It would be hard to describe Victory Office's H1 2021 results as...

It would be hard to describe Victory Office's H1 2021 results as anything other than disappointing.

Based on their 18 December 2020 trading update, and applying their occupancy rates to their geographic footprint gave the sense they had occupancy rates somewhere around 40%. Granted this was reported in December, with Victoria seemingly over the worst of their lockdown.

From those broad assumptions, it would be reasonable to have expected average occupancy for the half at perhaps 30% which against their current footprint (so excluding new sites yet to be opened), and allowing for some discounting, should have put them on track for revenue in the $9.5m - $10.5m range and a half year loss (ex impairments) of about $7m. Impairments were inevitable, but with net cash and almost all liabilities coming from Dan Baxter (or entities controlled by him), a modest write-down to ROU and increase in provisions was unlikely to kill the company. In this way it was not so much the statutory loss that was important, but the underlying loss and the degree to which the company was burning cash.

In this context, a half-year loss of $14.1m (underlying) could seem catastrophic.

However, after a few days to consider the results, some observations:

• Look carefully at the differences between their trading update from 18 December 2020 and their 26 February 2021 HY annoucement: In the space of about 6 weeks (over Christmas, no less) their Victorian occupancy range remains static, as does their QLD occupancy rates, while NSW occupancy increased from 55% to 60%, and WA increased from 54% to 60%. Victoria is still the key focus, but as COVID-related restrictions ease and a new year kicks into gear, one would think it reasonable to see a good increase over coming months.
• Their lease liability includes around $4.95m of leases not yet commenced. In the presentation issued alongside their half year the company states they are "actively pursuing surrendering 5 leases to reduce their cost base". Unsure which sites these refer to, but if leases can be broken this could slow the cash burn and buy time for demand to recover.
• They still have around $4m cash, plus an additional $15m loan on offer from Dan Baxter. It's likely the cash will be gone by 30 June 21, but entirely possible the extra $15m could buy another 18 - 24 months of tough trading conditions.
• This draws us to consider what might happen if conditions don't improve. One possibility is they could downsize. It looks like they are already doing this (as indicated by their comment about "actively pursuing" lease terminiation).The challenge here is that the bulk of Victory's leases are long term (see: Lease Liabilities maturity analysis in HY report). The value of these leases (RoU) is the bulk of VOL's assets, and so incurring penalties for early exit could render the business bankrupt.
• A related issue is the very high commercial vacancy rates across Melbourne metro. This has the impact of reducing the RoU value and potentially makes it cheaper for a new entrant to replicate VOL's business (in a Tobin's-Q, kind of way).

Victory have flagged that they expect shared office space to take longer to recover than single-tenant commercial office space. They would have more of an idea than me about that, so will assume that is correct. In their estimates for asset impairment (HY report, pg 15) they are forecasting occupancy of between 20% and 70% by December 21, and between 20% and 80% by December 22. With the Australian Government on track to deliver up to 1 million doses per week of the COVID-19 vaccine we should see the bulk of Australians vaccinated (both shots) by around August. One would expect that in such a scenario, VOL's management would/should be seriously looking to close any office space that is still only achieving an occupancy rate of 20% (or 50%, for that matter).

We might also speculate that with the bulk of the population vaccinated and virus under control, people would be eager to return tothe social and societal norms of business, which includes their physical presence. Indeed with smaller businesses perhaps now aware of the advantages of having people working from home, looking for ways to cost-effectively obtain a smaller geographic footprint that can adapt to fluctuating numbers of staff may tilt some businesses toward shared spaces, like those offered by VOL.

Ultimately, though, VOL's survival will largely depend on how quickly behaviours change. There is a chance the company will not survive the next 9 - 12 months.

Conversely, should the vaccine and demand for a return to "business as usual" see occupancy rates across the company's portfolio exceed 50% (or so), then it's likely the company will be profitable again. A return to pre-COVID levels (2 - 3 years) could see their current portfolio generating profits of $7m - $15m pa, and paying perhaps half of this to shareholders.

Company is currently valued at $20.45 m.