Picton Property Income (LSE:PCTN) — Half Year Results

0:01 Good afternoon, and welcome to the PICTON PROPERTY INCOME LTD Half Year Results Investor Presentation. Throughout this recorded presentation, investors will be in listen only mode. Questions are encouraged and can be submitted at any time by the Q and A tab situated in the right hand corner of your screen. Just simply type in your questions and press send. The company may not be in a position to answer every question received to the meeting itself. However, the company will review all questions submitted today and publish responses where it's appropriate to do so. Before we begin, I'd like to submit the following poll. I'd now like to hand you over to Michael Morris, CEO. Good afternoon, sir.

0:34 Thank you. So thank you everyone for dialing in. This is a short update following the release of our half year results this morning, and I'm gonna just explain a little bit about PCTN, more generally about the market, what's been happening in the last six months That's really relevant to kind of our underlying performance, which I'll talk about next. Then I'll talk about, you know, financial performance and indeed performance at a property level, give some thoughts in an outlook, and there's an opportunity, as has just been said, for q and a at the end. So just turning the slides.

1:23 For those that don't know, PICTON and on to the next page. Sorry. And the next one. Those that don't know PICTON, we're a diversified UK REIT. We own a £850,000,000 commercial property portfolio diversified across The UK. We've got net assets of just over 600 plus million and a market cap of just under 500,000,000. Borrowings, I'll talk about later, but very conservative in the way we use debt. And for us, you know, owning real estate is about delivering a service for our occupiers and also in terms of our investors and other stakeholders delivering for them as well. And these slides will be on our website, and there's more details about our strategy, etcetera, included in the appendices.

2:28 On the next slide is just a summary of our portfolio. So 58% in industrial warehouse logistics, a third nearly in the office sector, and 10% in retail and leisure. We're currently running at about 90% occupancy, so that's something that that that will drive income growth going forwards. And, again, this point about, you know, nearly 50 assets, nearly 400 occupiers. So a very diverse underlying cash flow from this multiple of occupiers. I think our largest occupier is less than 4% by value of our rent roll that underpins the business. The next slide just briefly talks to sustainability, and there there's a very big piece here on on ESG, very important to us. But I think sustainability for real estate is really important.

3:27 Occupiers are increasingly asking about, you know, the sustainability credentials of buildings. I think it's even more relevant in the last year as we've seen rising energy costs. You know, people want to be in in efficient buildings. And we've set out a very clear pathway at the start of the year that we're starting now to implement on the portfolio to decarbonize it and improve energy efficiency. And two things I just mentioned about that, you know, certainly in this last six month period, our own investment committee has been signing off transactions in terms of putting solar solar installations on buildings, particularly on warehouse buildings with large roofs. So where we are refurbishing buildings ahead of leasing, that's something we're looking at. And literally within the last few days, I. E, earlier this month, we appointed a head of building surveying not only to look at sustainability, but but more widely some of the refurbishment upgrading projects we've got on going on in the portfolio. So I'm not gonna say any more on that, but but, you know, this is a a key part of what we're doing now in terms of future proofing our assets.

4:49 And, again, on our website is our 2022 sustainability report if anyone wants to read about that in more detail. So the next few slides now about the market and just in terms of some headlines overall. I mean, I think we all know the sort of turmoil that's been happening, you know, political turmoil at Westminster. We've seen rising guilt yields, swap rates. Base rates have gone up considerably since the start of the summer, and that has affected the property markets. And the chart on that page just shows you in July, August, and September, you know, the market as a whole recorded downward valuations, downward pricing.

5:43 And, you know, this is actually you know, September valuations were September 30, and that was six or seven days after the mini budget. So, you know, the full impact, I don't think, is felt in these numbers. And and this is, you know, as I said, the the the marked change in in, you know, views on risk free rates and, you know, financing costs. And and it's not strictly a a one sector thing. All all sectors are seeing and subject to this rising yield movement.

6:23 And I think what I've put as a bottom point here is that in between sort of June and September, you know, yield movements were maybe 25 to 50 basis points, but we do think that there's more to come. You know, this this isn't just a a small blip. There there is a price correction that's happening. That's one of the reasons why PICTON shares and indeed the wider real estate sector is trading on quite marked discounts to net asset value. And we've put some thoughts in there, you know, maybe another 25 to 75 basis points coming, you know, in the next few months as that that sort of chaos of September works its way through the system. If we look at each sector in turn so on the next page, we've got the industrial sector.

7:16 And and really interesting with this, I think, you know, positive rental growth from the industrial sector every month this year. Demand is is is good. Supply is limited. You know, the way construction costs, development finance are going, you know, that that's relatively tight supply, we think. And rental value growth in that sector year to date, you know, just under 9%. I mean, that's, to my mind, inflation, you know, keeping up with inflation levels of rental growth. But the counterargument to that is what's happened on the capital side. You can see that in the bottom chart is that actually values in this sector have declined more this year. They they rose more at the start of the year, but but as this correction has come in, they've declined more than the other two sectors. And that principally reflects that the yields were were lower in the first place, so it's a it's a lower starting point, and and that yield movement has a has a bigger impact.

8:33 So there's a pricing correction going on, but the underlying fundamentals in terms of occupational demand supply remain remain healthy. If we turn the page and look at offices, same scale. So you can see far more lackluster rental growth story, in part, still driven through the kind of hangover of, you know, sort of post COVID or during COVID working patterns. I genuinely think things like the train strike, tube strikes, etcetera, don't help with getting people back into the office. We're seeing good demand for, you know, the best space, the space that's got good sustainability credentials.

9:23 So that goes back to my point at the beginning about it's important to offer space that that that meets that and what occupiers want and also flexible space. And and for those that that know PICTN better, we introduced something called Swift Space earlier in the year that's aimed at meeting some of that demand. Office values haven't corrected to the same extent as industrial in part coming off a higher base yield in the first place and seeing perhaps less growth at the start of the year. And if we turn to retail, it's it's a not dissimilar story, really. Rental values, in our mind, are broadly stabilizing.

10:10 There was These charts don't show it, but a huge correction in pricing in the retail sector during the course of COVID. We think that's broadly run its course. You know, occupational demand is there for the right units, the right towns, but but it is patchy. So I think, you know, you have to proceed with caution and limited growth. But limited growth in the retail sector is arguably the best it's been for the last few years. So I think, you know, that that sense of stability on the occupational side is is certainly something that one can be positive about. And, again, there was a bit of a recovery coming through at the start of the year, you know, the feeling that post pandemic, you know, there was more normality coming back, but but but the sort of sting in the tail has been these rising yields, and that's just crept into valuation movements, you know, July, August, September.

11:09 So that's the market, that we've been operating in. If I look at our specific results for the six month period so, the headline is a decrease in our net assets of just over 3% to a 117p per share. Our EPRA earnings, which is the kind of income profit, ignoring valuation gains or losses, was at 10,700,000, and that compares to 10.9 last year. So relatively stable. But the valuation movements on the portfolio led to a loss of 10,000,000 over the period. Our total return was minus 1.7. Our dividend cover was a 112%, so earnings fully kept up and covered the distributions.

12:01 And the distributions for this period was 6% higher than a year ago. And if we turn the page and just look at the income statement

12:13 it's coming. Next page. This just shows the higher rental income over the period, slightly higher property costs, financing costs, and and, you know, this, I suppose, is some of the inflationary pressures that we're seeing on on the cost base coming through. We refinanced some debt at the start of the year moving a floating rate RCF across to fixed longer term debt, and I'll talk about that in a minute. So, yeah, reasonably well insulated, I would say, the p and l is from from rising costs. On the balance sheet on page 16,

13:00 that shows our income profit flowing through the valuation movement and the dividends paid of 9,500,000 versus our income profit of 10.7. So, again, relatively straightforward, relatively simple to understand. On page 17 or or sorry. The next page, just our capital structure. I think it's really important to reemphasize this. You know? Firstly, PICTON's got relatively low gearing at at at 24%.

13:35 95% of the borrowings that we have drawn are fixed rate, so aren't subject to rising interest rates with, you know, the changing base rate environment that we're in. And not only are they fixed, but the maturity profile of that debt is just under nine years. So, you know, we are very well insulated from rising financing costs, and I wouldn't underestimate how significant that is. In fact, the fair value of our drawn debt is 191,000,000 versus the 225 that is actually drawn.

14:21 So you can see there the the the market value of the current debt structure that we have in the business. So if we just turn to the portfolio and what's been happening at a property level. So notwithstanding the valuation movement, which I'll talk about and explain in a in a little bit, actually, there's been some good activity in the portfolio in the last six months. The passing rent increased by 3%. The rental value of the portfolio increased by 5%, predominantly driven by our industrial assets. The lease renewals, the rent reviews, the lettings that we agreed were all above or in line ahead of our March GRVs.

15:15 And, actually, going back to the point I made earlier, you know, a number of those lettings have been more flexible lettings across our smaller suites. So meeting that more flexible demand that's in the the marketplace. And then we've invested just over 2,000,000 into the portfolio to upgrade assets. So that that ties in with just generally upgrading them on lease expiry to get the best rents, attract the best occupiers, but at the same time, putting in, you know, energy efficiency measures in terms of lighting, heating, etcetera. And on the right there, total property return, so this is ungeared, was minus naught 2%, naught point 2%.

16:05 MSCI, which is the real estate benchmark, the quarterly benchmark for that period, was minus 1.3. So, it's some comfort that relative outperformance is coming through still. Property valuation, occupancy are on the next couple of slides, so let me talk you through those. So on page on this page rather, the top chart shows the valuation movements in our portfolio over the first three months of the financial year, so March to June. And, actually, we saw rising values in all sectors driven actually by retail, but industrial still at that point was doing well, offices less so. But but there was growth in all sectors. And when we reported to the market in June, we did state at that time that we could see some downward pressure on values, particularly on very low yielding industrial assets. And that was actually already we started to correct pricing on some of those assets as we could see the market changing.

17:28 But the three months to September were markedly different, and and that covers this period of, you know, changing government budgets, not budgets, etcetera, etcetera. So in that period, you know, industrial values declined the the most. Overall, our portfolio declined 3.7%, retail, and then offices. And, again, this sort of diversified approach comes in here. This could've, dare I say it, been a lot worse, but there was leasing activity that we were doing in the portfolio that that meant that we were able to mitigate some, albeit not all, some of these downward revisions.

18:17 And I think it's important to recognize that whilst yields are moving out, you know, rental growth, extending income, you know, some of those factors can offset some of this this movement that that that's coming just through the benchmark yields rising. In terms of occupancy and income, if we turn the page, we're running 90% occupancy at the minute. That equates to about 5,400,000 of upside, the majority of it coming through offices, and the chart on the right shows you that between the offices in in purple and and sort of the the lighter purple color that that we're adopting a more flexible approach to leasing on than industrial and and a very, very small component of our portfolio is vacant in the retail sector.

19:16 The breakdown on the bottom chart just shows actually quite a bit of that occupancy or or vacancy rather has come back in the last twelve months. So in fact, half of it's come back in the last last nine months, which we're on-site refurbishing. 50% of our void is is being refurbished as we speak. And there is always that lag between getting space back, getting on-site, refurbishing, and and remarketing. So, look, we've got more void than we would like because everyone would like, you know, to be fully let. But, actually, it's being worked through. It's a timing of events, and, you know, it's about delivering, as I've said right from the beginning, good quality space that occupiers want.

20:04 In terms of properties that were acquired during the period, one was at the very beginning of the period and one was during the summer. The common themes with these are their multilets. They've got retail and offices up above. They're low entry points from a capital value perspective. Both of these assets, they're they're slightly different characteristics because one has got more void than the other. The one in London has more void. But both, when fully leased, yield between 89%. And I'm not saying they're immune from what's going on in the market, but those are, to my mind, attractive yield profiles, you know, of rebased rents and where, you know, the underlying value is underpinned by by residual value.

20:57 The one we bought in Hammersmith in May, we've completed our first swift space letting there. No CapEx leased as is. We're gonna upgrade some of the office suites in the building, you know, by the end of the year, and that's been instructed just to make them, I think, easier to lease, more amenity space within them. And we're looking at at alternative uses on on an element of this building as well. In terms of Cheltenham, there's less asset management involved in this particular asset, but, actually, we've we've got one retailer in there that we're probably gonna replace with a national retailer, which, you know, not only improves the underlying tenant quality, but also will improve the rent roll a bit. But but the yield profile of this asset in itself, you know, seven going to nine through fixed uplifts, we think is quite a quite an attractive entry point in the first place.

22:00 So nearly at the end, on the outlook slide, I've split it into two. So so an element of the the market and an element in relation to PICTON. I mean, I think the real estate sector is repricing due to financing cost, bond yields, etcetera. But occupational markets to to to our mind are are more resilient, and occupational demand, you know, is continuing notwithstanding all the all the noise that's going on in the financial markets. We have to be realistic, though, that, you know, that there's quite a lot of talk of recession. It's not gonna be easy.

22:48 Definitely rising cost of living, you know, higher mortgage costs, you know, inflation on food and energy, you know, is is gonna hamper the economy, you know, probably toughest for for for retailers and discretionary spending as well, you know, and that all of these factors are contributing to this sort of repricing that that that, you know, is bad for existing assets, but but but but positive in terms of buying opportunities. In terms of our own business, you know, reasonably well insulated. You know, our financing, as I've mentioned, provides real stability to the income line, which I think is really important. We've got a lot of headroom on our covenants.

23:37 You know, the work that the team are doing around leasing and regearing, you know, has definitely offset, and I think will continue to offset some of the wider market declines. You know, that's what's led to the outperformance over the over the six months. And, also, we don't really own bond bond like assets. That's not to say that there isn't a degree of bond proxy pricing in property, but but we've not, you know, tended to own nor wanted to own those assets that are very aggressively priced relative to bond yields because they're they're the ones that, in my view, are gonna experience the sharpest declines looking forwards.

24:24 I've spoken about occupancy and income up upside. And, you know, just just to end on a positive, you know, my point being about, you know, things that you can do to offset, you know, we've got a pipeline of around a million pounds worth of leasing transactions in lawyers' hands at the minute. So they're not signed, but they're agreed and and we're working through. And, you know, that to me just reinforces and hopefully shows to you listening that that that there is occupational demand, and and that's something that I think is really key in this current climate to to offsetting some of that that yield movement. So I'm gonna end there and very happily take questions.

25:10 Michael, thank you very much for your presentation. Ladies and gentlemen, please do continue to submit your questions just using the q and a tab, is situated on the top right hand corner of your screen. But just while my just while Michael takes a few moments to review those questions submitted today, I'd like to remind you the recording of this presentation along with a copy of the slides and the published q and a can be accessed by your investor dashboard. As you can see, we've received a number of questions throughout today's presentation. Mike, if I could just ask you to read out those questions and give response so it's appropriate to do so. I'll pick up from you at the end. Yep. So let me try and go through these. The first question just says, with rising interest rates and have you seen this impact have you seen this impact prices enough to start using the revolving credit facility in the near future?

26:03 It has impacted pricing. I suppose the key question is here, is it enough? I think we're quite keen to just see what the the budget holds and the the environment around that. The the way financing rates have been yo yoing, you know, in the last few weeks has has sort of just led us to be a bit more cautious on, you you know, sort of jumping in using the revolving credit facility at the first time, you know, we're seeing values move down. So I suspect we will use it, but I think we're we're we're not gonna sort of just just jump in at the first opportunity, if that makes sense.

26:49 So that's the first question. So someone's asked about the utilization of office space.

27:03 And and I think the question is is not strictly occupancy as we would think of it in terms of PICTON. It's like, well, what are your occupiers doing? How much of their space is in turn being used and therefore what that might mean for for the office market. I mean, I think I would broadly say and, you know, a lot seems to happen in a year, really. But if we look back a year ago from now, I think there were just the the starting signs of Omicron and us going back into a place where we were being told by government, if I've got this correct, to to work from home again and and no longer work in the office. I I'm sure that was sort of Christmas last year.

27:57 Since then, the general trend has been for more and more people, to my mind, to work in the office, Not necessarily five days a week, but that trend has only been upwards. What we see in our portfolio is different businesses are taking very different approaches. So some, you know, almost expect everyone in five days a week at one extreme. The other extreme is, well, come in when you want or come in a couple of days a week. But I think the majority of people are working in our offices, you know, three, maybe four days a week in the office. But I suppose from a utilization perspective, if it's three days a week in the office, then that's only 60% utilization.

28:52 Whether it was ever a 100% pre pandemic, I'm not sure because I don't think everyone worked in the office necessarily every day of the week either. But, generally, the trend is upwards. And I think as it gets a bit trickier, I wouldn't be surprised if there's a few more people wanting to be in the office. Generally, the biggest challenge, I think, at the minute is, you know, oh, is there a train strike today? Is there a tube strike or what? You know? And and those are the reasons that are disrupting people again from being in the office. But I think that the the the sort of a a more normal position is is happening now. You know? Yeah. May maybe 60 to 70% is is is standard utilization across our portfolio, I would say.

29:47 So that's the next question. And then I've got another question that's actually looks like a lot of questions. So let me just try and work through these. Someone's asked that valuations at a property level are holding up better than the market and what's driving this. And I think the key to what's driving this is in part the type of property that we own. I've said, I think, that that, you know, we don't tend to own bond proxy type assets. So those are subtly less sensitive to what's been going on in the market.

30:35 Secondly, I think, as I said, we we were keen to make sure our assets were sort of correctly priced, you know, throughout this year as indeed at all times. But, particularly, we started to move industrial values out early. So maybe to some extent, you know, we didn't capture the very high, but that means that we've not not quite got so far to move the other way. Thirdly, this point about active management and and leasing activity offsetting value declines because yield movement is just one driver and and rental income or indeed rental value is another driver of value.

31:22 And, you know, what we've had success with, you know, particularly this year, has been, you know, leasing buildings, regearing leases, setting rents, you know, considerably above our independent valuers estimates. And, you know, by achieving those rents, that's kind of offset some of those valuation movements.

31:56 Someone said, well, we've got industrial exposure, which is the part of the market that performed the best over the last, you know, four or five years, but has performed less well over the last six months, but we've still outperformed what's being missed. And I suppose that's this point that that, you know, it's less about sector. It's more about assets. And the things I just described in the first question, I think, tie into the answer for that one, if that's okay. There's a question about growing the business consolidation in your in the sector. I think those comments completely stand today and pro probably even more relevant, you know, in a market where cost bases are under pressure, discounts are, you know, wider than perhaps they should be.

33:03 You know, I genuinely believe that the sector per se would benefit from consolidation, But, you know, it has to be done at the right time at the right price. And, you know, I think the events of the last six or nine month show that our perhaps prudent approach you know, some people might say, you know, it's a lack of action or, PICTON, you've talked about it, but you haven't done anything. I I would sort of suggest the other way that that actually, you know, be being prudent over the last six months has been or nine months, whenever, twelve months, has been the right thing to do, recognizing the way the market has moved. But but my broad thesis that that that as a marketplace, you know, larger, more liquid, more efficient vehicles wouldn't be a good thing has hasn't changed.

34:08 There's another question there that relates to that around m and a, and I suppose that this that that I would refer to the previous answer. And someone's also asked about rent collection rates. Yeah. Our rent collection is back at pre pandemic levels. We're not seeing any issues with with occupiers currently. I don't think there's any specific sectors that we could draw out in the same way as you could in the pandemic around retail and leisure that were particularly hit hard, but, you know, this is very different to them. You know, businesses are able to trade, to operate, you know, not saying it's easy, and there are challenges, but that's very different to being told you can't operate, which caused, you know, the key issues around rent collection back in the pandemic. So, no, we we have a very a good view on on on rent collection borne out by by what we're seeing in the portfolio.

35:15 Michael, I I think you've actually addressed all those questions from investors. And, of course, the company will review all the questions submitted today and will publish those responses on the investor meet company platform. But just before redirecting investors to provide you with their feedback, which is particularly important to yourself and the company, could I just ask you for a few closing comments? Yes. Of course. So firstly, it's to thank everyone for dialing in and listening and asking questions of the company. We value your feedback as has been said. So, yes, to fill in the the the poll at the end and and any feedback would be well received. And, yeah, we look forward to updating you. You know, all of this is on our website, and, yeah, look forward to updating you in the coming months.

36:09 Michael, thanks once again for updating investors today. Could I please ask investors not to close the session as you'll now be automatically redirected to provide your feedback in order that the management team can better understand your views and expectations. This will only take a few moments to complete, but I'm sure will be greatly valued by company. On behalf of the management team of Picton PROPERTY INCOME LTD, we'd like to thank you for attending today's presentation, and good afternoon to you all.