Abacus Group (ABG) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the Abacus Group HY '25 Results Presentation. [Operator Instructions] At this time, I'd like to hand the conference call over to Mr. Steven Sewell, Managing Director. Please go ahead.

Thanks, and good morning, everybody. Welcome to the half year results presentation for Abacus Group. I'm joined here in Sydney with Evan Goodridge, the CFO for the group; Kevin George, Fund Manager for ABG and General Manager, Commercial; as well as the Investor Relations team. Abacus Group remains a diversified commercial REIT with a portfolio of office and retail assets as well as a 19.8% investment in Abacus Storage King, the $3.3 billion listed self-storage vehicle that we are the fund manager of. Our total assets for the group are valued at $2.6 billion as at the half with a weighted average cap rate now of 6.66%. A key result positive for the period was the strong double-digit operating earnings growth in our office portfolio, up 12% compared to the last corresponding period HY '24, with our like-for-like retail segment also performing strongly with operating earnings growth of 15.4% positive on the prior corresponding period. Across the half, we were pleased to announce a distribution of $0.0425 per security, flat on the last period, even though we have a slightly lower asset base. Gearing for the group sits comfortably at 34% within our target range and the level we think is appropriate for this point in the cycle, especially given our lack of any major capital developments -- development capital commitments. And finally, from an office and retail sector perspective, we are seeing the early signs of the cycle turning positive from both a capital and leasing perspective. Turning to the highlights for the half. We continue to build on recent leasing momentum in the period, delivering a strong performance in our portfolio of commercial assets, as I mentioned earlier. Office operating earnings of 12 percentage points positive year-on-year was supported by like-for-like rent growth of 6.3%, driven by higher average physical occupancy in the period as well as strong positive leasing spreads and rent reviews. The retail portfolio also performed strongly, supported by rent reviews of 4% positive and higher average physical occupancy in the period at our shopping center Oasis on the Gold Coast. Pleasingly, at Oasis, the moving annual turnover also continues to trend very positively, which drives higher turnover rent during the period. We continue to benefit strongly as the fund manager and a significant investor of Abacus Storage King. Our self-storage return on investment earnings as well as the fee earnings from ASK represent 2 of our major income sources for the group alongside the office and retail segments. Looking ahead, we remain very positive on the outlook for the self-storage sector in Australia and New Zealand, and we're encouraged by the strong result that ASK delivered on the ASX on the 14th of February, a result underpinned by an irreplaceable portfolio of land-rich assets in prime suburban locations with the sector having several structural tailwinds. Our investment management earnings from commercial fees as well as the fees for managing ASK delivered over 12% of the group's operating earnings in the period. Investment management growth of 10% compared to the prior period reflects an increase in asset values for ASK as well as 6 months of ASK management compared to the 5 months in HY '24 due to the timing of the de-staple taking effect in August 2023. We continue to explore further investment management initiatives, as Kevin will update you on later in the presentation. I'll now hand over to Evan to talk through the financial metrics and capital management of the group.

Thanks, Steven, and good morning, everyone. The group's income remains well diversified with approximately half of operating earnings coming from office income and the remainder collectively from retail income, management fees and investment returns from our ownership of Abacus Storage King. Our like-for-like operating earnings have risen by 13% for the period with significant growth achieved across all 4 segments being office, retail, self-storage and investment management. Breaking this down, our office income grew by 12%, driven by strong leasing, particularly in our Sydney CBD assets of 201 Elizabeth and 77 Castlereagh Street. The group also received $2.4 million in an early surrender fee as one of our larger non-SME tenants look to centralize their operations. Turning to retail. Our portfolio saw like-for-like income increased by 15%, driven by both successful leasing at the Oasis Shopping Centre and strong CPI-linked rental growth at the Myer Centre in Melbourne. In late October 2024, we divested our interest in Market Central, Lutwyche and in the asset partnership with ISPT. This asset contributed $1 million to the non-like-for-like retail income for the period with the proceeds of this sale used to repay outstanding bank debt. For self-storage, our ongoing 19.8% investment in Abacus Storage King contributed $8.6 million in earnings for the period. Additionally, the group received $8.7 million in storage-related fees being $6.3 million in funds management and $2.4 million in development management services. For the second half, we anticipate continued earnings growth from both management fees and our ASK capital investment, both of which continue to perform strongly. This year, we have brought forward the timing of certain admin costs, thus removing the skew in increased expenses for the second half. This means that the group remains on target to deliver a full year admin expense in line with last year's $34 million despite inflationary pressures. We continue to focus on improving efficiency and building a stronger and more scalable operating platform. The group is in the process of simplifying and replacing its existing financial systems, and we are forecasting from next year onwards annual savings of $0.5 million. The group's cost of debt for the period was 5.1%. With the RBA's rate cut decision last week, it appears that finance costs have likely peaked, and we expect our cost of debt to reduce, albeit slightly in the second half. For the 6-month period to December, the group delivered funds from operations of $0.045 and a distribution of $0.0425, which is 50% franked. The group saw sufficient credits to fully franked dividends of approximately $160 million, and it remains our intention to distribute these to our investors over the medium term. For the past 3 years, the group has provided a distribution at the upper end of its payout ratio range, and we are forecasting a similar ratio again this year. Our current forecast is subject to the continued success of our re-leasing program and no material deterioration in current business conditions. Our focus on delivering growing sustainable diversified returns remain steadfast, and Steven will further discuss the group's outlook and guidance later in the presentation. We continue to improve and simplify the balance sheet. As previously mentioned in late October 2024, Abacus divested its 50% interest in Market Central, Lutwyche for $60 million, shoring up the group's capital position. The group has also exchanged on 3 non-income-producing parcels at its Virginia Park joint venture, which is expected to return $23 million in proceeds to the group by Q4 financial year 2025. As at 31 December, the group has $1.5 billion of primarily A-grade office assets with about half of our office exposure located in Sydney. The group's largest single investment, though, remains its $423 million ownership in ASK, representing 16% of total assets with a further 16% reflecting our remaining 2 retail properties. As Steven mentioned, our balance sheet gearing is 34%, and we maintain high liquidity levels with over $250 million in existing acquisition capacity. Abacus has no committed development projects on foot with limited short-term capital requirements as our tenant incentives and maintenance CapEx track downwards period-on-period. We continue to maintain significant headroom with cap rates needing to rise by more than 220 basis points before approaching covenant limits. And further, we have no need to refinance and remain well supported by our existing lenders. The group has substantial hedge cover at 90%, maintaining a blend of both fixed rate swaps and collars, which allows us to still benefit from future rate cuts. We are confident in Abacus' outlook. And as we progress our noncore disposal program, the group will have additional flexibility to consider all capital management initiatives. Our income profile continues to strengthen. However, despite income growth over the period, our properties have not been immune to the prevailing market forces and, as such, a 16 basis point expansion in cap rates has been taken. This has resulted in an overall decrease in values of 2% for the period. Our office portfolio has now been revalued down 27% since pre-COVID with cap rates expanding by more than 150 basis points. But we believe that values are stabilizing with the group's weighted average cap rate now at 6.66%. With that, I'll hand over to Kevin to discuss the group's portfolio performance and operational priorities.

Thanks, Evan. Good morning, everyone. The Abacus Group strategy continues. That is identifying, owning and managing real estate to deliver both exceptional returns for our investors and value for our customers. Moving forward, we will continue to be a principal investor, prioritizing the office and retail sectors where we have embedded capability, but also look to leverage our platform to invest with like-minded capital partners in these sectors. To deliver the strategy, ABG is focused on some key priorities to improve and grow earnings sustainably through the cycle. Firstly, the composition of the portfolio will continually be reviewed to ensure we are invested in assets that can outperform their peer set. As a result, we will continue to divest noncore assets to provide capacity to pursue higher returning opportunities. We'll also consider selling down part interest in core assets to seek new relationships with programmatic capital partners. At this stage, we have earmarked circa $300 million of divestments over the next 12 to 18 months to assist in funding these initiatives. Growing the management business revenues via new partnerships will help further diversify our earnings and provide enhanced returns on our invested capital. Optimizing leasing outcomes through improved customer experience initiatives is also a big focus, which I'll expand upon shortly. And finally, we've embarked upon several platform initiatives to improve our efficiency that will increase our ability to scale profitably. The most significant being the consolidation of 14 operating systems to 2 with the primary platform being Yardi with a go-live date set for early FY '26. The repricing of office markets post-COVID has provided organizations with the opportunity to upgrade both quality and location with premium and A-grade buildings in major CBDs being the biggest beneficiaries. Our portfolio is proving resilient because of our diverse tenant base and asset quality. SME tenants continue their flight to value, seeking high-quality, well-located spaces with good amenity at competitive price points. This aligns with our portfolio, where over 50% of our nearly 300 customers lease under 500 square meters, the most active segment in the market. Flexibility within our buildings through fitted suites and adaptable space options is also driving retention and reducing downtime. We are also working on elevating tenant engagement through digital access, community initiatives and service improvements to strengthen relationships and future leasing outcomes. The group's office assets performed well in the period with like-for-like rent growth of 6.3%, driven by net face leasing spreads of 7.5% and average rent reviews of 3.7%. Our rental growth also benefited from higher average physical occupancy in the period. Our weighted average lease expiry of 3.7 years reflects our customer profile skew to SMEs who generally commit to leases in the 3- to 5-year range. It's also important to note that 96% of the group's leases are on a net or semi-gross lease basis. Therefore, there is minimal direct inflationary impact from recent outgoing increases. The group leased nearly 30,000 square meters of space in the period. As I mentioned previously, the strong leasing spreads of 7.5% included double-digit spreads on new deals of 10.5%. The step-up in leasing in the period was driven by the reintroduction of 11 floors at 201 Elizabeth Street that were previously being held for development. Incentives were higher in the period skewed by the large vacancy at 201 Elizabeth Street and competing vacancy at Darling Park. We expect incentives to moderate moving forward, particularly in Sydney and Brisbane, where vacancy rates in prime grade CBD continue to tighten. Turning now to our lease expiry profile. The 9% current vacancy, you can see on the slide, 2.7% of this is attributable to 710 Collins Street in Melbourne. The Goods Shed, as it is known, was vacated by 2 separate Victorian government departments during the period, leasing 6,400 square meters and 3,900 square meters of space, respectively. We are well progressed on our leasing campaign and refresh of the space and hope to report further progress at the full year results. Retail continues to remain a stable, albeit small part of the portfolio with our trophy asset, Myer in Melbourne and the Oasis on the Gold Coast, which is also an excellent asset with long-term income upside. The growth in our retail operating earnings was driven by a strong step-up in physical occupancy during the period as well as strong turnover rent growth from Oasis. Solid rent reviews also supported operating earnings. Oasis highlights from the period include MAT growth of 5% on half year '24. And pleasingly, MAT has grown at a compound annual growth rate of 5% since 2019. Retail strength at Oasis has been broad-based with recent population growth in the main trade area of Broadbeach exceeding that of the wider Gold Coast region. Myer provided a recent market update noting its year-to-date sales performance has been stable, and we continue to view our triple net lease favorably. In half year '25, we disposed of Lutwyche Market Central, as Evan mentioned. We also received an uplift in our Myer income after increasing our ownership in the asset to 50%. The storage. Our allocation to the self-storage sector through our 19.8% stake in ASK provides the portfolio with a very stable income stream with low CapEx and strong earnings outlook. The group's return on investment earnings of $8.6 million in half year '25 were driven by ASK's established portfolio RevPAM growth of 5.4% with average rents $373 per square meter, up 4.4% on half year '24 and strong occupancy of 91%. In addition, as the fund manager of the $3.3 billion vehicle, Abacus also earned a further $8.6 million in ASK fees, and we continue to view the self-storage sector favorably. The group enacting multiple growth initiatives, ranging from real estate development and acquisitions to platform enhancements. Thank you. I'll now hand you back to Steven for concluding remarks.

Thanks, KG and Evan and also the team for what has been a busy and very productive period. Looking ahead, we are confident that Abacus remains well positioned to leverage our platform as well as the key enablers that will deliver recurring income and value creation over the medium to longer term. Our commercial portfolio continues to perform very well. And the group also has a scalable platform. As Kevin mentioned, we're exploring further opportunities to do capital partnering alongside our ongoing management of ASK. We're pleased today to be able to affirm our distribution guidance of $0.085 per security, which will reflect a payout ratio in the range of 85% to 95% of FFO. That ends the formal remarks for the presentation. We look forward to taking any questions you may have or alternatively meeting you in person in coming days or weeks.

[Operator Instructions] Our first question today comes from Ben Brayshaw from Barrenjoey.

Just referencing Evan's comments on the surrender payments taken up in the office NOI. Could you just explain a bit about what happened there, please?

Ben, it's KG, I'll take that. So that was a consolidation of [indiscernible] from 99 Walker Street into the city. And so vacated early, and we're basically working with them to downsize that. And so we took the opportunity to take space back, got a payment and moved to re-lease the space, and we've re-leased a substantial part of that already.

Okay. Just also on James Ruse Drive, Steven, I think you talked about this at the August result. Correct me if I'm wrong, that was an asset held for sale. It doesn't appear to be still held for sale. Has that been withdrawn from the market? If you could just provide an update on that, please?

Yes. Ben, it was an off-market campaign that we ran. We do have one discussion continuing with a party, but there's nothing concrete to add to that at the moment.

So just on that, what do you see as the highest and best use for that site?

It's zoned industrial today. But as you know, it's quite the focus of the New South Wales government with the adjoining Rosehill proposal under constant review. So we've always targeted a more mixed-use, high-density residential mixed-use development use, but we do note that it is entitled for industrial as it stands today.

If you couldn't achieve an acceptable price, would you consider developing as industrial?

No. As Kevin mentioned, our focus is on the commercial and retail sectors.

Yes. I understand. No worries. And could you just -- perhaps this is a question for Evan. Could you just walk us through the main differences in operating cash flow and FFO for the first half? And just how you'd expect the second half to change because of the timing in cash flow recognition?

Yes, absolutely. So when I looked at the first half operation cash flow, it's a little bit low, partly due to the fact that we've got a number of joint ventures that declare their distributions at December, but then don't pay them until the second half period as well as the fact that some of our managing agents held back rent and then swept them in January. It's also partly due to the fact that we prepaid some expenses in the first half as well as obviously tenant incentives. So I'm looking at the second half cash flow is going to be stronger than the first half. And so therefore for the full year closer to FFO.

Okay. Terrific. And sorry, guys, just my final question around, I guess, the bank facility coming up in the next sort of couple of years and just referencing your interest cover covenants. Just wondering if you had any discussions with your banks on getting flexibility on the covenant.

Yes. Thanks, Ben. I'll take this one again. So the great thing about our interest cover ratio is it's a lagging 12 months. And so where we're seeing our earnings growth come through, that's not starting to show yet through the ICR as well as the fact that interest expense is coming down. So that buffer should get better and better as we go forward. In respect to a little bit of debt coming up in the next 12 months, we could let that debt roll off. So we've got really strong relationships with our lenders. There's no suggestion that the margins are going to change and that we should be able to refinance it. But worst case, if we didn't want to, we could let that disappear.

Our next question comes from Solomon Zhang from JPMorgan.

Just interested in a bit of further color on the $300 million of assets you've earmarked for potential capital partnerships and sell-downs. Could you just touch on maybe the types of assets that sit in that bucket? And it was also mentioned that there's interest in capital management potentially and deployment into high-returning opportunities. So just how you're thinking about deployment as well.

Well, there's some obvious ones in the noncore bucket like Camellia, Riverlands, Bowden Street, we are in the market with that [ notion ] of point at the moment. We're thinking about potential alternate uses as well as the re-letting prospects for Canberra Allara Street, but we don't see that as a long-term core holding for the group. Abbotsford potentially and 710 Collins Street potentially are assets that we would consider parting company with. So there's a bunch of assets from a core perspective and potentially sell-down a partial interest, we're not going to comment on those publicly at this stage. We're in conversations with potential partners at the moment, and there's a wood to chop yet, so we won't comment. But the way we're thinking about the business is, yes, having more capacity to pursue what some of the opportunities we're seeing off market in office and retail on the Eastern Seaboard I think are interesting to us and our potential new partners. So we want to make sure we've got sufficient capacity to be able to participate alongside them in those opportunities.

I think, Solomon, just if I could follow on from that. I think when we look at average cap rates, and I'd concur with some of our friends and peers who have reported over the last week or 2, when we look at where cap rates have adjusted, particularly for prime or A-grade Sydney CBD assets to think that you could buy properties in the fairly tightly held Sydney CBD with a 6 handle in a cap rate, we think at this point in the cycle makes attractive purchasing, and that's some of the discussions that we've been having with external capital.

Great. So I guess the stock is still trading at a pretty wide discount to NTA. Just your thoughts on acquisitions versus buybacks if the stock is still trading where it is.

Yes. I think we've got capacity on the balance sheet at 34%. Buyback is an option that we constantly look to review. However, we do think, as I said, that there is almost once in a cycle opportunities to purchase at the sort of price we're seeing. However, we will, every 6 months, constantly review that idea of buyback. However, where we see the balance sheet at the moment, as Kevin said, we think that there's an opportunity for us to use some of our invested capital in those noncore sales to continue to manage the balance sheet and potentially direct that -- some of that investment across into new assets.

Great. Maybe just a question for Evan. Just looking at Slide 6, we're just trying to reconcile the half year operating earnings for office. [indiscernible] down half-on-half on second half '24 despite the surrender fees. So any color there as to what's driving that?

No, not really. I remember in the second half last financial year, there was a bit of percentage rent, turnover rent and some surrender lease fees as well that came through, but not at the amount that we're talking this half. I wouldn't read into it as anything major period-on-period.

All right. So there weren't surrender fees benefiting second half '24 office?

Yes, they were, not to the same level, but there was about $1 million or so in the second half last year.

Yes. Maybe we can take it offline.

[Operator Instructions] Our next question comes from Callum from Bramah (sic) [ Callum Bramah from Macquarie ].

Just a couple for me. Just on guidance, and maybe I'm reading into it too much, but there was a comment about being at the high end of the payout ratio historically. And I guess, the guidance range implicitly is a 10% range for FFO in the second half. So is there 2 parts to it? One, will it be towards the high end of that payout ratio as it was in the past? And the second piece is, could you just give us a little bit of an idea of any of the swing factors that we ought to be thinking about into the second half that would drive the difference?

Yes, Callum, I did guide to the upper end of that payout ratio range based on the current forecast we're seeing. What we're seeing at the moment is, 11% vacancy or short-term expiries. And although the team has done a wonderful job of getting 1/4 of that already solved to date, that's going to be a swing factor. The other swing factor is a lot of the scalability and efficiencies that we're building throughout the organization, we're not going to see a lot of those benefits come until next financial year. So I guide to the upper end of that range.

I think as well, Callum, if I can jump in, I think our preference is to bring our distribution level lower in that range. And you'll see we've held distributions flat year-on-year even with growth in operating earnings. So we think that's quite a sensible proposition in the current market conditions. So you can see us continue to do that as well.

Maybe while you're talking about, I was just interested in the capital partnering opportunities. What sort of level of co-investment you would be looking to make? So as we move and look forward from here, I guess, if you get -- successfully recycle the $300 million, what's ideal look like and maybe what are capital partners expecting?

Yes. So it varies a little bit, but the range is probably typically going to be 10% to 20%. Some of the groups are talking to maybe wanting a bigger share than that would suggest. Others, depending on the size of the opportunity may want us to upsize that contribution as well. So -- but typically, we're going to be looking to be co-invested to the tune of 10% to 20%.

Maybe one last one, and apologies if I did miss it in the preso, but just an update on where you're at with 201 Elizabeth and the progress on leasing that up.

We've done substantial leasing in the period. I think we're up to about 80% and more to do, but we're pretty pleased with the last 6 months has been.

And ladies and gentlemen, at this time, and showing no additional questions on the audio side, I'd like to turn it back over to management for any offline questions.

Thanks. I think other than there's one small question online, just in respect of cash flows from disposals. And I think what Evan touched on is the $60 million from Lutwyche was received prior to balance date with $23 million from Virginia Park to be received in Q4, so after balance date. And the other questions, I believe, we've tackled. So we'll bring the presentation to an end. Thank you, everybody, for their time and interest and look forward to catching up. Thank you. Good morning.

That does conclude our conference for today. Thank you for participating. You may now disconnect your lines.