. And if we start seeing something different, we will be the first to comment differently. So, but at present, this is what we see.
Regarding data centers and the Lisbon, artificial intelligence campus, yes, the lease on campus brings a slightly different CapEx, higher CapEx because it sits on a river bank on a highly seismic territory. So that means basically that you need to provide for a number of construction solutions, which make the CapEx a little heavier than in other assets. However, rent also look significantly better than in other locations, given the desirability of at least one secondment to American engineers. So, we are -- I mean, happy with the numbers, and we will of course provide re projected numbers as soon as we start and have evidence on the real costs when we have coasted and priced correctly the project.
Ines Arellano
So, the next question comes from the line of Florent Laroche from ODDO.
Florent Laroche
Maybe I would've a question maybe on, your disposal plan and valuation of assets, I noted that you have a budget for this year maybe of to dispose between €80 million to €100 million. So, I don't know if you have any discussion in progress as of today. And I don't know if you could give us any comments on the current campaign for the valuation of asset.
And maybe on another question on the logistics. Could you please remember us, what is the space the pace expected for the development of the future? How this in your portfolio?
Ismael Clemente
Well, regarding the disposal program, we have a budget for the year of between €80 million and €100 million. We are perfectly on track to make it good. The only difference could be timing because there could be one or two transactions that might slip into the beginning of ‘24. Because everything now is a little bit more difficult in terms of signature or let's say between head of terms to due diligence and signature, it takes a little bit more time used to taking than used to take in the past, that budget is perfectly good, probably to be exceeded, because we are the first party interested of course in providing as much recycling of capital as possible to feed our data center program.
Valuations on those disposals at present. All of them above gross asset value, I know might look impossible, but it is the situation at present. I mean, of course we have no problem if we need to dispose an asset at or slightly below books, we will have no problem at all doing so. But at present, this is not the case overall on our disposal program. Regarding valuations as of 31st December at present, we don't have visibility yet because we haven't had yet the preliminary meetings with the valuers.
But I can tell you, that you should expect lower valuations. Why? Because of expanding cap rates. So, let's be frank about it. Everybody knows, there is no point in acting in denial of that. And by the way, with NTA at 1,550 and being trading at nine, there should be no special problem in bringing that NTA down a little bit, so that the NTA and the reality approach, little by little, which I hope will end up closing the gap by both things, reducing the NTA and increasing the share price. The important to say also that at present the cross variation in valuations is still to be significantly offset by a better operational performance. This company continues creating Alpha, plus CPI continues helping us for a moment.
So, as you have seen in the past, shopping centers in gross terms have probably adjusted close to 30% since before COVID. However, when you look at net, the difference is not that big, because part of that difference in cap rate expansion has been absorbed by better than expected performance, operating performance. Same is true for offices and what logistics in which in some cases we have gone even positive like in the first half of the year. That is all one -- all logistics. You made the question of at which moment we are starting the 180,000 square meters. They will be started between end of this year and beginning of next with the idea to have them ready, if at all possible, some before year end or beginning of ‘25. So, we are progressing with that logistic program business as usual.
Ines Arellano
So, the next question comes from the line of Jonathan Kownator from Goldman Sachs.
Jonathan Kownator
So, probably three, one, just to finish on the logistics theme. So, can you comment, so how much you intend to spend CapEx? I know you had also land reserves, so are you going to put these plans on hold given the center requirements or you continuing to plan for that? The second question just on a data center very quickly, would you consider to spin off that business, given the significant CapEx requirement? Do you want to keep it under Merlin? And let's start by these and then we can talk about the office pipeline afterward. And I will be satisfied. Thanks.
Ismael Clemente
Look, on Logistics, you have a reconciliation of what we are starting and what remains in our belly on Page 4 of the presentation. There, you will see that the 180 square meters that we are about to start involve a CapEx of around €109 million for an expected growth rental income of €10.4 million and therefore, a yield cost in the region of 7.4%. Regarding the remainder, 425,000 square meters that we keep in our balance sheet, our present cost estimate is in the region of €233 million. And the expected gross rental income is close to $25 million for a year on cost at or above 7%. The reason why if you divide gross rental income by pending CapEx, you get to 10%. And we say the yield is 7% is cost of land. I mean basically, it is land that we already own, because we bought it in '16, '17, '18, and we are keeping it basically at cost in our balance sheet. So that is on logistics and land reserve.
Then on the DC, you made a question regarding the possibility of a spin off. Jonathan, can you repeat the question?
Jonathan Kownator
Yes. Just to consider, obviously, I mean, if you keep because obviously, one of the options in terms of funding, I mean, you can raise IPO at the top call, you could raise funding at the sort of subsidiary level, so just the data center. But you could also consider spinning off data center to raise equity directly from the market in the data centers. Just wondering that was an option or that.
Ismael Clemente
My thoughts on these, they are very preliminary, but my thoughts on these are as follows. It is going to be mainly a mathematical decision. So, wherever we can achieve better pricing for the shareholders of the company, we will carry out the transaction. So, we are relatively -- we are going to be relatively agnostic on where to execute it. However, one thing that I can tell you out of experience is that, the type of people which is approaching us for an investment at the DC subsidiary level tend to be higher cost of capital than the people approaching us for a top co-investment. So, we will need to play with that peculiarity, when doing our calculations, because it makes a big difference.
And the second thing which is important is senior regime. I mean, spinning off, I mean, playing with boxes M&A style in a company, which is subject to a very strict legal regime is not that easy. So, we need to double-check what can be done and how this can be achieved. Plus, there is a problem regarding staffing. Do you take staff from the top and send it downstairs? Not easy. So, we need to check the different alternatives. We need to check the different characteristics of the different business plans which are offered to us and take the decision which is in the best interest of our shareholders.
Jonathan Kownator
Just last question. So, on the office pipeline, I mean, obviously you mentioned in your disclosure that you've got a number of projects in offices as well. I don't think there was details as of Q3, so just wanted to understand what is the status of the main projects plus a risk, Ruiz Picasso, AFCA one, PL ZSA [ph], what is the status of these projects?
Ismael Clemente
Look, on the office pipeline, Ruiz Picasso is about to be delivered to the first client on the 1st of December. So remaining CapEx in that building is only the let's say, written, the payments to the construction company, which normally go a number of days or months after the works are executed. And they have been verified by our project management people regarding other office projects, we are not doing anything big or which can really move the needle in terms of the company. We are doing some refreshment of buildings in -- with a hundred percent occupancy. And we are going little by little. So, as we are emptying one building, we are -- the next. And we are little by little refurbishing all that location.
There is a Lisbon Liberdade building, which at present we are in the middle of the licensing project. So, feel we don't achieve license. It is a little bit premature to comment on that project. And what basically this is at present, this building is 100% occupied, I mean by Novo Banco. So, we were in no rush to start that re-conversion. So, on offices, we will continue doing business as usual. We are a company. Offices have not disappeared from our balance sheet. So, whether you like it more or you like it less, we need to continue doing some investment in offices because we need to upkeep our portfolio state of the art because this is what is giving us a ‘24 market share in terms of letting, when we are only 4% market share in terms of space in Madrid or Barcelona or Lisbon for argument's sake.
Jonathan Kownator
Just, I mean, if it's possible, I mean, and that can be taken off fine, but it'd be good to have a bit of disclosure of how much CapEx do you expect for the project. For the project, the empty buildings, if they are empty or not. And the size of this buildings that'd be helpful because we are kind of losing track a bit of what's becoming vacant for rest. Thanks.
Ismael Clemente
I recommend, Jonathan, you call Ines and they will provide you with all the details you need in terms of the CapEx in offices.
Ines Arellano
So apparently there are no further questions. We thank you all for joining today's call and I said that we remain at your disposal for any further questions or comments. As always, you can reach us by phone or email. Well that's all. Thank you very much and have a great weekend. Good-bye.
For further details see:
MERLIN Properties SOCIMI, S.A. (MRPRF) Q3 2023 Earnings Call Transcript