CHAIRMAN'S STATEMENT - ANNUAL REPORT 2009
INVESTMENT PHILOSOPHY
CLS has an investment philosophy and a strategy to seek out and exploit imperfections in the market.
By this I mean that today’s prices and values will always be different in the future and CLS, therefore, tries to predict price movements and then position itself to benefit from them.
In order to achieve higher returns and minimise the associated higher risks, diversification is key; CLS’s main investment is in properties, but we have also invested in a portfolio of corporate bonds. Both asset classes cover a number of countries and currencies, and have exposure to different sectors. This diversification ensures that if some of the investments are unsuccessful the total return should still remain very good.
IMPERFECTIONS EXPLOITED
• In 2006, we anticipated significant falls in property values across Europe and embarked on a strategy to dispose of a number of properties. By the end of 2008 we had raised through sales almost £750 million, repaid associated debts, returned £72 million to investors and retained £150 million for subsequent investment. Consequently, whilst the UK listed property sector was repairing its collective balance sheet with right issues of over £6 billion, CLS was returning cash to shareholders.
• During the most critical period of the financial crisis we became uncomfortable with the outlook for the banking industry. In order to gain absolute protection for a large part of our liquid assets, we reduced our exposure to bank deposits and invested in government bonds.
• At the end of 2008, when we were convinced that the banking system would survive, we placed large cash deposits of 12 months’ duration at interest rates of 6.15% (sterling) and 4.9% (euro), expecting rates to fall. Within four to five months interest rates were virtually zero.
• Also in the autumn of 2008 we began to invest for the long term in a portfolio of liquid corporate bonds as we believed the prevailing market prices to be too low. In 2009 the bond portfolio provided a total return of £18.0 million, adding 37 pence per share to net asset value, and at 31 December 2009 the portfolio of £70.0 million was yielding over 8.1%. The increase in value of the bonds has not been included in profit before tax due to the long-term characteristics of this new investment.
• We broke several interest rate swaps in July 2009 as we were of the opinion that the yield curve was too steep and, therefore, the swaps were undervalued, which proved to be correct. In addition, we sought to increase the extent to which our interest rate risk was mitigated by caps rather than swaps, thereby allowing us to take advantage of the prevailing low interest rate environment whilst restricting our exposure to interest rate rises. At 31 December 2009 our weighted average cost of borrowing was 4.0% and 50% of our debt was at floating rates.
We believe CLS has served investors well; in the ten years since 2000, our total shareholder return has been 297%. Over the same period, using tender buy-backs and market purchases of shares, we have returned in aggregate £266 million to shareholders; in January 2000 CLS’s market capitalisation was £159 million. We believe that for the past ten years, CLS has been one of the three best performing property companies listed on the London Stock Exchange.
THE PORTFOLIO
In 2009, the property portfolio which we retained has performed well in difficult market conditions, a reflection of the strength of our rent roll and our team’s active management. 40% of the Group’s rental income is derived from governmental or quasi-governmental tenants, our weighted average lease length is 8.5 years, and our vacancy rate remains low at 4.5% by rental value. Further, our traditional focus on debt collection has consistently seen collection rates exceed 90% within a few days of the due date during the year.
The portfolio’s valuation at 31 December 2009 reflected the defensive benefits of well-let properties. In the UK, our portfolio began to rise in value in the first half of the year, and over the twelve months showed a gain of 7.5%. In recent years the French market has been less volatile than the UK, rising neither as quickly nor as far, and falling more slowly. In 2009 our French portfolio declined in value by 6.2% in local currency and the German portfolio by 5.7%.
FINANCIALS
Net assets per share at 31 December 2009, adjusted to exclude deferred tax, were 767.5 pence, 18.6% higher than a year earlier, and 4.8% above the pro forma equivalent of 732.0 pence, after the effect of the large tender offer in January 2009. This is a good result in the light of the adverse 36.0 pence impact of sterling strengthening during the period.
PROPERTY INVESTMENT
In the prevailing economic climate, we have been rigorous in assessing investment opportunities in 2009, restricting our acquisitions to the £29.2 million 7 Rue Eugène et Armand Peugeot, Rueil-Malmaison, to the west of Paris, a transaction which was completed at the end of December. Our only disposal in the year was 2 Deanery Street, London W1 for £2.2 million.
The UK market is now characterised by a far greater demand for property investment than supply and banking conditions remain relatively unfavourable. We see greater value and better conditions in both France and Germany and we will seek to take advantage of opportunities in these markets in the short to medium term.
CASH MANAGEMENT
During a year of uncertain property and financial markets, effective cash management has been key. With poor returns available from bank deposits, the Board sought to manage the Group’s cash resources by exploiting opportunities which arose in the corporate bond market as explained above. The corporate bond portfolio is a part of the Company’s long-term investment strategy.
A further initiative successfully executed in 2009 was the avoidance of potential breaches of covenants of bank loans with an aggregate value of £176.4 million, by repaying or placing on deposit new cash of £14.3 million. The fact that this was achieved at a time of significant banking turmoil is testament to the good relationships we enjoy with our principal lenders.
With the reduction in the appetite of banks to lend, it is encouraging that very little of our borrowing matures over the next two years.
EFFICIENCY
We successfully implemented a cost-cutting programme before the financial crisis began. In May 2008 we moved to cheaper premises in one of our own buildings and slimmed down the organisation, successfully reducing our administration costs from £16.1 million in 2008 to £12.2 million in 2009.
We believe that environmentally safe and energy-efficient buildings are both commercially beneficial and socially desirable. For this reason we incorporate environmentally effective features in our developments and convert or modify as many properties as possible. This provides an advantage in letting the buildings, creating benefits to tenants, who enjoy higher quality buildings, lower running costs and a healthier environment, and it provides cost savings for the Group and added investment value. At Solna Business Park in Sweden we developed buildings with geothermal heating and cooling systems, which cut running costs significantly, and met high specifications for air quality, sound proofing and illumination. Both of our recent developments in Germany, at Landshut and Bochum, were designed to comply with the ENEV requirements on energy saving, and at Landshut ground water is used in the cooling system for the office space. We intend to extend this programme of energy efficiency across the portfolio.
DISTRIBUTIONS
Following the substantial returns of cash to shareholders in late 2008 and early 2009, and with the share price at a discount of over 40% to adjusted net assets per share, we believe this is an appropriate time to restore our distribution policy. Accordingly, we propose to recommend a tender offer buy-back of 1 in 42 shares at 525 pence per share, and a general meeting to consider this will be convened for early April.
APPOINTMENTS
In November we welcomed John Whiteley to the Board as Chief Financial Officer, and Thomas Lundqvist succeeded Tom Thomson as Vice Chairman. In addition, David Fuller was appointed Company Secretary. I would like to thank my Board colleagues and our staff for their fortitude during demanding times, and our shareholders, lenders, customers and suppliers
for their continued support.
THE FUTURE
We operate in difficult markets, with banks seeking to reduce their exposure to the real estate sector. Good property deals, such as our recent French acquisition, are scarce. The fundamentals of our business remain sound. We have resources available to take advantage of opportunities as they arise and I am delighted to report that we face the challenges ahead from a position of strength and confidence.
Sten Mortstedt
Executive Chairman
11 March 2010
CLS has an investment philosophy and a strategy to seek out and exploit imperfections in the market.
By this I mean that today’s prices and values will always be different in the future and CLS, therefore, tries to predict price movements and then position itself to benefit from them.
In order to achieve higher returns and minimise the associated higher risks, diversification is key; CLS’s main investment is in properties, but we have also invested in a portfolio of corporate bonds. Both asset classes cover a number of countries and currencies, and have exposure to different sectors. This diversification ensures that if some of the investments are unsuccessful the total return should still remain very good.
IMPERFECTIONS EXPLOITED
• In 2006, we anticipated significant falls in property values across Europe and embarked on a strategy to dispose of a number of properties. By the end of 2008 we had raised through sales almost £750 million, repaid associated debts, returned £72 million to investors and retained £150 million for subsequent investment. Consequently, whilst the UK listed property sector was repairing its collective balance sheet with right issues of over £6 billion, CLS was returning cash to shareholders.
• During the most critical period of the financial crisis we became uncomfortable with the outlook for the banking industry. In order to gain absolute protection for a large part of our liquid assets, we reduced our exposure to bank deposits and invested in government bonds.
• At the end of 2008, when we were convinced that the banking system would survive, we placed large cash deposits of 12 months’ duration at interest rates of 6.15% (sterling) and 4.9% (euro), expecting rates to fall. Within four to five months interest rates were virtually zero.
• Also in the autumn of 2008 we began to invest for the long term in a portfolio of liquid corporate bonds as we believed the prevailing market prices to be too low. In 2009 the bond portfolio provided a total return of £18.0 million, adding 37 pence per share to net asset value, and at 31 December 2009 the portfolio of £70.0 million was yielding over 8.1%. The increase in value of the bonds has not been included in profit before tax due to the long-term characteristics of this new investment.
• We broke several interest rate swaps in July 2009 as we were of the opinion that the yield curve was too steep and, therefore, the swaps were undervalued, which proved to be correct. In addition, we sought to increase the extent to which our interest rate risk was mitigated by caps rather than swaps, thereby allowing us to take advantage of the prevailing low interest rate environment whilst restricting our exposure to interest rate rises. At 31 December 2009 our weighted average cost of borrowing was 4.0% and 50% of our debt was at floating rates.
We believe CLS has served investors well; in the ten years since 2000, our total shareholder return has been 297%. Over the same period, using tender buy-backs and market purchases of shares, we have returned in aggregate £266 million to shareholders; in January 2000 CLS’s market capitalisation was £159 million. We believe that for the past ten years, CLS has been one of the three best performing property companies listed on the London Stock Exchange.
THE PORTFOLIO
In 2009, the property portfolio which we retained has performed well in difficult market conditions, a reflection of the strength of our rent roll and our team’s active management. 40% of the Group’s rental income is derived from governmental or quasi-governmental tenants, our weighted average lease length is 8.5 years, and our vacancy rate remains low at 4.5% by rental value. Further, our traditional focus on debt collection has consistently seen collection rates exceed 90% within a few days of the due date during the year.
The portfolio’s valuation at 31 December 2009 reflected the defensive benefits of well-let properties. In the UK, our portfolio began to rise in value in the first half of the year, and over the twelve months showed a gain of 7.5%. In recent years the French market has been less volatile than the UK, rising neither as quickly nor as far, and falling more slowly. In 2009 our French portfolio declined in value by 6.2% in local currency and the German portfolio by 5.7%.
FINANCIALS
Net assets per share at 31 December 2009, adjusted to exclude deferred tax, were 767.5 pence, 18.6% higher than a year earlier, and 4.8% above the pro forma equivalent of 732.0 pence, after the effect of the large tender offer in January 2009. This is a good result in the light of the adverse 36.0 pence impact of sterling strengthening during the period.
PROPERTY INVESTMENT
In the prevailing economic climate, we have been rigorous in assessing investment opportunities in 2009, restricting our acquisitions to the £29.2 million 7 Rue Eugène et Armand Peugeot, Rueil-Malmaison, to the west of Paris, a transaction which was completed at the end of December. Our only disposal in the year was 2 Deanery Street, London W1 for £2.2 million.
The UK market is now characterised by a far greater demand for property investment than supply and banking conditions remain relatively unfavourable. We see greater value and better conditions in both France and Germany and we will seek to take advantage of opportunities in these markets in the short to medium term.
CASH MANAGEMENT
During a year of uncertain property and financial markets, effective cash management has been key. With poor returns available from bank deposits, the Board sought to manage the Group’s cash resources by exploiting opportunities which arose in the corporate bond market as explained above. The corporate bond portfolio is a part of the Company’s long-term investment strategy.
A further initiative successfully executed in 2009 was the avoidance of potential breaches of covenants of bank loans with an aggregate value of £176.4 million, by repaying or placing on deposit new cash of £14.3 million. The fact that this was achieved at a time of significant banking turmoil is testament to the good relationships we enjoy with our principal lenders.
With the reduction in the appetite of banks to lend, it is encouraging that very little of our borrowing matures over the next two years.
EFFICIENCY
We successfully implemented a cost-cutting programme before the financial crisis began. In May 2008 we moved to cheaper premises in one of our own buildings and slimmed down the organisation, successfully reducing our administration costs from £16.1 million in 2008 to £12.2 million in 2009.
We believe that environmentally safe and energy-efficient buildings are both commercially beneficial and socially desirable. For this reason we incorporate environmentally effective features in our developments and convert or modify as many properties as possible. This provides an advantage in letting the buildings, creating benefits to tenants, who enjoy higher quality buildings, lower running costs and a healthier environment, and it provides cost savings for the Group and added investment value. At Solna Business Park in Sweden we developed buildings with geothermal heating and cooling systems, which cut running costs significantly, and met high specifications for air quality, sound proofing and illumination. Both of our recent developments in Germany, at Landshut and Bochum, were designed to comply with the ENEV requirements on energy saving, and at Landshut ground water is used in the cooling system for the office space. We intend to extend this programme of energy efficiency across the portfolio.
DISTRIBUTIONS
Following the substantial returns of cash to shareholders in late 2008 and early 2009, and with the share price at a discount of over 40% to adjusted net assets per share, we believe this is an appropriate time to restore our distribution policy. Accordingly, we propose to recommend a tender offer buy-back of 1 in 42 shares at 525 pence per share, and a general meeting to consider this will be convened for early April.
APPOINTMENTS
In November we welcomed John Whiteley to the Board as Chief Financial Officer, and Thomas Lundqvist succeeded Tom Thomson as Vice Chairman. In addition, David Fuller was appointed Company Secretary. I would like to thank my Board colleagues and our staff for their fortitude during demanding times, and our shareholders, lenders, customers and suppliers
for their continued support.
THE FUTURE
We operate in difficult markets, with banks seeking to reduce their exposure to the real estate sector. Good property deals, such as our recent French acquisition, are scarce. The fundamentals of our business remain sound. We have resources available to take advantage of opportunities as they arise and I am delighted to report that we face the challenges ahead from a position of strength and confidence.
Sten Mortstedt
Executive Chairman
11 March 2010
