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Preliminary Results for Year Ended December 31 2002
Performance and dividend
Q.
People are going to be disappointed by a net asset value figure down 2.4 per cent, and 4.4 per cent since the half year. So what's happened?
A.
Well, I don’t think there's any great drama there. We flagged the potential for a slowdown certainly at the interim stage last year and indeed before that as well. In actual terms, the capital value movement growth has been positive at 0.7 per cent. That does translate to a 1.7 per cent deficit, which as you quite rightly say, comes through to a net asset value reduction of 2.4 per cent.
We did flag certain detrimental trends that were likely to affect the valuation in the second half. Primarily that was our view that there was a disconnect between the investment market, the weight of money coming into the market, and the true level of occupational demand. And that has actually come to fruition as people have realised that one can't be sustained without the other.
In effect, we were the first to call that market, or call that market change, and we've reacted accordingly. So we think we’re in reasonably good shape. Finally, I think, just to put into context, our NAV growth over the last five years has still been just about 60 per cent.
Q.
So you talk there about reacting accordingly to a difficult market. What exactly have you done to tailor the business to today’s market?
A.
We've thought the occupational slowdown was quite a long time coming, but actually we thought it would be quite dramatic when it did. So for two years we've been doing various things to mitigate for that effect. First and foremost, we've really slowed down on the speculative development programme. Last year we were only on site with two schemes and this year, in fact as we sit at the moment, we’re not developing anything out.
Secondly, we became a lot more choosy about what we were going to buy in investment terms. We've concentrated on our core markets, predominantly around Heathrow, and there we've only really been buying when we believe there has been a pricing mismatch. We've been helped in that respect because office values have fallen more than industrial and we've been buying some sites at industrial value that are probably more, in a stabilised market, suited for offices and that gives us a great cushioning effect.
The third thing we did was set up a customer services business, B-Serv, at the tail end of 2001. We believe it’s the only way to go forward. To get closer to the tenants, get closer to the customers. But it’s even more important at a time when perhaps the tenants negotiating strength has increased.
And finally, because there has been a bedrock of sustained demand for industrial investment product, we've been selling into that market.
Q.
So where does this leave your dividend policy of progressive growth?
A.
We see that as one of our strengths. But first of all let's just look at the results and how that will impact on it. First of all, over the year our investment profit was up 3.9 per cent. That’s the recurring profit and the way that the business should really be measured. Adjusted EPS was up 2.7 per cent and our interest cover is now 2.0 times, compared with 1.8 in 2001.
Now the dividend at 10.9p is up 2.8 per cent, and the dividend cover there is 1.4 times, which is exactly the same as it was in 2001. Now there's no doubt there's some challenging markets. The market is in a difficult position. But, as we've said many times now, we have an almost unrivalled 35-year record of dividend growth and we think with the measures that we've put into the place and the resilience of our portfolio, we should be able to continue in that tack.
Voids
Q.
A big factor for the business this time around is voids. You forecast 10 per cent. It has come in at 7.8 per cent. But this is still well above last years 4.9 per cent. Why is that?
A.
As you quite rightly say, the overall void level is 7.8 per cent, the industrials are 7.3 per cent, and we were expecting them both to be nudging towards 10 per cent. We spend a lot of time managing our income base. It’s obviously quite difficult to precisely predict at any one stage in time how many potential expiries are going to come to fruition and how many breaks are going to be exercised. All we said at the half year stage last year, and we would repeat now, is that 2003 and 2004 for Brixton provide a greater propensity for breaks and expiries potentially than an average year would do. And therefore it’s likely that there will be more breaks. So that’s really where the 10 per cent mark came from.
Now against that we think the level of breaks is really quite manageable. Various things are thrown up from that. There are some opportunities. Let me give you some examples. At Radlett, for example, which is probably the area where we’re most exposed to breaks on a particular estate, we have about 300,000[square] feet breaks or expiring over the next two years. And we’re already in discussions on 250 of that 300,000[square] feet on re-leasing. So that’s very positive. Alternatively that Radlett site would provide 20 acres of prime distribution site if we knocked the buildings down.
Alternatively we've got things like Polar Park at Heathrow, where the tenant will be leaving next year and we've just got a resolution to grant planning for over 300,000[square] feet and that’s a prime site.
In terms of where the percentage number has moved from, 1 per cent of the change has come about because of the vacancy of the two buildings that we finished at the end of last year, finished completing, at Aviator Park.
The office side though, we have no other major office expiries or breaks and in fact we’re pleased to be able to announce that we've just re-let 40,000[square] feet up at Rickmansworth where a tenant went into administration at the end of last year. So there are some positive signs there.
Q.
But it is very difficult to say, I know, but you were talking 10 per cent before, is that an unrealistic target now?
A.
We've always thought 10 per cent would be the sort of top level. Maybe the prediction is that it’s going to happen a little later. But we would be very surprised if it went much higher than that.
Sustainability: tenants and rental growth
Q.
Your business depends on the strength of its tenants and you say that you have a very diversified tenant base. But is it really so diversified?
A.
Yes it is, is the simple answer and I'll explain about that in a second. The record is that we've had about the same number of tenant defaults in 2002 as we did in 2001. There's no increasing trend. We had 17 tenants go bust in 2002, 16 in 2001. The loss of rent in both years, or each year, was about £1m each year and that’s out of a total rent roll of £92m. So there is a really sustainable resilience there. That’s now proven.
In terms of the tenant base, TMT has been something that people have highlighted in the past. It’s largely irrelevant because we were never exposed to, if you like, the “dot com boom” type companies. And generally speaking our TMT exposure has been around about 25-26 per cent now for the last six years. If we look down at Heathrow, which is where the lion’s share of our new activity is - we have 40 per cent of the portfolio there - we have considerably less than a third in TMT. The biggest tenants down there will give you an idea of the resilience and diversity. Basically in order of size it’s the Royal Mail, it’s Morgan Stanley, it’s British Airways, it’s Le Pain (who are bread manufacturers), it’s Penguin and it’s Noon (who are again food processors). Now they're our biggest tenants and you can see from that there’s quite a spread really.
Q.
But occupational demand is slowing. Isn't that a worry for you?
A.
It is a worry but it would be a lot more of a worry if we were exposed to having to re-lease or lease a lot of vacant space, which we’re just not. The vacancy statistics as a whole are very modest at sub 5 per cent - that’s King Sturge’s numbers for the South East - and you know that’s broadly half where a lot of the other commercial markets are sitting at the moment. Whether it’s offices in the Western Corridor or offices in Central London, which are potentially going to three or four times that level.
Q.
You showed no rental growth overall in 2002, indeed negative in the South East. It sounds a bit grim out there, is it?
A.
Yes. It’s good in parts and bad in parts. We've always said that the strength of our portfolio is Greater London, which, for the purposes of us humble surveyors, is the M25 and in. We've been deliberately pushing towards that part of the world and although our overall rental growth on the industrials was static last year, Greater London still showed 2.2 per cent positive. And over the last five years, Greater London has shown a cumulative rental growth of about 36 per cent, Heathrow has shown 38 per cent and the rest of the South East, 17 per cent.
What the valuers believe at the moment is that our overall portfolio, industrially, is still about 10.8 per cent reversionary. So there's still quite a lot of gas in the tank there, and in Greater London they're saying it’s 15 per cent reversionary. Now these are all hypothetical statistics and obviously you can throw numbers around the whole time. The reality of it is, though, that if we actually look and see what we created in terms of new income last year, we benchmark what we've done against what the valuers estimated rental values - their ERVs - and on lettings we were 7.2 per cent up on the valuers’ ERVs in the year and on rent reviews, we were 3.7 per cent up. And that’s a consistent record of growth each year now for the last five years. So we are seeing growth over and above what the valuers and the market think we should be doing.
Q.
So long-term you believe there is a resilience in your business there?
A.
Oh totally. Totally.
Heathrow – the core market
Q.
Why do you believe that your chosen focus on Heathrow and Park Royal, high-end industrials, will pay off?
A.
It’s basically just a factor of supply constraint and robust demand. That’s the reasons we’re really there. At Heathrow itself there's the guarantee now of expansion because of T5. T5 is very important. Not only is it likely to increase passenger numbers by 50 per cent, which is about 30m people, but it will have a huge knock-on effect to the growth prospects of cargo, because over 90 per cent of the cargo that comes into Heathrow is actually freighted in the underbelly, or the belly-hold, of aircraft. So with guaranteed expansion of passenger flights there will be guaranteed potential expansion, if the market is there - and certainly the Department of Transport believe it is - for cargo to grow at an even faster rate down at Heathrow.
Q.
You mention the T5 development there Tim, but why do those supply-side constraints benefit you in particular?
A.
Well, the supply-side constraints are there because of the Greenbelt policy. Because of the Greenbelt policy, one of the reasons behind our expansion down there has been simply that. There's a constraint to entry into the market because you can't develop on that type of land. So we've gone out and bought a position down at Heathrow over the last four years. We've expanded our portfolio from, I think, four estates at about 0.5m sq ft to something over 12 estates and 4m sq ft. So we are the most dominant player in that market and we’re really sitting now waiting for the capacity expansion to bring dividends for us.
Q.
But you must have purchased at a fair old asking price. Those buildings you purchased down at Heathrow can't have been cheap. How can you make those buildings work for you and pay off in the long-term?
A.
Pricing is a relative thing. Heathrow happens to be the most expensive industrial location in the world. That’s not our fault, that’s just the way it is. And there are reasons for that. As I say we've become the dominant owner down there, but all you really have to do is look at the underlying basis of the valuation of our whole portfolio. We only now need 0.75 per cent rental growth each year for the next five years to match our pre-tax weighted average cost of capital and create shareholder value. That doesn’t seem a big call, particularly when you remember over the last five years there's been 38 per cent rental growth at Heathrow. So we think there are very good reasons why there's pricing there and we believe we've bought in the market at the right time, at the right price.
Q.
But if I could just ask you there, war with Iraq looks imminent and isn't that going to stuff airports, passenger growth, cargo growth? In the short-term all these things look grim don’t they?
A.
I think war with anyone, Iraq or otherwise, will have a major effect on confidence. So that’s a thing that will affect our economy, because our economy is very determined by what's going on in the world economy. So that’s a given for any business. Whether it has a bigger effect or not on airport and freight is another question.
I think we have to repeat that basically medium and long-term, because of T5, growth is secured. Freight is becoming more dominant. And we mustn't forget that one of the reasons that it’s so important - and it has handled for each of the last 10 years more freight than all the other UK airports put together - is that it still has the best access and most access to more international routes than anywhere else. So it’s international freight that really drives it.
And I think the interesting statistic, these numbers have just come out, is that post 9/11 cargo growth in 2002 was 4.9 per cent higher than in 2001. So it has recovered. Passenger growth was 4.3 per cent higher than in 2001. This is at Heathrow. So there was quite a quick recovery, even after the obvious fallout from the events of September 11th. So, whilst we wouldn’t try and belittle the effect of war in Iraq, we think taking a longer-term view, the market will recover and respond and do quite well.
B-Serv
Q.
To what extent is B-Serv, your customer service division, a long-term driver of client retention and rental growth?
A.
We've always said that the main effect of B-Serv is holistic on the whole portfolio. That’s the stuff that we own and the stuff that we manage for third parties. In terms of how it has performed, all we can really do at this stage, and it’s only been on the go since September 2001, is to look back at the second of a series of annual, independent, customer surveys that have been carried out. And we've seen some quite staggering improvements. For example, 44 per cent of the people that occupy B-Serv managed properties now believe it’s a distinct business advantage of doing that. Customer satisfaction has risen by over a fifth to 66 per cent. That’s satisfaction with the management regime. And over 60 per cent of these tenants would now actually recommend us to a third party or consider taking space again from Brixton.
On top of all that, we've developed this bespoke lease pricing model for the industrial sector, which allows us to take account of the risks of granting shorter leases against the premium demand of tenants who want those shorter leases. We’re using this model, OPRent. We've offered it in about 66 per cent of all the lease negotiations and it has been taken up in 60 per cent of them.
So what we’re really saying is we've never meant B-Serv to be a generator of a distinct income stream on its own account. It’s supposed to help the retention of income and the creation of income from the portfolio that we own or manage. And I think it’s undeniable that, with the improvement in the ratings that I've just mentioned and the flexibility that we can offer, that it would be very difficult to argue that we wouldn’t get a better level of tenant retention. The statistical proof, I guess, or a hint towards that, is the fact that our void ratio hasn’t increased as quickly as perhaps we thought and that may well be to do with the new regime and the new customer service focus.
Board appointments
Q.
You’ve announced a number of Board changes today. What's the thinking behind this?
A.
The retirement of two longstanding Directors gives us an opportunity to actually look at the way of restructuring the Board for the future. And what we've been very keen to do and Alan Gormly’s been working along side me on this, is to effectively secure the succession. To make the transition orderly. So really we were looking to bring in people with new complementary skills. The new Chairman is promoted from within the Board and we think we've got the formwork and framework to make the Board more effective for our business going forward.
Q.
And are you happy with the balance that you’ve got now?
A.
Oh totally. I mean we've deliberately gone out to bring in people with different disciplines. Louise Patten, who becomes Chairman, her background is very consumer orientated through interest in hotel groups and retailers. We have David Scotland, who is basically a management and marketeer at Allied Domecq. Then we have some professional men in the form of the managing partner of Allen & Overy, John Rink. Nicholas Fry, whose background is corporate finance, banking and accountancy. They sit alongside Michael Moore, who has been on our Board since 1997, and his background is one of being a barrister, banker and general businessman. So we think we've got a fairly unusual but unique mix, in that we've actually gone out to fit the jigsaw together to assist the executive directorship in the way we will move the company forward.
Outlook
Q.
Given your focus on South East industrial property, what are the prospects for the current year?
A.
As I say, it’s challenging but we think we anticipated the challenge that was in front of us and therefore we reacted and put various measures, which we've discussed, into place. So yes, we do believe that’s right. We think that the fact that so much of our development programme when we started is in big box development is also quite interesting, because that’s the one area in the South East which has seen a consistent reduction in availability. The tenants aren't there at the moment, otherwise we would be doing pre-lets, but we believe that when occupational demand comes back, that will be the first area to benefit, because relatively there will be less space available. So we think that model works. And when you look at what we've actually done over the last 12 months with lettings above the valuers’ forecast, with rent reviews above the valuers’ forecast, with vacancy rates below the forecast and with bad debt provision no worse than it was in 2001, we think the model probably works.
Q.
And what about prospects for Brixton into the future beyond that?
A.
We are very, very wedded to the business model that we've developed. Not blinkered to the ideas of anything else but we do think it works. We think we've got a market advantage now. We think we've positioned ourselves in a prudent manner for what's coming. The customer services business is very important to us. It seems to be working. Certainly the surveys show that and we think it is translating into empirical data and obviously, as we develop on, we will be able to gauge that more accurately. We seem to be able to maintain and improve the resilience of the income and what we’re really striving to do is to continue to be a market leader, to outperform and to continue this record of 35 years of growing dividend.
Q.
So far so good then?
A.
We think so.
Forward Looking Statement
This interview contains certain forward-looking statements with respect to the financial condition, results of operations and businesses of Brixton plc. These statements and forecasts involve risk and uncertainty because they relate to events and depend upon circumstances that will occur in the future. There are a number of factors which could cause actual results or developments to differ materially from those expressed or implied by these forward looking statements and forecasts. The statements have been made with reference to forecast price changes, economic conditions and the current regulatory environment. Nothing in this announcement should be construed as a profit forecast.
Past share performance cannot be relied on as a guide to future performance.
Tim Wheeler,
Chief Executive
18 March 2003
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