REG - Derwent London PLC - INTERIM RESULTS FOR THE SIX MONTHS ENDED 30 JUNE <Origin Href="QuoteRef">DLN.L</Origin> - Part 5
29/10/2014 12:44
- Part 5: For the preceding part double click ID:nRSN0758Pd
· Inconsistent strategyThe Group's strategy is inconsistent with the state of the market in which it operates. · The Group carries out a five-year strategic review each year and also prepares an annual budget and three rolling · The last annual strategic review was carried out by the Board in June 2014. This considered the sensitivity of six key measures to changes in underlying assumptions including timing of projects, capital recycling, rental levels and property values. · The three rolling forecasts prepared during the year focus on the same key measures but consider the effect of varying different assumptions to reflect changing economic and market conditions. · The timing of the Group's development programme and the strategies for individual properties reflect the outcome of these considerations.
· Inconsistent development programmeThe Group's development programme is not consistent with the economic cycle. forecasts which cover the next two years. In the course of preparing these documents the Board considers the effect on the
· During the year the Group's loan-to-value ratio remained below 30%, its net interest cover ratio was above 285% and the REIT ratios were comfortably met.
The Group currently benefits from a strong central London market which could be adversely affected by a number of high level economic or political factors. This would reduce the value of the Group's portfolio with a consequent effect on two of its KPIs - total return and total property return. Group's KPIs and key ratios caused by changing the main underlying assumptions to reflect different economic scenarios. ·
The Group's plans can then be set so as to best realise its long-term strategic goals given the expected economic and market
conditions. This flexibility arises from the policy of maintaining income from properties for as long as possible until
development starts. · Over 50% of the Group's portfolio has been identified for future redevelopment. This enables the
Board to delay marginal projects until market conditions are favourable.
· The risk remains significant and therefore in forming its plans the Board pays particular attention to maintaining
sufficient headroom in all the Group's key ratios, financial covenants and interest cover.
· Regulatory non-complianceThe Group's cost base is increased and management time diverted through a breach of any of the legislation that forms the regulatory framework within which the Group operates. An increase in costs would directly impact on the Group's total return KPI. A significant diversion of management time could affect a wider range of key metrics. · The Group's Risk Committee reports to the Board concerning regulatory risk. · The Group employs a Health and Safety · A Health and Safety report is presented at all Executive Committee and main Board meetings. · The Executive Committee receives regular reports from the sustainability manager.
manager. · The Group employs a Sustainability manager who reports to the Sustainability Committee which is chaired by Paul
· The Group pays considerable attention to sustainability issues and produces a Sustainability Report annually.
Williams. · The Company's policies including those on the Bribery Act, Health and Safety, Equal Opportunities, Harassment
and Whistleblowing are available to all staff on the Company intranet and in the Group's Staff Handbook.
· Reputational damageThe Group's reputation is damaged through unauthorised and inaccurate media coverage. · All new members of staff benefit from an induction programme and are issued with the Group's Staff Handbook. · Social · The Group employs a Head of Investor and Corporate Communications and retains the services of an external PR agency. Both maintain regular contact with external media sources. · The Group engages with a number of local community bodies in areas where it operates as part of its CSR activity.
This risk would most directly impact on the Group's total shareholder return - one of its key metrics. Indirectly it could impact on a number of the formal KPIs. media channels are monitored. · The Group takes advice on technological changes in the use of media and adapts its approach
accordingly. · There is an agreed procedure for approving all external statements.
Financial risks
That the Group becomes unable to meet its financial obligations or finance the business appropriately.
Risk, effect and progression Controls and mitigation Action
· Higher interest ratesFinancing costs are higher due to increases in interest rates. · The Group uses interest rate derivatives to "top up" the amount of fixed rate debt to a level commensurate with the perceived risk to the Group. · In 2013 the Group terminated two interest rate swaps which were at historic rates and initiated new instruments which have locked in the lower long-term rates that are currently available. · 98% of borrowings were fixed or hedged at the half year end. · Additional 15 and 20-year fixed rate debt was put in place in January 2014.
This risk would affect the Group's interest cover ratio KPI.
· Increase in interest ratesIncreases in interest rates can lead to higher property yields which cause property values to fall. · The impact of such changes on the Group's financial covenants and performance are monitored regularly and are subject to sensitivity analysis to ensure that adequate headroom is preserved. · The Group produces three rolling forecasts each year which contain detailed sensitivity analyses. · Quarterly management accounts report on the Group's performance against covenants. · Project appraisals are regularly reviewed and updated. · Changes to the Group's financing profile during 2013 have simplified the management of its financial covenants.
This would affect the following KPIs:
· The impact of yield changes is considered when potential projects are appraised.
o Loan-to-value ratio.o Total return.o Total property return. Interest rates have remained low for an extended period of time and yields are at or near
historic lows. With the UK's improving economic background, gilt rates rose in 2013, but have subsequently fallen in H1 2014 and a base rate rise is likely within the
next year. Though there is no direct relationship, property yields may soften in due course.
Operational risks
The Group suffers either a loss or adverse consequences due to processes being inadequate or not operating correctly.
Risk, effect and progression Controls and mitigation Action
· Reduced development returnsThe Group's development projects do not produce the anticipated financial return due to one or more of the following factors: · Standardised appraisals including contingencies are prepared for all investments and sensitivity analysis is undertaken to ensure that an adequate return is made in all circumstances considered likely to occur. · The scale of the Group's development programme is managed to reflect anticipated market conditions. · Regular cost reports are produced for the Executive Committee and the Board that monitor progress of actual expenditure against budget. This allows potential adverse variances to be identified and addressed at an early stage. · Post completion reviews are carried out for all major developments to ensure that improvements to the Group's procedures are identified and implemented. · Alternative procurement methods are being evaluated as a way of minimising · The Group is advised by top planning consultants and has considerable in-house planning expertise. · Executive Directors represent the Group on a number of
: Delays in the planning process.: Delays due to contractors/ sub-contractors defaulting.: Increased construction costs.: Adverse letting conditions. This would have an effect on the Group's total return and total property return KPIs. the effect of increased construction costs. local bodies which ensures that it remains aware of local issues. · The procurement process used by the Group includes the use of highly regarded firms of quantity
surveyors and is designed to minimise uncertainty regarding costs. · Development costs are benchmarked to ensure that the Group obtains competitive pricing. · The
Group's style of accommodation remains in demand as evidenced by the 27 lettings achieved in the first half of 2014 which totalled 89,800 sq ft. · The Group has
secured significant pre-lets of the space in its current development programme which significantly "de-risks" these projects.
· Tenant defaultThe Group suffers a loss of rental income and increased vacant property costs due to tenants vacating or becoming bankrupt. Low levels of growth in the UK economy could lead to an increase in tenant business failure. · All prospective tenants are considered by the Group's Credit Committee and security is taken where appropriate either in the form of parent company guarantees or rent deposits.· The Group's property managers maintain regular contact with tenants and work closely with any that are facing financial difficulties. · The Group's credit committee regularly reviews a list of slow payers and considers what actions should be taken. · The Group has a diversified tenant base. · The credit committee meets each week and considered 63 potential tenants in the first half of 2014. · In total
This risk would have an immediate effect on the Group's tenant receipts and void management KPIs and, if significant, on the total property return, total return and interest cover ratio. the Group holds rental deposits amounting to £10.0m. · On average during the first half of the year, the Group has collected 99% of the rents due within 14 days of
the due date.
· Shortage of key staffThe Group is unable to successfully implement its strategy due to a failure to recruit and retain key staff with appropriate skills. This risk could impact on any of the Group's KPIs. · The remuneration packages of all employees are bench-marked regularly. · Six-monthly appraisals identify training requirements which are fulfilled over the next six months. · The Nominations Committee considers succession matters as a standard agenda item. · The Group recruited six new members of staff during the first half of 2014. · Staff turnover during the first half of 2014 was low at 4%.
Financial instruments - risk management
The Group is exposed through its operations to the following financial risks:
· credit risk;
· fair value or cash flow interest rate risk; and
· liquidity risk.
In common with all other businesses, the Group is exposed to risks that arise from its use of financial instruments. The
following describes the Group's objectives, policies and processes for managing those risks and the methods used to measure
them. Further quantitative information in respect of these risks is presented throughout these financial statements.
There have been no substantive changes in the Group's exposure to financial instrument risks, its objectives, policies and
processes for managing those risks or the methods used to measure them from previous periods.
Principal financial instruments
The principal financial instruments used by the Group, from which financial instrument risk arises, are trade receivables,
cash at bank, trade and other payables, floating rate bank loans, fixed rate loans and private placement notes, secured and
unsecured bonds and interest rate swaps.
General objectives, policies and processes
The Board has overall responsibility for the determination of the Group's risk management objectives and policies and,
whilst retaining ultimate responsibility for them, it has delegated the authority for designing and operating processes
that ensure the effective implementation of the objectives and policies to executive management.
The overall objective of the Board is to set policies that seek to reduce risk as far as possible without unduly affecting
the Group's flexibility and its ability to maximise returns. Further details regarding these policies are set out below:
Credit risk
Credit risk is the risk of financial loss to the Group if a customer or counterparty to a financial instrument fails to
meet its contractual obligations. The Group is mainly exposed to credit risk from lease contracts in relation to its
property portfolio. It is Group policy to assess the credit risk of new tenants before entering into such contracts. The
Board has established a credit committee which assesses each new tenant before a new lease is signed. The review includes
the latest sets of financial statements, external ratings, when available, and, in some cases, forecast information and
bank and trade references. The covenant strength of each tenant is determined based on this review and, if appropriate, a
deposit or a guarantee is obtained.
As the Group operates predominantly in central London, it is subject to some geographical risk. However, this is mitigated
by the wide range of tenants from a broad spectrum of business sectors.
Credit risk also arises from cash and cash equivalents and deposits with banks and financial institutions. For banks and
financial institutions, only independently rated parties with minimum rating of investment grade are accepted. This risk is
also reduced by the short periods that money is on deposit at any one time.
The carrying amount of financial assets recorded in the financial statements represents the Group's maximum exposure to
credit risk without taking account of the value of any collateral obtained.
Market risk
Market risk arises from the Group's use of interest bearing instruments. It is the risk that the fair value or future cash
flows of a financial instrument will fluctuate because of changes in interest rates (interest rate risk).
Fair value and cash flow interest rate risk
The Group is exposed to cash flow interest rate risk from borrowings at variable rates. It is currently Group policy that
generally between 60% and 85% of external Group borrowings (excluding finance lease payables) are at fixed rates. Where the
Group wishes to vary the amount of external fixed rate debt it holds (subject to it being generally between 60% and 85% of
expected Group borrowings, as noted above), the Group makes use of interest rate derivatives to achieve the desired
interest rate profile. Although the Board accepts that this policy neither protects the Group entirely from the risk of
paying rates in excess of current market rates nor eliminates fully cash flow risk associated with variability in interest
payments, it considers that it achieves an appropriate balance of exposure to these risks. At 30 June 2014, the proportion
of fixed debt held by the Group was above this range at 98%. During both 2014 and 2013, the Group's borrowings at variable
rate were denominated in sterling.
The Group monitors the interest rate exposure on a regular basis. The Group manages its cash flow interest rate risk by
using floating-to-fixed interest rate swaps. The Group generally raises long-term borrowings at fixed rates.
Liquidity risk
Liquidity risk arises from the Group's management of working capital and the finance charges and principal repayments on
its debt instruments. It is the risk that the Group will encounter difficulty in meeting its financial obligations as they
fall due.
The Group's policy is to ensure that it will always have sufficient headroom in its loan facilities to allow it to meet its
liabilities when they become due. To achieve this aim, it seeks to maintain committed facilities to meet the expected
requirements. The Group also seeks to reduce liquidity risk by fixing interest rates (and hence cash flows) on a portion of
its long-term borrowings. This is further explained in the 'fair value and cash flow interest rate risk' section above.
The executive management receives rolling three-year projections of cash flow and loan balances on a regular basis as part
of the Group's forecasting processes. At the balance sheet date, these projections indicated that the Group expected to
have sufficient liquid resources to meet its obligations under all reasonably expected circumstances.
The Group's loan facilities and other borrowings are spread across a range of banks and financial institutions so as to
minimise any potential concentration of risk. The liquidity risk of the Group is managed centrally by the finance
department.
Capital disclosures
The Group's capital comprises all components of equity (share capital, share premium, other reserves, retained earnings and
minority interest).
The Group's objectives when maintaining capital are:
· to safeguard the entity's ability to continue as a going concern so that it can continue to provide above average
long-term returns for shareholders; and
· to provide an above average annualised total return to shareholders.
The Group sets the amount of capital it requires in proportion to risk. The Group manages its capital structure and makes
adjustments to it in light of changes in economic conditions and the risk characteristics of the underlying assets. In
order to maintain or adjust the capital structure, the Group may adjust the amount of dividends paid to shareholders,
return capital to shareholders, issue new shares or sell assets to reduce debt. Consistent with others in its industry, the
Group monitors capital on the basis of NAV gearing and the loan-to-value ratio. During 2014, the Group's strategy, which
was unchanged from 2013, was to maintain the NAV gearing below 80% in normal circumstances. These two gearing ratios, as
well as the interest cover ratio, are defined at the end of this announcement and are derived in note 21.
26. List of definitions
Capital return
The annual valuation movement arising on the Group's portfolio expressed as a percentage return on the valuation at the
beginning of the year adjusted for acquisitions and capital expenditure.
Diluted figures
Reported results adjusted to include the effects of potential dilutive shares issuable under the Group's share option
schemes and the convertible bonds.
Earnings/earnings per share (EPS)
Earnings represent the profit or loss for the period attributable to equity shareholders and are divided by the weighted
average number of ordinary shares in issue during the financial period to arrive at earnings per share.
Estimated rental value (ERV)
This is the external valuers' opinion as to the open market rent which, on the date of valuation, could reasonably be
expected to be obtained on a new letting or rent review of a property.
European Public Real Estate Association (EPRA)
A not-for-profit association with a membership of Europe's leading property companies, investors and consultants which
strives to establish best practices in accounting, reporting and corporate governance and to provide high-quality
information to investors. EPRA's Best Practices Recommendations includes guidelines for the calculation of the following
performance measures which the Group has adopted.
- EPRA earnings per share
Recurring earnings from core operational activities.
- EPRA net asset value per share
NAV adjusted to include properties and other investment interests at fair value and to exclude certain items not expected
to crystallise in a long-term investment property business model.
- EPRA triple net asset value per share
EPRA NAV adjusted to include the fair values of (i) financial instruments, (ii) debt and (iii) deferred taxes on
revaluations, where applicable.
- EPRA cost ratio (including direct vacancy costs)
EPRA costs as a percentage of gross rental income less ground rent (including share of joint venture gross rental income
less ground rent). EPRA costs include administrative expenses, other property costs, net service charge costs and the share
of joint ventures' overheads and operating expenses (net of any service charge costs), adjusted for service charge costs
recovered through rents and management fees.
- EPRA cost ratio (excluding direct vacancy costs)
Calculated as above, but with an adjustment to exclude direct vacancy costs.
- EPRA net initial yield (NIY)
Annualised rental income based on the cash rents passing at the balance sheet date, less non-recoverable property operating
expenses, divided by the market value of the EPRA property portfolio, increased by estimated purchasers' costs.
- EPRA "topped-up" net initial yield
This measure incorporates an adjustment to the EPRA NIY in respect of the expiration of rent free periods (or other
unexpired lease incentives such as discounted rent periods and stepped rents).
- EPRA vacancy rate
Estimated rental value (ERV) of immediately available space divided by ERV of the EPRA portfolio.
- EPRA like-for-like rental income growth
The growth in rental income on properties owned throughout the current and previous periods under review. This growth rate
includes revenue recognition and lease accounting adjustments but excludes properties held for development in either
period, surrender premiums and properties acquired or disposed of in either period.
Fair value movement
An accounting adjustment to change the book value of an asset or liability to its market value.
Ground rent
The rent payable by the Group for its leasehold properties. Under IFRS, these leases are treated as finance leases and the
cost allocated between interest payable and property outgoings.
Headroom
This is the amount left to draw under the Group's loan facilities, i.e. the total loan facilities less amounts already
drawn.
Interest rate swap
A financial instrument where two parties agree to exchange an interest rate obligation for a predetermined amount of time.
These are generally used by the Group to convert floating rate debt to fixed rates.
Investment Property Databank Limited (IPD)
IPD is a company that produces independent benchmarks of property returns. The Group measures its performance against both
the Central London Offices Index and the All UK Property Index.
Key Performance Indicators (KPIs)
Activities and behaviours, aligned to both business objectives and individual goals, against which the performance of the
Group is assessed.
Lease incentives
Any incentive offered to occupiers to enter into a lease. Typically the incentive will be an initial rent free or half rent
period, stepped rents, or a cash contribution to fit-out or similar costs.
Loan-to-value ratio (LTV)
Drawn debt divided by the fair value of the property portfolio. Drawn debt is equal to drawn facilities less cash and the
unamortised equity element of the convertible bonds.
Mark-to-market
The difference between the book value of an asset or liability and its market value.
NAV gearing
Net debt divided by net assets.
Net assets per share or net asset value (NAV)
Equity shareholders' funds divided by the number of ordinary shares in issue at the balance sheet date.
Net debt
Borrowings and derivative financial instruments plus bank overdraft less cash and cash equivalents.
Net interest cover ratio
Net property income, excluding other income, net surrender premiums received and reverse surrender premiums, divided by
interest payable on borrowings and non-utilisation fees.
Property income distribution (PID)
Dividends from profits of the Group's tax-exempt property rental business under the REIT regulations.
Non-PID
Dividends from profits of the Group's taxable residual business.
Real Estate Investment Trust (REIT)
The Government established REIT status in the UK on 1 January 2007 to remove tax inequalities between different real estate
investors and aimed to improve overall investor access to real estate. REITs are companies which are exempt from corporate
taxation on profits from property rental income and capital gains on the sale of investment properties. REITs must
distribute 90% of profits from rental income in the form of property income dividends (PIDs). This makes the tax
implications of investing in REITs equivalent to investing directly in property. REITs are also required to meet certain
conditions including the proportion of total profits and assets accounted for by their property rental businesses. They
remain liable to corporation tax on non-property investment businesses e.g. management fees and interest receivable.
Derwent London has been a REIT since 1 July 2007.
Rent reviews
Rent reviews take place at intervals agreed in the lease (typically every five years) and their purpose is usually to
adjust the rent to the current market level at the review date. For upwards only rent reviews, the rent will either remain
at the same level or increase (if market rents are higher) at the review date.
Reversion
The reversion is the amount by which ERV is higher than the rent roll of a property or portfolio. The reversion is derived
from contractual rental increases, rent reviews, lease renewals and the letting of vacant space.
Scrip dividend
Derwent London offers its shareholders the opportunity to receive dividends in the form of shares instead of cash. This is
known as a scrip dividend.
Total property return
The annual capital appreciation, net of capital expenditure, plus the net annual rental income received, expressed as a
percentage of capital employed (property value at the beginning of the period plus capital expenditure).
Total return
The movement in EPRA net asset value per share on a diluted basis between the beginning and the end of each financial
period plus the dividend per share paid during the period expressed as a percentage of the EPRA net asset value per share
on a diluted basis at the beginning of the year.
Total shareholder return
The growth in the ordinary share price as quoted on the London Stock Exchange plus dividends per share received for the
period, expressed as a percentage of the share price at the beginning of the year.
Underlying portfolio
Properties that have been held for the whole of the period, i.e. excluding any acquisitions or disposals made during the
period.
Underlying valuation increase
The valuation increase on the underlying portfolio.
Yields
- Net initial yield
Annualised rental income based on cash rents passing at the balance sheet date, less non-recoverable property operating
expenses, divided by the market value of the property, increased by estimated purchasers' costs.
- Reversionary yield
The anticipated yield, which the net initial yield will rise to once the rent reaches the estimated rental values.
- True equivalent yield
The constant capitalisation rate which, if applied to all cash flows from the portfolio, including current rent, reversions
to valuers' estimated rental value and such items as voids and expenditures, equates to the valuation having taken into
account notional purchasers' costs. Rent is assumed to be received quarterly in advance.
- Yield shift
A movement in the yield of a property asset, or like-for-like portfolio, over a given period. Yield compression is a
commonly-used term for a reduction in yields.
27. Copies of this announcement will be available on the company's website, www.derwentlondon.com, from the date of this
statement. Copies will also be available from the Company Secretary, Derwent London plc, 25 Savile Row, London, W1S 2ER.
Independent review report to Derwent London plc
Report on the condensed consolidated interim financial statements
Our conclusion
We have reviewed the condensed consolidated interim financial statements, defined below, contained in the interim results
of Derwent London plc for the six months ended 30 June 2014. Based on our review, nothing has come to our attention that
causes us to believe that the condensed consolidated interim financial statements are not prepared, in all material
respects, in accordance with International Accounting Standard 34 as adopted by the European Union and the Disclosure and
Transparency Rules of the United Kingdom's Financial Conduct Authority.
This conclusion is to be read in the context of what we say in the remainder of this report.
What we have reviewed
The condensed consolidated interim financial statements, which are prepared by Derwent London plc, comprise:
· the Group condensed balance sheet as at 30 June 2014;
· the Group condensed income statement and statement of comprehensive income for the period then ended;
· the Group condensed cash flow statement for the period then ended;
· the Group condensed statement of changes in equity for the period then ended; and
· the explanatory notes to the Group condensed interim financial statements.
As disclosed in note 1, the financial reporting framework that has been applied in the preparation of the full annual
financial statements of the Group is applicable law and International Financial Reporting Standards (IFRSs) as adopted by
the European Union.
The condensed consolidated interim financial statements included in the interim results have been prepared in accordance
with International Accounting Standard 34, 'Interim Financial Reporting', as adopted by the European Union and the
Disclosure and Transparency Rules of the United Kingdom's Financial Conduct Authority.
What a review of condensed consolidated financial statements involves
We conducted our review in accordance with International Standard on Review Engagements (UK and Ireland) 2410, 'Review of
Interim Financial Information Performed by the Independent Auditor of the Entity' issued by the Auditing Practices Board
for use in the United Kingdom. A review of interim financial information consists of making enquiries, primarily of persons
responsible for financial and accounting matters, and applying analytical and other review procedures.
A review is substantially less in scope than an audit conducted in accordance with International Standards on Auditing (UK
and Ireland) and, consequently, does
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