SEGRO - Annual Report 2007 - Business Review

	2007	2006	Increase/ (Decrease)

NAV per share	690p	718p	(3.9%)
Adjusted diluted NAV per share 1	704p	775p	(9.2%)
Profit before tax arising on sale of US business	£437.3m	-	-
Adjusted profit before tax - continuing operations only 2	£131.3m	£99.6m	31.8%
Adjusted profit before tax 2,3	£153.7m	£142.7m	7.7%
Diluted adjusted EPS 2,3	32.2p	25.1p	28.3%

Total ordinary dividend for the year	23.0p	19.0p	21.1%
Special dividend	53.0p	-	-

1 Adjusted to exclude deferred tax on investment properties
2 Adjusted to exclude EPRA and exceptional items
3 Continuing and discontinued operations

NAV per share at 31 December 2007 stood at 690 pence, down 3.9 per cent from 31 December 2006 whilst adjusted diluted NAV per share showed a decline of 9.2 per cent (13.2 per cent since June 2007) to 704 pence. These reductions reflect a decline in UK property valuations and are analysed further below.

The Group’s successful exit from the USA realised a pre-tax gain on sale of £437.3 million (£134.9 million after tax), enabling the payment of a £250 million special dividend (53 pence per share) in August 2007. Meanwhile, the business produced a strong underlying profit performance with adjusted profit before tax from continuing (£131.3 million) plus discontinued (£22.4 million) operations up 7.7 per cent to £153.7 million (2006: £142.7 million). Profit before tax reported under IFRS was £242.9 million (2006: £690.1 million).

Adjusted diluted earnings per share were up 28.3 per cent at 32.2 pence (2006: 25.1 pence) with a basic unadjusted loss per share of 16.4 pence (2006: 201.8 pence earnings per share), reflecting the UK valuation deficits.

The final dividend per share of 14.7 pence, makes a total (excluding the special dividend) of 23.0 pence per share, up 21 per cent over 2006 and reflecting the Group’s REIT conversion on 1 January 2007.

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Analysis of movement in net asset value

	£m	Pence per share

Adjusted diluted equity attributable to shareholders at 31 December 2006	3,648.8	774.9
Property losses	(342.8)	(79.0)
Profit after tax on sale of US business	134.9	31.1
Deferred tax adjustment on sale of US business	(213.4)	(49.2)
Profit after tax on sale of Utilities business	7.7	1.8
Adjusted profit after tax	147.6	34.0
SIIC conversion charge	(13.9)	(3.2)
Currency translation differences	17.7	4.1
Ordinary dividends paid	(91.9)	(21.2)
Special dividend paid	(250.0)	(57.6)
Other items	11.3	2.6
Dilution adjustment for movement in number of shares	-	66.0

Adjusted diluted equity attributable to shareholders at 31 December 2007	3,056.0	704.3

The most significant factor affecting the NAV movement and total return for the year was the property losses of £342.8 million (79.0 pence per share), which followed the well-publicised valuation reductions seen across the UK property industry. Whilst being a very significant item, it should be placed in the wider market context of falling UK commercial property values across all sectors and the £1.3 billion in aggregate valuation gains which the Group recorded in the previous three years (including US properties).

The other significant drivers of the NAV movement were the after-tax gain of £134.9 million arising on the sale of the US business, the related £250 million special dividend which was paid to shareholders in August and the adjusted profit after taxation for the year of £147.6 million. The share consolidation completed in August 2007 resulted in an increase in NAV of 66 pence per share.

Financial Review

-	Strong operating performance
	-	excellent profit + 7.7%
	-	record lettings + 69%
-	Adjusted NAV down 9.2%
	-	UK valuation down 9.5%
	-	Continental Europe valuation up 6.2%
-	Strong financial position
	-	Gearing of 56%
	-	Available facilities £1.1 billion

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Valuation movements
The valuation movement can be analysed as follows.

Property (losses)/gains - continuing operations	2007 £m	2006 £m

Investment properties
- UK	(394.2)	367.4
- Continental Europe	56.6	24.8
- Realised profits on disposals	3.0	4.8

Development properties
- UK	(47.9)	2.7
- Continental Europe	0.3	(2.2)

Total property (losses)/gains taken to the income statement - continuing	(382.2)	397.5

Investment & Development properties (SORIE)
- UK	(1.7)	12.4
- Continental Europe	12.9	3.0

Share of joint ventures' valuation (losses)/gains	(1.1)	7.2

Total property (losses)/gains - continuing	(372.1)	420.1

Valuation gains from discontinued operations	29.3	148.5

Total property (losses)/gains from continuing and discontinued operations	(342.8)	568.6

The property valuation losses in the income statement comprised valuation losses of £442.1 million relating to the UK and gains of £56.9 million relating to Continental Europe and included deficits of £337.6 million arising on investment properties and £47.6 million arising on development and owner-occupied property.

Valuation gains were 3.1 per cent for the Group in the first half of the year, offset by a fall of 9.1 per cent in the second half of the year.

Good valuation gains were achieved in the first half of the year in Central Europe (in Poland), France and Belgium, driven mainly by development activity and some yield compression, with valuation gains of 9.1 per cent being reported overall. In the second half of the year, there was a slight softening in valuation yields but development gains enabled us to maintain the portfolio valuation with a 0.2 per cent surplus being reported in Continental Europe.

The UK has experienced significant valuation deficits in the year, which are broadly in line with the monthly IPD UK industrial capital deficit of 9.6 per cent for the year (2006: 11.0 per cent growth). Valuation gains of 2.1 per cent in the first half in the UK were offset by deficits of 11.3 per cent in H2. Further analysis of the valuation gains and losses is provided in the Completed Investment Properties table on page 129.

For the first time in 2007 the Group had all its trading properties externally valued as of 31 December 2007. The trading property portfolio had an unrecognised valuation surplus of £74.3 million at 31 December 2007, which we expect to realise as developments are completed and sold. An impairment charge of £2.3 million (2006: nil) relating to 100 per cent owned trading properties is offset against the profit on sale of trading properties and the remaining impairment provision of £1.6 million is reflected in the share of profits from joint ventures after tax.

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Adjusted profit before tax

Analysis of increase in adjusted profit before tax	£m

Adjusted profit before tax from continuing and discontinued operations - 2006	142.7
Decrease in profit before tax from discontinued operations	(20.7)
Increase in net rental income	15.1
Increased profits from sales of trading properties	16.1
Interest earned/saved on US proceeds net of special dividend	13.7
Reduction in capitalised interest	(9.3)
Increase in other finance costs	(3.3)
Increased administration expenses	(9.0)
Other changes (mainly in other income)	8.4

Adjusted profit before tax from continuing and discontinued operations - 2007	153.7

Adjusted profit before tax of £153.7 million (2006: £142.7 million) comprised £131.3 million (2006: £99.6 million) from continuing operations and £22.4 million (2006: £43.1 million) from the discontinued operations of Slough Estates USA and Slough Heat & Power. Adjusted profit before tax from continuing operations increased by 31.8 per cent partly due to increased net rental income of 8.0 per cent and the benefit of interest earned on the net US sales proceeds.

In addition, an increase in profits on sale of trading properties of £16.1 million to £22.0 million (2006: £5.9 million) also contributed, with the gains mainly arising on the sale of Farnborough residential land (£9.7 million), a fire control centre at Cambridge Science Park (£3.5 million), non-core buildings in the Karstadt portfolio in Germany (£3.7 million), a surplus land holding in the Netherlands (£2.3 million) and other UK and Continental European property (£2.7 million and £2.4 million respectively), partly offset by provisions against impairment of trading properties of £2.3 million.

During the year other investment income increased significantly by £9.9 million to £18.4 million, as a result of realisations of previous investments by the Candover and Charterhouse USA venture capital investment funds, in which the Group invested some years ago. These gains were partly offset by an increase in administration expenses of £9.0 million to £34.5 million (2006: £25.5 million), of which £6.8 million relates to the Continental European business as we continue to expand the scale of operations, with new offices and additional employees. The cost of share based incentives payable to Directors and other senior executives represented an increase of £1.7 million.

Adjusted profit and earnings per share are stated after adjusting for valuation gains/losses and similar items recommended by EPRA and exceptional items. The only other adjustments in the year were the SIIC conversion charge of £13.9 million, included within continuing operations, a repayment penalty of £9.7 million after tax in discontinued operations related to the early redemption of US debt incurred as part of the disposal and negative goodwill of £0.9 million credited to the income statement (2006: none). Full details of all the EPRA and exceptional adjustments are provided in note 13 to the attached financial statements.

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Rental income
Gross rental income, excluding discontinued operations, increased by £30.2 million (13.2 per cent) to £258.8 million and net rental income, on the same basis, increased by 8.0 per cent to £203.9 million.

The key drivers of the increase in net rental income are set out in the table below:

	£m

Net rental income from continuing operations 2006	188.8
Acquisitions	19.3
Disposals	(11.8)
New developments	11.5
Re-lettings and rent reviews	9.3
Space returned	(9.9)
Increase in property operating expenses	(11.8)
Lease surrender premiums	6.4
Other	2.1

Net rental income from continuing operations 2007	203.9

Acquisition related growth arose from transactions in both 2006 and 2007 and, in particular, Vimercate, Italy (£1.8 million), Neckermann.de, Germany (£2.2 million), Longbow, France (£0.8 million) and Treforest (£1.0 million), Sunbury (£1.6 million), Peterborough (£0.9 million) and Pucklechurch (£1.0 million) in the UK. This was offset by the loss of rents on disposals, including £9.0 million in the UK.

Strong lettings, particularly of new developments in Central Europe (£1.7 million) and the UK (£3.9 million) and good income from re-lettings in the UK (£7.7 million), contributed to the growth in net rental income.

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Like-for-Like Rents

	UK		Continental Europe		Group
Gross Rental Income	2006 £m	2007 £m	2006 £m	2007 £m	2006 £m	2007 £m

Completed properties owned throughout 2006 & 2007	172.1	174.4	22.2	25.8	194.3	200.2
Properties acquired during 2006 & 2007	2.3	8.9	4.5	14.0	6.8	22.9
Properties sold during 2006 & 2007	12.2	3.2	-	-	12.2	3.2

Rent from development completions during 2006 & 2007	1.3	8.5	0.3	2.5	1.6	11.0
Rent from trading properties	-	-	8.4	9.9	8.4	9.9

Total rental income pre-exceptionals	187.9	195.0	35.4	52.2	223.3	247.2

Lease surrenders and dilapidations	5.3	11.6	-	-	5.3	11.6

Total rental income per accounts	193.2	206.6	35.4	52.2	228.6	258.8

Property operating expenses comprise all of the costs of managing our portfolio including, for example, salaries, building maintenance and refurbishment costs, agents’ fees, marketing expenses, insurance, the costs of maintaining empty buildings and rental guarantees payable in respect of buildings sold with vacancy. The level of costs incurred can vary according to a number of factors such as the level of lettings, take-backs, vacancy and, above all, the scale of the overall portfolio. The apparent increase in 2007 expenses was partly caused by an element of service charge income having been netted-off operating expenses in 2006, but not in 2007. Adjusting for this item, property operating expenses increased as a percentage of gross rental income from 18.9 per cent in 2006 to 21.2 per cent in 2007. This increase reflects the very high volume of letting activity in 2007 (up 69 per cent on 2006) as well as increases in a number of the underlying expenses in areas such as insurance and building maintenance. We aim to reduce costs as a percentage of income in 2008, but the impact of the UK Government’s abolition of empty rates relief is likely to offset these savings.

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Tax – continuing operations
The underlying tax charge on the adjusted profit before tax was 1.4 per cent (2006: 14 per cent) with the decrease primarily due to the effect of the Group’s REIT and SIIC status in the UK and France, respectively.

The Group achieved UK Real Estate Investment Trust (REIT) status with effect from 1 January 2007 and, as a REIT, all eligible investment property income and capital gains are tax exempt. During the period the Group also elected for Sociétés d’Investissements Immobiliers Cotées (SIIC) status in France, with effect from 1 January 2007, meaning that income and capital gains on the Group’s eligible French investment activities will also be tax exempt.

The accounts already show the benefits of the Group’s changes to its tax structure, with an underlying tax charge of just £1.9 million for the year (2006: £13.9 million).

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Sale of non-core activities
During the year the Group made two important divestments, being the disposal of the Group’s US business to Health Care Property Investors, Inc., in August 2007 and the sale of Slough Heat & Power to Scottish and Southern Energy plc in December 2007.

Disposal of US business
The headline consideration before the deduction of debt transferred with the business, taxes, transaction costs and certain estimated post-closing adjustments amounted to approximately $2.9 billion (£1.47 billion). The sale completed on 1 August 2007 and a special dividend of £250 million, payable out of the net proceeds, was paid to shareholders on 31 August 2007. The special dividend was accompanied by a share consolidation in August 2007, the effect of which was to reduce the number of existing ordinary shares in issue by approximately 8 per cent. The share consolidation facilitates comparability of earnings per share and share prices before and after payment of the special dividend.

The pre-tax profit on sale of £437.3 million is reflected in the accounts within ‘profit from discontinued operations’ which totals £134.9 million profit after deduction of a tax charge of £302.4 million. This is higher than the £107.4 million we estimated at the time of the 2007 Interim Report as a result of historic translation gains being ‘recycled’ from reserves.

Disposal of Slough Heat & Power
The headline consideration before transaction costs and certain estimated post-closing adjustments amounted to approximately £49.3 million. The sale completed on 31 December 2007.

The profit on sale of £7.7 million is reflected in the accounts within ‘profit from discontinued operations’.

The results from our US business (profit before tax £42.0 million) and Slough Heat & Power (profit before tax £2.4 million) to the respective dates of disposal are shown within ‘profit from discontinued operations’ in the accounts.

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Earnings per share and dividend
Basic loss per share for the Group (including discontinued operations) were 16.4 pence (2006: 201.8 pence earnings) and diluted adjusted earnings per share (including discontinued operations) increased 28.3 per cent to 32.2 pence (2006: 25.1 pence).

Diluted adjusted earnings per share for the continuing group increased by 46.9 per cent to 28.2 pence (2006:19.2 pence) and adjusted basic earnings per share for the continuing group was 28.2 pence (2006: 18.9 pence). The 46.9 per cent increase in diluted adjusted earnings per share for the continuing group is higher than the increase in adjusted profit before tax for the continuing group of 31.8 per cent mainly due to the reduction in the underlying tax charge of £12 million.

The Directors have proposed a final dividend of 14.7 pence per share, an increase of 21.5 per cent from 2006, which will be paid on 23 May 2008 to those shareholders on the register on 18 April 2008. The final dividend of 14.7 pence will consist of 5.7 pence to be paid as a property income distribution (PID) and 9.0 pence to be paid as a regular dividend. The 2007 total dividend of 23.0 pence represents an increase of 21.1 per cent from 2006.

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Capital expenditure
During the year, the Group made investments totalling £865.8 million, compared with £651.1 million in 2006. A number of strategic acquisitions of income-producing properties were made to establish a presence in new markets (Lyon and Milan), to strengthen an existing presence (Neckermann.de in Frankfurt) or to deepen our customer relationships (DHL). Development expenditure including joint ventures and trading properties amounted to £254.9 million, comprising £142.5 million relating to UK developments and £112.4 million relating to Continental Europe. In addition, land purchases of £74.8 million were made to provide future development opportunities (2006: £11.2 million). Of the total capital expenditure relating to continuing operations of £776.6 million, 68.3 per cent was in Continental Europe which is consistent with the previously stated intention to establish critical mass on the Continent.

Capital expenditure on investment and development properties	2007 £m	2006 £m

Land purchases	74.8	11.2
Development expenditure	186.4	175.2
Acquisitions of income producing properties	423.6	158.6
Discontinued operations	89.2	135.8

	774.0	480.8
Expenditure on trading properties	77.5	151.8
Expenditure on joint venture properties	14.3	18.5

Total capital expenditure	865.8	651.1
Less sales proceeds:
- from disposals of investment properties	(185.1)	(171.3)
- from disposals of trading properties	(84.0)	(35.8)

Net capital expenditure	596.7	444.0

Regarding future capital expenditure plans, we have already agreed acquisitions (both income producing and development land) amounting to £164 million, which will be completed in 2008. This includes the previously announced Berlin Airport site (€34 million), the €113 million sale and leaseback agreed with Mannesmann (Munich, Hamburg and Hannover), the remaining expenditure on the DHL and Neckermann.de acquisitions, plus two further land purchases. Future development expenditure on projects already internally approved is approximately £220 million and a further £100 million could be spent in 2008, depending on further project approvals during the balance of the year.

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Cash flow
A summary of the cash flow for the period is set out in the table below:

	2007 £m	2006 £m

Cash flow from operations	181.9	137.6
Finance costs (net)	(124.6)	(122.8)
Dividends received (net)	2.5	35.7
Tax received/(paid) (net)	4.1	(11.6)

Free cash flow	63.9	38.9
REIT/SIIC conversion charge paid	(44.5)	-
Sale of subsidiary undertakings	1,499.7	-
Tax paid on sale of US subsidiary undertaking	(87.2)	-
Capital expenditure	(756.9)	(451.9)
Property sales (including joint ventures)	207.3	164.1
Ordinary dividends	(335.9)	(84.0)
Other items	1.2	(3.6)

Net funds flow	547.6	(336.5)
Net (decrease)/increase in borrowings	(361.9)	321.4

Net cash inflow/(outflow)	185.7	(15.1)
Opening cash and cash equivalents	151.0	166.9
Exchange rate changes	3.5	(0.8)

Closing cash and cash equivalents	340.2	151.0

Cash flows generated from operations for the period were £181.9 million, an increase of 32.2% from 2006 as a result of higher proceeds from the sale of trading property developments. Cash flows generated from continuing operations were £147.8 million (2006: £74.7 million) and from discontinued operations were £34.1 million (2006: £62.9 million).

Dividends received were significantly lower than 2006, mainly due to a one-off dividend from the Group’s joint venture with Tesco in 2006 which was not repeated in 2007. Finance costs of £124.6 million, net of interest income, were higher by £1.8 million due to property acquisitions in 2006 and 2007, partly offset by the interest paid in 2006 on the preference shares of £5.2 million, which were converted into ordinary shares during 2006 plus a benefit of £13.7 million from the proceeds of the sale of the US property business net of the special dividend. A net tax refund of £4.1 million was received in the year (2006: £11.6 million tax paid) primarily due to a tax refund in the UK relating to prior years. In addition, tax of £87.2 million was paid on the profit on the sale of the US property business and REIT and SIIC conversion charges paid of £41.0 million and £3.5 million, respectively.

After payment of the dividend, there was a net funds inflow of £547.6 million (2006: £336.5 million outflow). Allowing for the decrease in borrowings in 2007, the net cash inflow for the period was £185.7 million (2006: £15.1 million outflow).

Proceeds from disposals amounted to £1,707.0 million including £1499.7 million from the sale of the US property business and Slough Heat & Power, and £207.3 million from the sale of investment and development properties.

Further analysis of acquisitions and disposals in the year is included on pages 26 and 32.

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Financial position
At 31 December 2007 the Group’s borrowings totalled £2,049.4 million (31 December 2006: £2,384.8 million). Cash balances totalled £348.3 million (2006: £161.4 million) resulting in reported net debt amounting to £1,701.1 million (2006: £2,223.4 million). The weighted average maturity of the debt portfolio was 10.5 years.

Unsecured borrowings represent 96 per cent of gross debt at the year end. Secured debt totalled £80.2 million representing some historical mortgage debt domiciled in the Group’s overseas operations. £1,383.7 million of debt domiciled in the UK was unsecured and was issued by SEGRO plc without any supporting up-stream guarantees. £585.5 million of unsecured debt was issued by subsidiary companies located overseas.

Reported financial gearing was 57 per cent (2006: 66 per cent) or 56 per cent (2006: 61 per cent) after adding back deferred tax of £67.0 million (2006: £276.1 million). The loan to value ratio (net debt divided by property assets) of the Group at 31 December 2007 was 34 per cent (2006: 38 per cent).

Interest cover based upon adjusted profit before interest and tax and adjusted net finance costs was 2.6 times, or 2.4 times if capitalised interest is included. The market value of borrowings of the Group at the end of December 2007 was £2,004.5 million, £44.9 million lower than the book value.

Funds availability at 31 December totalled £1,136.5 million, comprised of £348.3 million of cash deposits and £788.2 million of undrawn bank facilities. Only £25 million of the Group’s facilities are uncommitted overdraft lines with the balance of undrawn facilities being fully committed and with £738.9 million remaining available to 2010/12.

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Hedging policies
The Group has established policies on interest rate and foreign currency translation exposures, liquidity and funding. These policies state that around 85 per cent of the Group’s debt portfolio should attract a fixed or capped rate of interest and that between 75 per cent – 90 per cent of foreign currency assets should be matched with liabilities of the same currency.

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Interest rate exposure
As at 31 December 2007, 83 per cent (2006: 83 per cent) of the gross debt portfolio attracted a fixed or capped rate of interest at a weighted average rate of 5.6 per cent (2006: 6.0 per cent). Much of this debt was in the form of fixed rate debt issues raised through Sterling Eurobonds. Such fixed-rate debt issues are held in the balance sheet at amortised cost. Interest rate swaps, caps, collars and forward rate agreements are also used to convert variable rate bank debt to fixed rate. The 17 per cent of debt remaining at a variable rate of interest brought the overall weighted average cost of debt down to 5.5 per cent (2006: 5.8 per cent).

The Group has decided not to elect to hedge account its interest rate derivatives portfolio. Therefore movements in the fair value are taken to the Income Statement but, in accordance with EPRA recommendations, these gains and losses are eliminated from adjusted profit before tax and adjusted EPS.

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Foreign currency translation exposure
Due to the nature of the Group’s business it has no cross-border trading transactions and therefore, foreign exchange transaction exposure is negligible. However, it does have operations located overseas which transact business in the domestic currency of the country in which the business is located – mostly in Euros. The Group’s main currency exposure therefore is the translation risk associated with converting net currency assets back into sterling in the Group consolidated accounts at each balance sheet date. As mentioned above, the policy is that between 75 per cent – 90 per cent of currency denominated assets must be matched with liabilities of the same currency. At 31 December 2007, £221.1 million or 7 per cent of currency denominated net assets were exposed to exchange movements. A 10 per cent movement in the value of sterling against all currencies in which the Group operates would change net assets by £25.2 million and net assets per share by 6 pence or 0.9 per cent.

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