CBRE Group Inc - Class A (CBRE) — Q1 2018 Earnings Call Transcript

Thank you and welcome to CBRE's first quarter 2018 earnings conference call. Earlier today, we issued a press release announcing our financial results, and it is posted on our website, cbre.com. On the Investor Relations page of our website, you will find a presentation slide deck that you can use to follow along with our prepared remarks. This presentation contains forward-looking statements. These include statements regarding CBRE's future growth momentum, operations, market share, business outlook, and financial performance expectations. These statements should be considered estimates only, and actual results may ultimately differ from these estimates. For a full discussion of the risks and other factors that may impact these forward-looking statements, please refer to our first quarter 2018 earnings report furnished on Form 8-K and our most recent Annual Report furnished on Form 10-K. During our remarks, we may refer to certain non-GAAP financial measures, as defined by SEC regulations. Where required by these regulations, we have provided reconciliations to what we believe are the most directly comparable GAAP measures. These reconciliations, together with explanations of these measures, can be found within the appendix of this presentation. Additionally, all growth rate percentages cited in our remarks are in local currency, unless otherwise stated. Please turn to Slide 3. Participating on our call today are Bob Sulentic, our President and Chief Executive Officer; and Jim Groch, our Chief Financial Officer and Head of Corporate Development. Now please turn to Slide 4, as I turn the call over to Bob.

Thank you, Brad, and good morning, everyone. CBRE had an excellent start to 2018 with double-digit growth in revenue and a 20% increase in adjusted earnings per share. The strong sustained growth you’ve seen from CBRE results from the execution of our strategy which is centered on delivering differentiated client outcomes around the world as well as the attractiveness of our sector. I will briefly hit a few highlights from the first quarter. First, occupier outsourcing was once again a standout performer with fee revenue up by double digits in all three global regions. The secular trend to outsource real estate services remains a powerful long-term catalyst for growth and CBRE is the clear market leader in commercial real estate outsourcing. Second, capital markets revenue also grew by double digits as we benefited from ongoing share gains in key markets globally and continued strong investor interest in commercial real estate. Finally, our Asia-Pacific business had a particularly strong quarter on both the top and bottom lines led by leasing and occupier outsourcing. We’ve seen outstanding performance over the past few years in several countries, notably Greater China, India, and Japan. While we caution against extrapolating first quarter results, we’re tracking slightly ahead of our full-year 2018 guidance. First quarter results were ahead of our expectations across revenue, margins, and earnings, and we continue to see solid momentum in our business. As most of you know, the first quarter is seasonally our slowest of the year. We will provide further commentary next quarter. With that, I will turn the call over to Jim, who will take you through the quarter in detail.

Thanks, Bob. Please turn to Slide 5 for a discussion of our financial performance. Fee revenue increased 18% in U.S. dollars and 13% in local currency, driven by strong organic growth and reflecting positive momentum across our business. M&A contributed 2% to fee revenue growth in the quarter. Adjusted EPS of $0.54 represents a 20% increase over Q1 of last year in line with our expectation of achieving double-digit adjusted EPS growth in 2018 for a ninth consecutive year. Our adjusted EBITDA margin on fee revenue for Q1 was 15.3%, below the prior year, but as Bob noted, slightly above our expectations. Last quarter we noted the increased level of investment planned for 2018, which had a disproportionate impact on Q1 due to the seasonality of our revenue. We also achieved higher growth rates in our contractual and overseas businesses compared to our higher-margin U.S. transaction business. Our EMEA segment was negatively impacted by a $6 million adjustment to the value of a legacy defined-benefit plan. Absent this charge, adjusted EBITDA in our EMEA segment would have grown by 6% in local currency and 21% in U.S. dollars over the prior year. Shifting from EBITDA margins to profit margins, for the full-year and with the benefit of a reduced tax rate, we continue to expect our adjusted net income margin on fee revenue to reach a record 10%. Our strong and flexible balance sheet was recognized by Moody's and S&P, as both further upgraded our existing investment-grade corporate credit rating in the last two months. CBRE's low leverage and nearly $3 billion of liquidity are strategic assets that position us well for the future. M&A activity continues at a steady pace. Since the start of the year, we acquired our long-time affiliate in Israel and a boutique retail specialist in Australia, and we continue to have a healthy pipeline of M&A activity. Please turn to Slide 6, which at the bottom of the page highlights our revenue growth by line of business for Q1. In the first quarter, we continued to benefit from recruiting gains made in our capital markets and leasing businesses. Our recruiting efforts in 2018 are running ahead of the pace set last year. Capital markets, which includes property sales and commercial mortgage origination, achieved very strong combined revenue growth of 14%. Our capital markets professionals are continuing to see significant global capital looking to be invested in commercial real estate. We continue to gain market share in property sales which increased 11% globally led by the Americas with 14% growth. According to Real Capital Analytics, our market share increased by over 100 basis points to 14.9%. Sales growth of 8% in Asia Pacific was driven largely by Japan. In EMEA, growth of 3% in sales was led by Germany, which more than offset a soft start to the year in the U.K. Increased sales in EMEA are on top of a 16% growth achieved in Q1 of 2017. Commercial mortgage origination increased 26%, reflecting our brisk growth with both government agencies and private sector lenders. Strong commercial mortgage origination supported the continued growth of our now $184 billion loan servicing portfolio. Recurring revenues from loan servicing increased 14% from the prior year. Leasing revenue rose 5% with notable strength in international markets. EMEA growth of 19% reflects overall healthy market conditions as well as our success in recruiting producers. Americas leasing revenue was up 1% as we closed fewer large deals in the quarter than in the prior year. Market fundamentals and our leasing pipeline remain strong. The leasing results can fluctuate quarter-to-quarter. Property management fee revenue increased by 13% supported in part by continued strong growth in our investment fund administration business, which we described at our Investor Day. Slide 7 highlights our occupier outsourcing business. As Bob mentioned, this business once again achieved robust fee revenue growth, up globally 26% in U.S. dollars and 18% in local currency with approximately 5% attributable to acquisitions made in 2017. Growth was broad-based across our three regions and reflects both expansions with existing clients and new client wins. Demand remains strong in our outsourcing pipeline as once again hit an all-time high. Tetra Pak, a Switzerland-based food processing and packaging company is an example of a new client win. It did not previously outsource commercial real estate services, but were motivated by the opportunity to reduce costs and improve the utilization of real estate. For Tetra Pak, we're providing a full suite of services, including facility management, project management, transaction management, and real estate strategy consulting. A key factor in winning this assignment is our ability to combine all these services cross-country spanning North America, Europe, the Middle East, Latin America, and Asia. We offer our clients an unmatched depth of capability across our global platform. The Tetra Pak win is another illustration of the growing appetite for outsourced commercial real estate services and CBRE's advantaged competitive position. Slide 8 summarizes the results for our Global Investment Management segment. This business continues to show improved performance reflecting our focus on offering fewer, more strategic investment strategies and on streamlining costs. In Q1, growth of 30% in fee revenue and 8% in adjusted EBITDA was largely driven by increased asset management fees and by the carried interest we earned for exceeding return hurdles within our value-added funds. Growth in carried interest offset quarterly marks-to-market in our public equity co-investments, which were largely affected by broad weakness in public market REIT and infrastructure markets. Our investment performance has been strong and we continue to attract investment capital with new equity commitments totaling $9.6 billion for the 12 months ending Q1. Assets under management increased by $1 billion from the fourth quarter as favorable shifts in FX more than offset the decline in our public securities funds. Slide 9 summarizes the results for our Development Services segment. This business continues to perform well, realizing $21 million of EBITDA in Q1, up substantially from last year, which was a light quarter for sales activity. The timing of asset sales in our development business can vary a great deal quarter-to-quarter. Our in-process development portfolio increased by $900 million during the quarter to a record $7.7 billion as a large number of pipeline deals converted to in-process activity. Pipeline activity also increased by $300 million from year-end 2017. The fundamentals in our development business are healthy and cap rates for completed development projects remain stable. This business continues to generate very attractive risk-adjusted returns for our equity partners and deliver excellent results for CBRE shareholders.

Thanks, Jim. As we look ahead, the macro environment continues to provide a supportive backdrop for our business. Global economic growth and job creation, the two most important macro drivers of demand in our sector remain healthy. While we are mindful of heightened trade and geopolitical tensions, they have not appreciably impacted our business and sentiment around the world remains upbeat. Higher interest rates have not resulted in any meaningful cap rate expansion as the spreads over treasuries remain relatively attractive. As I said at the outset, the investment market is also being supported by significant institutional capital interest in commercial real estate. This is an ongoing trend that our professionals are observing in markets around the world. CBRE continues to benefit from the strong secular trends to support our industry. These trends include growing occupier appetite for outsourced real estate services, increasing institutional capital allocation to the commercial real estate asset class, and the continued consolidation in our sector around the leading global service providers. We have a strategy which we described in detail at our Investor Day aimed squarely at making the most of these macro trends. We are sustaining progress on many fronts from commercially focused digital technology investments to client care initiatives to enhancing our talent base and better connecting our people around the world. The successful execution of our strategy will ensure that we continue to produce outcomes for our clients that others find difficult to replicate. I'll close by thanking our people for getting CBRE off to an excellent start in 2018 and for their tireless dedication to our clients. With that, operator, we will now take your questions.

Yes, thanks. Good morning. Nice quarter. You didn’t change guidance, but you mentioned in the release running a little bit ahead at this point. If we look back at the brackets you’ve put on the business lines last quarter when you put out guidance, which one of those or perhaps all of them or more than one is kind of most running ahead?

Tony, well, clearly what you saw in capital markets from us in the first quarter is running ahead of what we talked about at year-end. And we did take market share, we did have a really good quarter, but that’s a lumpy business and it was only the first quarter, so we don't want to get ahead of ourselves and extrapolate across the year. We are enthused about what happened. Our team did a good job and the market is solid. Our outsourcing business grew kind of like we said it would. That business has gotten much better over the last couple of years. We're delivering measurably better outcomes to our clients, we are better connected around the world. We have more capability than we've had historically in a number of verticals. We've embedded some technology in that business that works very well for our clients and we had high expectations and we probably saw something that was a little better than we expected in the quarter. If you look at leasing, we expected mid single-digit leasing growth for the year, and that's what we got in the first quarter. Property management grew nicely. So, on balance, a little better than we thought things would go, but it was only the first quarter.

Okay. Got you. And then, on the leasing side, again I know it's just a quarter, but can you talk about just any sense of behavior on the corporate side for incremental space, given the tax form that’s going through? Even in the Americas, I think that was only up a couple percent in the quarters. So just wondering how you’re thinking about that business line in the region?

Yes. Well, we stay really close to the big corporates around the world and across the U.S. So we have a good sense of what's going on. Corporations are in good shape. If you look at what they're saying, they expect to spend more money this year, put out more capital this year, they’re adding jobs, revenues are expected to grow, balance sheets are in great shape. So corporations are positive. But corporations are also very focused on costs as we are. And as a result, their appetite for leasing is not frothy, but it’s solid. So we saw 5% growth around the world, and 1% growth here in the U.S. Keep in mind, we saw well into the double-digit growth just 90 days ago in our biggest quarter, in the fourth quarter. And our expectations for leasing here in the U.S and around the world are very much as they were when we announced our year-end results.

Okay. And then just last question for me. Can you give us some updated thoughts on the acquisition environment and what you are seeing on that front?

Yes, Tony. This is Jim. I think we're seeing a pretty consistent balanced environment. We’ve got a solid pipeline, and I think we’re continuing to see this year what we saw last year. We are generally doing an infill acquisition a month plus or minus, and that remains to be quite solid.

Okay. So nothing to expect at this point in terms of like outsized capital spent on M&A from what you can tell?

Yes, obviously that’s an area we can never really comment on. And as you know, we're always quite attentive to the larger opportunities, but the right ones come along when they do, and that tends to be quite intermittent over time.

Good morning. It looks like U.S. sales were up 14%, looking at the RCA data, it didn't look fantastic, I guess. Is that really attributed to market share growth or are those kind of RCA statistics not necessarily representative of the markets that you guys are playing in?

Well, we think it was real market share gain. Again, Jason, it's important to keep in mind, it's only one quarter. We do a bunch of work in the capital markets area that’s not captured in the RCA data and that’s gone quite well for us, and we’re confident we took market share in those areas too. But the best public information available that’s independent of any of the providers is RCA, and RCA showed us taking a nice chunk of market share. And I will go back to the comments I made in response to Tony's questions, we believe those market share gains were real but we don't want to overstate anything based just on first quarter results because first quarter is a relatively small quarter and capital markets is a bit of a lumpy business.

Got it. And then just in terms of cap rates kind of staying stable, given the 10-year rate has been rising, and a lot of people have been anticipating some type of rising in cap rates commensurate with the rising in interest rates, is there something that the investor community is missing, whether it would be an abundance of capital on the sidelines or some other factor that's kind of keeping these cap rates steady and will continue to do so moving forward?

Jason, this is Jim. I would say two things. One, there's quite a bit of capital out there. And, two, from a relative value standpoint as you look at the universe of alternative investments and core investments, our real estate is still reasonably well priced. And if you look at cap rate spreads over time and whatever metric you want to compare to treasuries or the BBB bonds, obviously it varies depending on product type. But in general, spreads are at the midpoint of where they've been over time and that's quite a healthy place to be. When you compare relative valuations for other asset classes, real estate looks pretty good. And then, I think for that same reason if you look back over the last couple of years when you’ve seen 10-year treasuries jump during those periods cap rates have been fairly stable as well.

Good morning. Thanks for taking my questions. First here, how should we think about the strong growth in occupier outsourcing over the last few quarters? Is there a way to quantify how much of an impact the business you’re seeing from wallet share gains from existing clients compared with maybe new client wins within that business? And are those factors notably different by regions, just any detail there on the growth drivers?

Yes, Stephen, we don’t separate that thinking out region to region because those clients are often global. In fact, that's what we're looking for, global clients. But if you look at that business over time it is relatively equally driven by expanding what we do with our big existing base of clients and bringing on new clients. It's not precise and it changes from quarter-to-quarter and year-to-year. What we do know is that the quality of the outcomes we deliver for our clients, the measurable outcomes, plays a huge impact on renewals and expansions. There's very few of these clients that we do all or most of their real estate work for. There's a large opportunity to expand with them. We have obsessed over knowing those outcomes in improving those outcomes and I can assure you we measurably improved those outcomes as measured by third parties over the last couple of years, and that is coming to our growth rates. It's really important to the expansion of that business, and of course you’ve got the secular dynamic that we talk about and others talk about all the time with corporations, hospital systems, government entities, and schools, deciding to bring on third-party providers to do work that they used to do themselves. The more we do, the more opportunity for that there is because there's more evidence out in the marketplace as to how well it works for these occupiers. We had healthy recruiting around the world and a particularly good quarter here in the U.S. We’ve had really strong recruiting in the last three years in Asia-Pacific. That's one of the reasons why you’ve seen our competitive profile, as evidenced by our financial results, change so much in Asia-Pacific over the last two or three years. Really strong recruiting in China, particularly on the capital market side, really strong recruiting in India, excellent recruiting starting to surface on the occupier advisory side in Japan, which is something we’ve been working on for a few years, and then steady progress in Pacific, largely Australia.

Thanks. Good morning, everyone. Just going to the occupier outsourcing business again, if we look at Slide 7 where it talks about the difference in the split between new expansion and renewal contracts, in the first quarter it was, roughly a third, a third, a third. How should we relate that back to the 18% year-over-year revenue change in that business in the first quarter? I mean, would the split also be similar between that gross split between new expansions and renewals based on what's on Page 7? Just trying to understand what's actually driving the growth in that outsourcing business?

Yes, it's not precise obviously because the size of any particular contracts within that mix can affect how you divide up the overall impact on growth. But I think Bob highlighted that the opportunities within our existing base of clients are extremely strong. As a matter of fact we gave some fairly specific data on that at our Investor Day. So if you go back and look at the slides, you can get some pretty good data around that, where we looked at share of wallet amongst some of our top customers. I would reiterate what Bob said, which is over time we’ve seen roughly a split between new and existing clients. I think that's a fair view of what to expect going forward.

Thanks for taking my question. In the occupier outsourcing segment, are you seeing a change in contract size? Are they getting bigger?

Mitch, over time the tendency has been for those contracts to get bigger. They get more global, they include more services, and as a result, they get bigger. One of the things that our outsourcing people would tell you, if you run around the world and talk to them today, is that historically there was always this concern, can anybody really deliver all these different services for us in 60 markets around the world or whatever. There was skepticism about that. As time has rolled forward, and as we’ve built this business organically and built it through acquisitions, improved our technology, and built our base of brokerage around the world that works with our outsourcing clients, the confidence that we can serve these clients around the world and across product lines has grown. That's just a very definitive trend if you talk to our people. So you're seeing that now and as a result our contracts are getting bigger. I will give you one metric, it's not all outsourcing, but a significant portion of it is outsourcing. If you look back five years, we had one client that was $100 million or more. We now have 17. Over that same period of time, we had 18 that were $25 million or more. We now have 82, those are $25 million or more. So the clear empirical facts are that the clients are getting bigger and a bunch of those big clients are our outsourcing clients.

Hey, good morning. I’m curious to get your updated thoughts on flexible workspace providers, particularly in regards to signs that they’re increasingly targeting large corporations as well as moving into the facilities management space and providing some of those services on behalf of property owners?

Patrick, the trend of co-working and flexible workspaces is significant, and we strongly believe in its potential. It operates on two key aspects: experience management and co-working. Co-working providers typically acquire space at wholesale prices and sell it at retail to individuals or smaller groups. On the experience management side, related to our outsourcing clients, we oversee office spaces for approximately 8 to 9 million people globally, encompassing several billion square feet of office space. This focus on enhancing the work experience has been ongoing and increasingly revitalized for years. We've transitioned our spaces to accommodate flexible office layouts, enabling a variety of uses, and adopting technology-centric, paperless approaches, which have positively influenced employee morale and recruitment. Our substantial workplace solutions team collaborates with clients worldwide on these initiatives, which, while not entirely new, are evolving rapidly. Regarding co-working, we have found that about 40% of our larger clients, those with 50 or more employees, utilize co-working spaces in some capacity. We're assisting many of these clients with a portion of their workforce in co-working setups to optimize their overall space needs, which we believe will become a lasting trend. Though it may remain a small segment of the overall space usage, it's still relevant. Meanwhile, investors are somewhat lagging; approximately 25% recognize the need for co-working spaces, but only about 10% currently possess them. Although there is some apprehension about how co-working impacts the value of their properties, I believe investors are gradually coming around to this model, and we can expect to see an increase in adoption.

Sure. Good morning. Within Americas investment sales, obviously, strong results there. I’m wondering if there were perhaps some slippage from the first quarter and then on the sort of inflection of the transactions, are you seeing a shift to Class B, Class C properties in Tier 2, Tier 3 cities, more activity in the sub-$50 million assets versus $50 million? Any color you could give there would be helpful.

Yes, I don’t think we saw much slippage from Q4 into Q1. So I really don't think there was a factor. We are seeing some movement with more focus on Tier 2 markets and sometimes even a little bit of tier share. We’ve been seeing that trend for a while, but I would say we are seeing a little bit more of it today. The other factor is a lot of companies are really looking for the tech talent, and we do quite a bit of work on that over time. We’ve got some research reports that you can access and that's part of what's driving some users and capital that’s following those users to some of the smaller, but still quite significant cities. So a couple of things. We actually started that cost-saving initiative in '15, so that’s kind of from '15, '16, '17 efforts. Those efforts continue; it's part of our culture. Over that period we had so many of those going that we called out and some of those expenses is one-time. We’ve enormous number of projects that are underway on a regular basis, and the expense associated with those projects is what we consider to be part of our normal business. Yes, the investments are a good bit less than that.

Well, thank you everyone for being with us and we look forward to talking to you again at the end of the second quarter.