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Macfarlane Group by thename

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									Financial review




 Andrew Macfarlane
 Group finance director




Profit before interest and tax (including joint   bond issues. The Group’s gross interest              in a valuation deficit for the year of £56.8m,
ventures) for the year to 31 March 2003 was       payable, excluding Telereal, was covered             after taking into consideration the accounting
£591.9m (2002: £530.2m). This represents an       2.4 times by operating profits compared with         movement of £9.2m on the UITF28 debtor.
11.6% increase over the previous year and was     3.0 times in the prior year.                         The valuation deficit has been offset by
driven by two main factors:                                                                            £62.5m of retained earnings and this, coupled
                                                  During the year, we divested investment and          with the impact of our return of capital,
• a full year’s contribution from Telereal, our   operating properties with a book value of            resulted in an adjusted diluted net asset value
  50:50 joint venture with The William Pears      £539.1m (2002: £510.4m) generating an FRS3           per share of 1215p (2002: 1155p), up 5.2%
  Group; and                                      profit of £41.7m, compared with £13.4m in            over the year.
                                                  the previous year. This includes our share of
• profits of £43.5m (2002: £19.2m) from the       Telereal property disposals. Property disposals      In terms of cash flow, the Group realised
  sale of operating, trading and investment       also crystallised revaluation surpluses earned       £436.3m (2002: £549.2m) from property
  properties.                                     in prior years of £281.2m.                           divestment and secured £80.6m from Telereal.
                                                                                                       These funds have been reinvested in the
At the pre-tax level, profits decreased by        Profit after tax was £229.9m (2002: £263.6m)         business and we returned £511.1m to
12.1% from £363.5m to £319.6m largely as          equivalent to a 7.6% decrease in basic               shareholders during the year, spent £301.4m
a result of exceptional costs related to our      earnings per share; however adjusted earnings        on investment property development
capital reorganisation, convertible bond          per share only fell by 2.4% and the Directors        expenditure and £311.8m on property
redemptions and new debt issues. Revenue          are recommending a total dividend for the            acquisitions, including the costs incurred by
profits declined by 6.6% to £340.9m               year of 35.5p per share (2002: 34.0p), a 4.4%        Land Securities Trillium in constructing White
(2002: £364.8m), due to increased interest        increase. If approved, this will result in a final   City II for the BBC. Overall, there was a net
costs related to the return of capital in         dividend of 26.0p per share (2002: 24.95p).          cash outflow of £177.2m during the year
September 2002 and the dilutive effect of         At this level, adjusted dividend cover is            before financing and return of capital
property sales over the last two years.           1.5 times (2002: 1.5 times).                         to shareholders (2002: £219.2m).
                                                                                                       Net indebtedness increased by £647.2m
After capitalisation of interest on               In absolute terms, the year end market value         in the year to £2,589.3m (2002: £1,942.1m)
developments, total interest charges were         of the portfolio was some £33.1m higher than         resulting in year-end gearing of 47.3%
some £115.0m higher than the prior year,          the previous year, an increase of 0.4%.              (2002: 32.2%).
of which nearly half can be attributed to the     This reflects increased development capital
full year effect of Telereal and the balance      expenditure and the impact of property               Over the last year, the Group’s pre-tax total
to exceptional interest costs incurred in         purchases and sales. However, the value of           return (that is the percentage increase in pre-
redeeming convertible bonds and cancelling        our like-for-like portfolio, and certain             tax net asset value per share, plus dividends)
surplus interest rate hedges, following our       development schemes has declined, resulting          was 8.2% compared with our estimated cost




12                                                                                                                       LAND SECURITIES ANNUAL REPORT 2003
                                                                                                                                   Financial review




                                                                                                                                                      OPERATING AND FINANCIAL REVIEW
                                                  Tax and treasury          Finance
                                                  (from left)               (from left)
                                                  Stephen Leung and         Richard Bushell,
                                                  Martin Wood               David Holt and
                                                                            Lyndsay Smailes




of equity of 9.1%. Total returns were held back   scheme is approximately £18.6m. Cash               Investment portfolio
this year as a result of the difficult London     pension costs are expected to be some £1.5m        Rental income decreased by 1.2% from
office market.                                    per annum higher than in previous years as a       £525.9m to £519.7m, reflecting the sale of
                                                  result of a recent decision to increase funding    mature assets over the last two years.
During the year, we arranged to return            rates for the time being. New schemes will be      Adjusting for the effects of property
£541m to shareholders. This was achieved by       set up to meet obligations to employees            acquisitions and disposals, rental income on
introducing a new holding company for the         transferring to the Group under total property     properties owned throughout the last two
Group, combined with a B share issue to           outsourcing contracts.                             years increased by £24.8m. The main
all shareholders. Approximately 94% of                                                               contributors to this increase were £20.8m
shareholders elected for an immediate             In June 2002, the European Parliament              from reviews and renewals and £10.2m from
redemption of their B shares in September         approved a regulation requiring all listed         the letting of new developments, which were
at a cash cost to the Group of £511.1m, with      companies in the European Union to prepare         offset by a loss of £7.5m due to the vacation
a further 3.5% redeeming their B shares in        consolidated financial statements under            of buildings for redevelopment. Some £39.8m
April 2003 at a cash cost to the Group of         International Financial Reporting Standards        of rental income was lost on disposals offset
£18.8m. The remaining 11.3m B shares are          (IFRS) for financial years beginning on or after   by £8.8m from property acquisitions. The cost
next redeemable in October 2003. At the same      1 January 2005 and this will apply to us for the   of bad and doubtful debts was some £1.6m,
time we effected a capital reduction, which       first time in the year to 31 March 2006. As        equivalent to approximately 0.3% of the rent
created some £3.1bn of distributable reserves     currently drafted, the implementation of IFRS      roll (2002: 0.3%).
in the new holding company, providing             will have a marked impact on financial
significant flexibility for the future.           reporting for property investment companies.       During the last 12 months, the net
                                                  However, it should also be noted that there is     reversionary potential of the portfolio,
The return of capital and the purchase of         considerable activity, both at the International   excluding voids has reduced to 5.1% at
convertible bonds had a positive influence on     Accounting Standards Board (IASB) and at the       31 March 2003, compared with 9.6% at the
earnings per share and net asset value per        UK’s Accounting Standards Board, to refine the     end of the prior year. The mean weighted
share, while also reducing the diluted share      reporting framework. The implications for the      unexpired lease term over the portfolio as a
capital of the Group.                             Group are under active review and we will          whole is 11.2 years, assuming all lease breaks
                                                  provide an update when we report our half-         and expiries occur.
The Group has a defined benefit pension           year results at the end of the year.
scheme. The scheme, which had gross                                                                  During the year we divested investment
liabilities of some £95m as at 31 March 2003,                                                        properties with a book value of £396.1m
is now closed to new entrants. However,                                                              (2002: £498.1m), at an average rental yield
during the year, the Group made a special cash                                                       of 7.0%, realising profits on sale of £26.5m
funding contribution of £9.0m following                                                              and crystallising £234.3m of previous
which the current deficit of the pension                                                             valuation surpluses.




LAND SECURITIES ANNUAL REPORT 2003

                                                                                                                                             13
Financial review


Investment portfolio activity                                                             Year to 31 March 2003
                                             Acquisitions/      Proceeds from sales and            FRS3 profit
                                         developments £m          other divestments £m                    £m

Retail/leisure                                       170.8                       117.9                    14.2

Offices                                              258.1                       127.2                      4.7

Warehouses and industrial properties                  20.1                         18.0                     2.9

Hotels, leisure, residential and other                29.3                       159.5                      4.7

Total                                               478.3                        422.6                    26.5




Development                                                  gross property income (2002: 40%). This              The financing benefit is unlikely to recur in
The projects that comprise the current                       business unit is now making good progress            future periods and the 2002/3 cash tax rate
development programme are listed in the                      towards achieving 25% of our operating profit        may not be representative of our tax position
development pipeline schedule on pages 76                    in the medium term.                                  for the future. The requirement in FRS19 to
to 77. To be included in the programme, a                                                                         make full provision for timing differences
project must have, or be close to obtaining,                 Revenue and profits from the PRIME contract          means that, in profit and loss account terms,
final approval to proceed (although that                     have exceeded expectations and we also               our reported tax rate for the year is 28.1%
approval may be conditional on the receipt of                earned fees on the substantial programme of          (2002: 27.5%) and the factors causing this are
planning consent or obtaining an appropriate                 capital works that we managed on behalf of           explained in the notes to the accounts.
level of pre-lets). For reporting purposes we                the DWP. On the BBC contract, we incurred
retain properties in the programme until they                £111.8m in the year on the construction of           Following the latest property valuation and
are 95% let.                                                 the White City II building with an estimated         assuming that all properties are sold at the
                                                             £99.3m (excluding interest) to be spent              revalued amounts without any tax mitigation,
The carrying value of development                            mainly over the next year. We have incurred a        the Group has an estimated potential capital
programme assets, (which excludes the BBC                    full year’s start-up operating loss on this          gains tax liability in the region of £435m
development at White City, trading properties,               contract, but expect it to become profitable         (2002: £535m). However, as indicated in the
proposed developments and the project at                     when the new building is occupied by the BBC         notes to the accounts, it is unlikely that such
Kent Thameside) was £967.4m at 31 March                      later this year.                                     an amount would be payable even in the
2003 (2002: £790.8m). During the year, we                                                                         event of a sale of all investment property
spent £291.1m on the development                             Telereal has made a good contribution to             assets. In particular, the sale of property
programme, and capitalised associated                        earnings, despite a reduction in unitary charge      portfolios by means of the disposal of certain
finance costs of £30.8m.                                     reflecting the sale of its investment properties     asset-owning companies would reduce this by
                                                             during the year. Sale proceeds were £270m,           some £110m.
The estimated future cash spend required to                  generating a profit on disposal of £18.8m,
complete the development programme,                          with our share being £9.4m. This transaction         Treasury management
excluding interest, will be approximately                    and Telereal’s profits enabled the joint venture     The treasury function operates under
£440m. Proposed developments (excluding                      to return £80.6m to us during the year.              delegated authority from the Board and
Kent Thameside) have a current carrying value                Telereal’s profits are growing in line with          maintains policies and procedures which
of £180m and the estimated future cash                       our expectations.                                    monitor, control and report on interest rate,
spend required to complete these schemes, if                                                                      liquidity, credit and other financial risks.
we proceed with them, is approximately                       Taxation                                             The function operates as a cost reduction
£900m, excluding interest.                                   The cash tax charge, equivalent to 12.1%             centre rather than a profit centre.
                                                             (2002: 25.6%) of profit on ordinary activities,
Total property outsourcing                                   reflects the benefit of capital allowances from      The Group’s finance policy is primarily based
Land Securities Trillium (including our share of             developments, refurbishments, acquisitions           on an unsecured funding strategy which
Telereal) generated some 53% of the Group’s                  and financing transactions during the year.          the Board believes offers the right balance




14                                                                                                                                 LAND SECURITIES ANNUAL REPORT 2003
                                                                                                                                                                  Financial review


 Performance measures                for the four years ended 31 March 2003                Forecast spend on development pipeline




                                                                                                                                                                                     OPERATING AND FINANCIAL REVIEW
%                                                                                          £m
                                                                                           450
14
                                                                                           400
12
                                                                                           350
10                                                                                         300
 8                                                                                         250
 6                                                                                         200
                                                                                           150
 4
                                                                                           100
 2
                                                                                            50
 0                                                                                           0
           1 year          2 years            3 years             4 years                            02/03     02/03     2003/04    2004/05   2005/06   2006/07   2007/08
                                                                                                    Forecast   Actual
     IPD            WACC       Investment property return                                        Development programme         BBC
                                                                                                 Proposed developments         02/03 Forecast       02/03 Actual
Average:                                   For year Over 2 yrs     Over 3 yrs Over 4 yrs
IPD                                          6.6%        6.0%               7.4%   9.0%    Includes BBC, excludes Kent Thameside and interest
Total investment property return             6.0%        5.6%               7.2%   8.8%
Pre-tax weighted average cost of capital     7.5%        8.0%               8.1%   8.4%


between debt capacity, flexibility and cost.                     reduction in long-term interest rates since the            were cancelled as surplus to requirements,
In limited circumstances the Group will still                    Group’s fixed rate borrowings and interest                 leading to a £23.5m exceptional interest
consider secured funding, but only after                         rate hedges were originally taken out. After               charge in the profit and loss account.
carefully reviewing the impact on its                            tax, the implied adjustment to the Group’s
unsecured finance sources.                                       net asset value would be to reduce reported                The Group had a net cash outflow before the
                                                                 diluted adjusted net assets per share by 90p               use of liquid resources and financing of
The Group uses interest rate swaps to hedge                      (2002: 60p).                                               £177.2m for the year (2002: £219.2m),
the interest rate exposure on floating rate                                                                                 primarily attributable to its return of capital,
debt and to protect the cost of future                           At the time of our return of capital in May                capital expenditure and investment activities.
borrowings. Due to the long-term nature of                       2002, redemption notices were issued to the
property investment and our expectation of                       holders of our convertible bonds as these                  Insurance
increased gearing in the medium-term, we                         bonds were beginning to convert, with                      In common with other property owners, our
aim to take advantage of low interest rates to                   bondholders taking advantage of the                        insurers are applying terrorism exclusions to
hedge the majority of our debt. The business                     difference between the share and conversion                our policies as they become due for renewal in
has minimal direct foreign exchange                              prices. So, where the opportunity arose at                 2003. The Group continues to buy the most
exposures and consequently there are                             appropriate prices, we purchased bonds in the              comprehensive terrorism insurance cover
currently no foreign exchange hedging                            market to pre-empt conversion and                          available from the Government-backed Pool
contracts in place.                                              successfully acquired some 80% of the bonds                Reinsurance Company Limited.
                                                                 outstanding at 31 March 2002. This resulted in
To provide access to immediate liquidity and                     an exceptional loss of £28.2m, which is tax                Going concern
to inject additional funding flexibility, the                    deductible and is reported as an interest                  After reviewing detailed profit and cash flow
Group has in place two committed syndicated                      expense in the profit and loss account. The                projections, and taking account of available
bank facilities. At the year-end, the total                      amount of share capital to be returned to                  bank facilities and making such further
committed facilities available to the Group                      shareholders is £541m which reflected £48m                 enquiries as they consider appropriate, the
were £1.5bn, of which £0.6bn was utilised.                       of nominal new equity capital created as a                 Directors are satisfied that the Company and
                                                                 result of bond conversions.                                the Group have adequate resources to
At 31 March 2003, the average maturity of                                                                                   continue to operate for the foreseeable future.
the Group’s debt was 13.3 years (2002: 14.1                      The purchase of the convertible bonds and the              For this reason, we have continued to adopt
years) or 16.3 years (2002: 16.2 years) if                       return of capital to shareholders was financed             the going concern basis when preparing the
short-term bank facilities are excluded,                         by a new £1.5bn syndicated bank facility.                  financial statements.
reflecting the long-term nature of property                      £600m of our bank debt was subsequently
investment.                                                      refinanced by two new unsecured bonds, a
                                                                 5.875% £400m bond maturing in 2013 and
At the year-end, the fair values of the Group’s                  a 6.375% £200m bond maturing in 2024.
financial liabilities exceeded book value by                     Following this transaction, £700m of bank
£598.5m (2002: £474.9m), mirroring the                           facilities and £300m of interest rate swaps



LAND SECURITIES ANNUAL REPORT 2003

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