Financial review

Overview

Table 1: Highlights

1.    Including our proportionate share of subsidiaries and joint ventures, as explained in the Presentation of financial information below.

2.    Pro forma Group LTV is adjusted for the £475m capital distribution to shareholders, which was paid in October 2017.

In the property markets in which we operate, valuations were broadly unchanged as investor demand for well-let prime assets remained strong. Despite the backdrop of increasing political and economic uncertainty, high quality income remained attractive in a low interest rate environment. This was evidenced by the sale of our 50% share of 20 Fenchurch Street, EC3 at record pricing. As this was an unplanned disposal and we already had low gearing with plenty of firepower, we chose to return the majority of the proceeds to shareholders in the form of a capital distribution, accompanied by a 15 for 16 share consolidation.

During the period, we took advantage of strong demand for long dated bonds, issuing a total of £1bn of 20 and 40 year notes as part of a debt management exercise to lock into low long-term interest rates and lengthen the overall term of our debt. We also redeemed the Queen Anne's Gate Bond in its entirety.

Over the six months, our assets fell in value by 0.1% or £19m (including our proportionate share of subsidiaries and joint ventures) compared with a £260m reduction in the first six months of last year. This marginal decline in asset values, together with the costs associated with the redemption of certain outstanding bonds, is behind the loss per share of 4.3p (12.1p loss in the comparative period). Basic and adjusted diluted net assets per share have increased as a result of the share consolidation associated with the £475m return of capital to shareholders. The Group has delivered good underlying earnings growth; revenue profit was up 5.2% from £193m to £203m and adjusted diluted earnings per share were up 5.8% at 25.7p.

Presentation of financial information

Our property portfolio is a combination of properties that are wholly owned by the Group, part owned through joint arrangements and those owned by the Group but where a third party holds a non-controlling interest. Internally, management review the results of the Group on a basis that adjusts for these forms of ownership to present a proportionate share. The Combined Portfolio, with assets totalling £14.2bn, is an example of this approach, reflecting the economic interest we have in our properties regardless of our ownership structure. We consider this presentation provides a better explanation to stakeholders of the activities and performance of the Group, as it aggregates the results of all of the Group's property interests which under IFRS are required to be presented across a number of line items in the statutory financial statements.

The same principle is applied to many of the other measures we discuss and, accordingly, a number of our financial measures include the results of our joint ventures and subsidiaries on a proportionate basis. Measures that are described as being presented on a proportionate basis include the Group's share of joint ventures on a line-by-line basis, but exclude the non-owned elements of our subsidiaries. This is in contrast to the Group's statutory financial statements, where the Group's interest in joint ventures is presented as one line on the income statement and balance sheet, and all subsidiaries are consolidated at 100% with any non-owned element being adjusted as a non-controlling interest or redemption liability, as appropriate. Our joint operations are presented on a proportionate basis in all financial measures.

Most of the measures discussed in this Financial review are presented on a proportionate basis. Measures presented on a proportionate basis are alternative performance measures as they are not defined under IFRS. For further details see table 15 in the Business analysis section.

Income statement

Our income statement has two key components: the income we generate from leasing our investment properties net of associated costs (including finance expense), which we refer to as revenue profit, and items not directly related to the underlying rental business, principally valuation changes, profits or losses on the disposal of properties and exceptional items, which we refer to as Capital and other items.

We present two measures of earnings per share; the IFRS measure of earnings per share is based on the total profit for the period attributable to owners of the parent, while adjusted diluted earnings per share is based on tax-adjusted revenue profit, referred to as adjusted earnings.

Table 2: Income statement

Our loss before tax was £33m, down from a loss of £95m in the comparative period, largely due to a reduction in Capital and other items. While the valuation deficit was significantly smaller this period, we incurred higher costs associated with the redemption of some of our bonds. The smaller loss before tax drives a 7.8p reduction in loss per share from 12.1p in the comparative period to 4.3p in the six months ended 30 September 2017. Adjusted diluted earnings per share increased by 5.8% from 24.3p to 25.7p in this period as a result of an increase in revenue profit from £193m to £203m.

The reasons behind the movements in each component of our income statement are discussed in more detail below.

Revenue profit

Revenue profit is our measure of underlying pre-tax profit, presented on a proportionate basis. A full definition of revenue profit is given in the glossary. The main components of revenue profit, including the contributions from London and Retail, are presented in the table below.

Table 3: Revenue profit

1.  Includes finance lease interest, after rents payable.

Revenue profit increased by £10m from £193m in the comparative period to £203m for the six months ended 30 September 2017. This was the result of a £5m increase in net rental income for the period and a lower net finance expense, partly offset by higher indirect costs. The movements are explained in more detail below.

Net rental income

Table 4: Net rental income(1)

1.    Including our proportionate share of subsidiaries and joint ventures, as explained in the Presentation of financial information above.

Net rental income increased by £5m in the six months ended 30 September 2017 as rental income growth from our development portfolio and acquisitions was only partly offset by the impact of properties sold since 1 April 2016 and a decline in like-for-like income. Significant disposals included 20 Fenchurch Street, EC3 and The Junction Centre, Clapham sold in the current period, as well as The Printworks, Manchester and The Cornerhouse, Nottingham, both sold in the prior year. The impact of recent disposals will continue to be felt in the remainder of the year as we recognised £8m of net rental income this period from assets we have now sold. Our developments generated £10m of additional rent following the completion of Nova, Victoria, SW1, 20 Eastbourne Terrace, W2 and 1 New Street Square, EC4. Like-for-like net rental income declined by £5m primarily due to lower surrender premiums received in Retail and reduced income at Piccadilly Lights, W1 while under refurbishment.

Further information on the net rental income performance of the London and Retail portfolios is given in the respective business reviews.

Net indirect expenses

The indirect costs of the London and Retail portfolios and net unallocated expenses should be considered together as collectively they represent the net indirect expenses of the Group including joint ventures. In total, net indirect expenses were £39m, up from £36m in the comparative period. The £3m increase is the result of higher staff costs, in particular due to share-based payment charges, depreciation and administration costs.

Net finance expense (included in revenue profit)

Table 5: Net finance expense(1)

1.    Including our proportionate share of subsidiaries and joint ventures, as explained in the Presentation of financial information above.

Our net finance expense has decreased by £8m to £61m, primarily due to interest savings following the repurchase of medium term notes in the year to 31 March 2017 and the redemption of the £273m Queen Anne's Gate (QAG) Bond this period. This has been partly offset by lower capitalised interest following the completion of developments.

Capital and other items

An explanation of the main Capital and other items is given below.

Table 6: Capital and other items(1)

1.    Including our proportionate share of subsidiaries and joint ventures, as explained in the Presentation of financial information above.

Valuation of investment properties

Our Combined Portfolio declined in value by 0.1% or £19m compared with a decrease in the comparative period of £260m. A breakdown of valuation movements by category is shown in table 7.

Table 7: Valuation analysis

1.    Rental value change excludes units materially altered during the six month period.

Over the six months to 30 September 2017, there was little movement in the valuation of most categories of our Combined Portfolio. Overall values were down 0.1%, with the like-for-like portfolio down 0.5%. With the wider market experiencing limited rental value change and yield shift in the property sectors in which we operate, changes to individual asset values generally have a greater impact than market movements.

Within the like-for-like portfolio, our shopping centres fell in value by 0.7% as gains on most assets were pulled down by valuation declines at two of our larger centres. The value of our Retail parks was up slightly due to a 4 basis points tightening in yields as investor appetite improved for this asset class. Our Leisure and hotel assets saw almost no change in overall value while London offices were down 0.8% as rental values showed a small decline.

Outside the like-for-like portfolio, our pre-letting to Deutsche Bank at 21 Moorfields, EC2 was behind the increase in the value of proposed developments. The development programme saw a 3.4% increase in values on the back of letting progress while completed developments showed little change. The requirement to adjust for future purchaser's costs was behind the 2.2% fall in the value of our acquisitions, partly offset by rental growth.

Profits on disposals

Profits on disposals relate to the sale of investment properties, trading properties and joint ventures. We made a total profit on disposals of £84m, up from £11m in the comparative period. The profit on disposal of trading properties of £16m primarily relates to the sale of residential units at Nova and Kings Gate, both SW1. The £66m profit on disposal of investment in joint venture is the profit recognised on the sale of 20 Fenchurch Street, EC3.

Net finance expense (included in Capital and other items)

This largely comprises the amortisation of the bond exchange de-recognition adjustment (as explained in the Notes to the financial statements) partly offset by the fair value movement on interest-rate swaps.

Exceptional items

During the period, we have classified three items totalling £292m as exceptional. They are excluded from revenue profit by virtue of their exceptional nature, but form part of our loss before tax.

Between April and May 2017, the Group repurchased and redeemed the entire £273m Queen Anne's Gate Bond for a total premium of £62m including costs.

In September 2017, we purchased some of our medium term notes with a nominal value of £502m, at an additional cost of £173m. This additional cost and the unamortised bond exchange de-recognition adjustment of £57m associated with the redeemed notes have been charged to the income statement as a finance expense. Further details are given in the Financing section below.

Taxation

As a consequence of the Group's REIT status, income and capital gains from the qualifying property rental business are exempt from corporation tax. Profits on non-qualifying activities, such as residential sales, are subject to corporation tax. This period, we were able to offset taxable gains on non-qualifying disposals with brought forward losses. In the period, there was a current tax charge of £1m (2016: £1m).

Balance sheet

Table 8: Balance sheet

Our net assets principally comprise the Combined Portfolio less net debt, although this period we also need to deduct the capital distribution which is recorded as a creditor. We calculate an adjusted measure of net assets, which is lower than our net assets reported under IFRS due to an adjustment to increase our net debt to its nominal value. We believe this better reflects the underlying net assets attributable to shareholders as it more accurately reflects the future cash flows associated with our debt instruments. Both our net assets and our adjusted net assets declined over the period due to the premiums paid to redeem bonds and the impact of our commitment to return £475m to shareholders by way of a capital distribution.

At 30 September 2017, our net assets per share were 1,468p, an increase of 10p or 0.7% from 31 March 2017. Adjusted diluted net assets per share were 1,432p, an increase of 15p or 1.1%. These increases were driven by the impact of the share consolidation which accompanied the decision to return capital to shareholders.

Table 9 summarises the key components of the £593m decrease in our adjusted net assets over the period.

Table 9: Movement in adjusted net assets(1)

1.    Including our proportionate share of subsidiaries and joint ventures, as explained in the Presentation of financial information above.

Net debt and gearing

Table 10: Net debt and gearing

1.    Including our proportionate share of subsidiaries and joint ventures, as explained in the Presentation of financial information above.

2.    Adjusted net debt divided by adjusted net assets.

3.    Pro forma for the £475m capital distribution to shareholders, paid in October 2017.

Over the period, our net debt increased by £21m to £2,926m. The main elements behind this increase are set out in our statement of cash flows and note 14 to the financial statements.

Adjusted net debt was down £111m to £3,150m. For a reconciliation of net debt to adjusted net debt, see note 13 to the financial statements. Table 11 sets out the main movements behind the decrease in our adjusted net debt.

Table 11: Adjusted net debt(1)

1.    Including our proportionate share of subsidiaries and joint ventures, as explained in the Presentation of financial information above.

Net operating cash inflow was £172m, substantially offset by dividend payments of £150m. Capital expenditure was £115m (£97m on investment properties and £18m on trading properties), largely relating to our development programme. Net cashflows from disposals totalled £857m; £114m from the disposal of investment properties, £110m from the disposal of trading properties and £633m from the disposal of investments in joint ventures. We incurred an additional £173m to repurchase the medium term notes and £62m for the redemption of the QAG Bond.

The most widely used gearing measure in our industry is loan-to-value (LTV). We focus most on Group LTV, presented on a proportionate basis, which decreased from 22.2% at 31 March 2017 to 21.8% at 30 September 2017. Adjusting for the £475m capital distribution to shareholders which occurred in October 2017, the Group LTV increases to 25.1%. The decrease in our Security Group LTV from 28.3% to 24.5% is primarily due to a permitted change in the calculation method, which now allows bonds purchased and held within the Security Group to be offset against debt outstanding.

Financing

At 30 September 2017, our committed revolving facilities totalled £1,940m (31 March 2017: £1,940m). The pricing of our facilities which fall due in more than one year are between LIBOR +75 basis points and LIBOR +80 basis points. Borrowings under our commercial paper programme typically have a maturity of less than three months, currently carry a weighted average interest rate of LIBOR +32 basis points and are unsecured. Overall, the amounts drawn under the syndicated bank debt and commercial paper programme totalled £326m (31 March 2017: £441m).

Between April and May 2017, the Group repurchased and redeemed all £273m of the outstanding QAG Bond for an additional cost of £62m. In addition, on 22 September 2017, we conducted a tender exercise which resulted in us buying back £502m (nominal value) of medium term notes (MTNs). Further details are set out in the table below and note 14 to the financial statements. In conjunction with the tender offer, we issued a £500m MTN paying a coupon of 2.625% with an expected maturity of 2037 and a £500m MTN paying a coupon of 2.750% with an expected maturity of 2057.

Table 12: Purchase of medium term notes

A premium to par of £171m was paid on the MTN purchases, reflecting future gross coupon savings of £356m. Taking into account the interest cost of the longer dated notes issued to fund the purchases, we estimate the Group's net interest saving next year will be £8m. This saving will be offset by a £6m increase in interest expense as a result of replacing over £300m of cheaper short-term debt with the new longer dated notes.

The Group's debt (on a proportionate basis) has a weighted average maturity of 15.1 years (up from 9.4 years at 31 March 2017), a weighted average cost of 3.8% (3.4% pro forma for the £475m capital distribution and down from 4.2% at 31 March 2017) and 97% is at fixed interest rates. At 30 September 2017, we had £1.8bn of cash and available facilities. This gives the business considerable flexibility to deploy capital quickly should acquisition opportunities arise.

Dividend

We will be paying a second quarterly dividend of 9.85p per share on 5 January 2018 to shareholders registered at the close of business on 1 December 2017. This will be paid wholly as an ordinary dividend. Taken together with the first quarterly dividend of 9.85p per share, paid wholly as a Property Income Distribution on 6 October 2017, our first half dividend will be 19.7p per share (six months ended 30 September 2016: 17.9p), representing a total payment of £151m (six months ended 30 September 2016: £141m). This 10.1% increase in the half-year dividend is a reflection of last year's 10.1% increase in the total dividend and should not be viewed as a forecast of how this year's total dividend might change.

Martin Greenslade

Chief Financial Officer