Northstar Realty Europe's (NRE) CEO Mahbod Nia on Q2 2016 Results - Earnings Call Transcript

| About: NorthStar Realty (NRE)

Northstar Realty Europe Corp. (NYSE:NRE)

Q2 2016 Earnings Conference Call

August 5, 2016 09:00 ET

Executives

Trevor Ross - General Counsel & Secretary

Mahbod Nia - CEO

Scott Berry - CFO

Analysts

Frank Lee - UBS

Operator

Good day and welcome to the NorthStar Realty Europe Corp. Second Quarter 2016 Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Trevor Ross, General Counsel and Secretary. Please go ahead.

Trevor Ross

Good morning and welcome to NorthStar Realty Europe's first quarter 2016 earnings conference call. Before the call begins, I would like to remind everyone that certain statements made during the course of this call are not based on historical information and may constitute forward-looking statements. These statements are based on management's current expectations and beliefs and are subject to a number of trends and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements.

I refer you to the Company's filings made with the SEC for a more detailed discussion of the risks and Risk Factors that could cause actual results to differ materially from those expressed or implied in any forward-looking statements made today.

The Company undertakes no duty to update any forward-looking statements that may be made in the course of this call. Furthermore certain non-GAAP financial measures will be discussed on this conference call. Our presentation of this information is not intended to be considered in isolation whereas a substitute for the financial information presented in accordance with GAAP. Reconciliations of these non-GAAP financial measures to the most comparable measures prepared in accordance with GAAP can be accessed through our filings with the SEC at www.sec.gov.

I will now turn the call over to our CEO, Mahbod Nia. Mahbod?

Mahbod Nia

Thank you Trevor and thank you everyone for joining us today. In addition to Trevor I'm joined by Scott Berry, our CFO. NorthStar Realty Europe or NRE is a New York Stock Exchange-listed REIT focused on prime European office properties.

We're in 40 properties, predominantly prime offices in key cities across eight countries, with a concentration in our core markets of Germany, the United Kingdom, and France. Our objective is to create shareholder value by generating a stable and recurring income stream supplemented by capital growth over time.

Lastly, I would like to say a few words regarding the macroeconomic environment and European commercial real estate market. European economy continues to show signs of a gradual and sustained recovery. In the second quarter of 2016, Gross Domestic Product in the European Union or EU and the Euro area grew by 1.8% and 1.6% year-on-year respectively. Unemployment reached 8.6% in June 2016 from 9.5% in June of last year which coupled with rising disposable incomes should continue to fuel private consumption.

The International Monetary Fund or IMF recently arrived at full year 2016 forecast for the Euro area up by 0.1% to 1.6% reflecting robust vertical to 2016 results and from country fundamentals. However, the 2017 outlook area has been revised slightly downwards to 1.4% reflecting the anticipated mid-term impact of Brexit on the European economy.

Yesterday the Bank of England announced a series of measures designed to provide support to the UK economy post Brexit including a reduction in the interest rate from 0.5% to new record low of 0.25% and expansion of its quantitative easing program by 70 billion pounds. Leaving its 2016 GDP growth forecast unchanged at 2%, the Bank of England anticipated a climb in the UK economy in 2017 resulting in forecast GDP growth of 0.8%, 1.5% below its May projections.

The European Central Bank continues to pursue its quantitative easing program aiming to buy an average of 80 billion euros of corporate bonds per month and it's ready to act if necessary to ensure continued momentum in the economic recovery. Our continued expectation of the gradual sustained European recovery is underpinned by a combination of factors that are generally conducive of economic growth including low energy prices, low interest rates, a weaker Euro and Sterling and the prospect of further Central Bank intervention if necessary.

However, economic growth both globally and within the EU faces headwind that presents a potential risk to the pace of recovery and give rise to greater uncertainty. This uncertainty has been exasperated by Brexit. The prospect of Brexit has resulted in a high degree of uncertainty regarding the future of the UKs relationship with the EU as well as non-EU trading partners within their conduct straights or existing agreements that are accessing it through the membership of EU.

The process of exiting the EU is unprecedented and likely to be protracted and it is simply too early to assess the potential impact on the UK, European or global economy. Turning to the Real Estate markets, total European investment volume in the second quarter of 2016 stood at 53 million euros of which approximately 44% was in the office sector.

The decline in investment activity compared to the second quarter of 2015 was primarily driven by sharp fall in investment volume in the UK during the run up to the EU referendum on June 23. Post Brexit UK transaction data is limited and as such it is too early to draw conclusions. While the UK REITs continue to trade at discounts of their cheaper exit valuations, a sense of calm appears to have been restored in the private investment market and we understand the number of the UK open ended property funds have reduced the fair market value adjustments on the funds and reported stabilized levels of redemptions in capital flows.

Early indications are that the impacts on the prime UK properties maybe limited given their scarcity value and the advantageous currency impact for overseas investors given Sterling's post Brexit devaluation. Overall we expect some capital diversion from the United Kingdom to mainline Europe including towards Germany and France both of which recorded stable investment volumes throughout 2016 year-to-date.

Property yields remained at a significant premium to sovereign yields which have contracted further in recent weeks. The average of the 10 year German, UK and French government bond yields feel by approximately 29 basis points to just 39 basis points during the second quarter potentially placing further downward pressure on prime property yields.

Turning the discussion back to NRE, our $2.2 billion portfolio of 40 properties is a lease to blue chip and other high quality tenants in key cities across Europe. As of June 30, 2016 the had a combined bankable area of approximately 419,000 square meters and average occupancy rate of 85% and remaining weighted average leased time of approximately 6.5 years.

Earlier this year we announced a strategy of focusing on prime office properties in key cities of within our core markets of Germany, The United Kingdom and France. With our non-strategic properties being sold overtime. I am pleased to announce that we have made significant progress with the execution of the strategy having sold 9 primarily non-strategic properties year-to-date including two regional UK properties for a total sales price of approximately $300 million reflecting a 4% premium to the year end 2015 independent valuation conducted by Cushman & Wakefield.

And releasing approximately $130 million of net proceeds. Aside from generating significant liquidity for NRE, we are beginning to realize the ancillary benefits of executing our stated strategy in the form of a simplified business where we are now present in fewer countries resulting on anticipated structural cost savings overtime, a reduction in our leverage and lower cost of debt.

Since the inception of NRE we have developed a notable track record of actively managing our portfolio to enhance the income profile and value of our properties. The June 30, independent valuation of our real estate portfolio which resulted in a valuation of $2.2 billion reflecting interim currency movements and excluding approximately $300 million of assets sold year-to-date equates to an implied net asset value of approximately $17 per share.

Representing a significant premium to NREs current share price as described by the public market, we remain focused on eroding the current trading discount on NAV and I am knocking this embedded value for our shareholders. We continue to actively manage our core portfolio which has a value of approximately $1.9 billion based on the June 30 independent valuation and comprises of 24 properties in key cities of Germany, UK and France.

Represents 84% of the overall portfolio by values and generates approximately 80% of our total rental income. It has a combined area of approximately 245,000 square meters and average occupancy of 93% and the remaining weighted average lease time of 7 years as of June 30, 2016. Brexit is a recent event that further reaffirms our conviction in the business model that we have adopted at NRE.

We are in a desirable collection of prime office properties with a strong income profile. The quality of our portfolio coupled with its geographic diversification provides defensive characteristics while simultaneously allowing us the flexibility to adjust the allocation across our core markets overtime taking advantage of market opportunities as we seek to drive returns to shareholders.

With that I am pleased to announce that NRE delivered solid operating results during the second quarter of 2016 and we will now hand over to Scott Berry, our Chief Financial Officer to further discuss our financial results. Scott?

Scott Berry

Thank you, Mahbod. Good morning everyone and welcome to second quarter earnings call. NRE reported first quarter CAD of $13.4 million or $0.22 per share. We believe CAD is a good indicator of our operations and performance and among other metrics is an important factor when you are evaluating a dividend and operating strategy. We reported net operating income or NOI of $32.6 million for the second quarter 2016.

In comparison to the first quarter this year in the local currency, this was an increase of $8 million excluding its rent income. We believe NOI is a useful measure of the operating performance of our real estate portfolio. Included in our net loss after-tax is $8 million of gains in relation to asset sales, and $0.8 million of gains on the finance currency forwards which was expect to cap the quarter which is hedged by 15 month [ph].

For the non-asset souvenir [ph] the sales price was a weighted average premium of 4% independent valuation and in line with the depreciated PPA. An impairment charge of $27 million was recorded to adjust the depreciated current value of an asset sold subsequent to quarter end. The sales price was in line with the year end 2015 independent valuation of Cushman & Wakefield and represents the market value of the asset at this time.

This is a longer holding period assumption used to term and depreciate the value under US GAAP. As of the reporting date, the current value of all the assets is or at above the independent valuation. The change in NAV for $0.18 per share to $0.17 per share reflects the currency movement in GDP in Europe and our interim variations in the company's next cash position. In terms of liquidity, we repurchased approximately $4 million of NRE common stock for $48 million by the end of 2016.

Of which $2.3 million was made in the second quarter. We have a remaining balance of $52 million left in the share repurchase program approved in November 2015. During the second quarter we incurred $4 million of non-recurring CapEx and $1.5 million of costs of which majority was recoverable through service charges and primarily used to maintain the quality of our assets in the years to come.

In addition we repurchased $80 million of stock-settable notes through privately negotiated transactions with the remaining balance of the $110 million payable in December 2016. As I have always said 2016 NRE had an unrestricted cash balance of $166 million. On May 10, we got a $75 million revolving credit facility with Bank of America which may be used for general corporate and capital purposes and was used on a temporary basis to repurchase the stock-settable notes in the quarter.

The facility was fully repaid in July 2016. I am pleased to announce that we reducing NREs leverage to 55% compared to 58% in Q1 with those quarters activity resulting in an interest saving of $3 million in cash. On August 3, 2016, we declared a cash dividend of $0.15 per share of commonstock. This dividend is expected to be paid on August 19 to stockholders of record as of the close of business on August 15. Based on the closing share price of NRE on August 4, 2016, NRE's dividend yield is approximately 6.6%.

Overall, we are pleased with our financial performance in the quarter and progress in focusing on our core markets. We look forward to updating you on the development ahead for the quarters ahead. Operator?

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] And we'll go to Frank Lee with UBS.

Frank Lee

Can I talk about -- the lease that expired, what are your kinds of plan for back selling out this space, maybe how demand has been like?

Mahbod Nia

Hi Frank, it's Mahbod here. The Young [ph] space was actually in a property in [indiscernible] which has been sold during the quarter. So it's not really relevant to us anymore.

Frank Lee

Okay, great. I also noticed that KPN no longer showed up on the Top Ten tenant list. Where they also in the asset that was sold?

Mahbod Nia

Correct. That asset was also sold in the quarter.

Frank Lee

Okay, great. Thank you.

Operator

[Operator Instructions] And that concludes our question-and-answer session at this time. And it also concludes today's conference. We thank you for your participation. You may now disconnect.

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