Argosy Property Limited (ARG) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the Argosy Property Limited FY '25 Annual Results Briefing. [Operator Instructions] I would now like to hand the conference over to Mr. Peter Mence, CEO. Please go ahead.

Thank you. Thanks for joining us this morning for the summary of the financial year results. Aware that we're not the only result that you might be trying to cover today, so we'll try to keep to the highlights and be reasonably succinct. Overall, we are pleased with the way the business has come through what's been a relatively challenging year. Occupancy remains challenged in terms of profitability and in terms of costs specifically, and of course, by the confusion generating a lack of confidence with the U.S. taking a good share of the blame for that. Uncertainty also domestically with central government changes and personnel manpower and in policy, both with seismic, albeit that's okay for us, depreciation and cost control measures. The property investment market remains relatively thin, but the values for the portfolio have improved, principally driven by rental increases, particularly so with respect to green buildings. Turning to the main strategy slide, and you'll see there's very little change or there's no change with this slide. We remain diversified, remain focused on green and on maintaining a resilient business. The year has been pretty good to us in terms of awards. Very pleased, of course, with the Supreme Award from the Property Council for the Willis Street development for Statistics and 105 Carlton Gore Road taking a gold award at last week's building awards. Turning to some of the activity that we've got on at 224 Neilson Street. This has been a reasonably profitable building for us during the year. The first building is now complete, leased to basic transport. The second building is on schedule with current negotiations and play on that. So hopefully, that will all come through as scheduled there and unrealized profit on both the land and on the development. Turning to Mt Richmond. This has been particularly successful for us. The first building is underway and is progressing according to plan. Leased to Viatris. And again, really solid unrealized profit on the land of around $15 million. Dave will pick up on that detail a bit later on and on the development on the way through. It is notable that the softer construction market we've been experiencing reduces the risk of a potential overrun for us and improves the overall pricing and profitability of those developments. Turning to the value-add green developments. We've got quite a bit still happening with Mt Richmond, with 224 Neilson Street, both in play. East Tamaki Road, which we have yet to settle. In fact, the vendor works on that site are running a bit behind program, and we now expect that, that is likely to push settlement into September before they're able to hand over. But overall, we're seeing better-than-expected demand and better-than-expected rental returns, which will give us a higher holding return on that site. The summary of the results. Obviously, net property income is up. It's a relatively positive year from that perspective. The revaluation, as we've mentioned, driven largely by increased revenue, has lifted the NTA to $1.53. So it just moves the discount further away from the trading price. Gearing importantly, remains within the target band around the middle of that target band. And with a market that we still expect to be lifting, that's a pretty good result. Operationally, it's been a reasonably solid year, albeit leasing is a bit like trying to drag race a bulldozer. I expect leasing will continue to be tough during the year ahead. We're getting very, very good inquiry and particularly in areas where there is an opportunity for a lower-than-market rental. But the reality is that the conversion time for those inquiries is lengthy and is challenging. There is no doubt that many tenants are still worried about the uncertainty and where the market is going. The WALT has declined during the year, and this is what we should expect to see in a period of uncertainty. Having said that, we've got a couple of reasonably lengthy leases that we're working on and expect to have over the line shortly should prop that number up. We've got a sector summary there, which I won't dwell on. Except to say, when we look at the portfolio as a glance, there's little change in asset allocation. It's fair to say that some of the Board would prefer to see us move faster to within our target bands. But at the end of the day, we have to be cognizant of what the market is doing and stock selection must take a front seat in some of those decisions. I'll cover the revaluations, but Dave will get into a greater level of detail. Importantly, the portfolio is sitting at around 11% under rented. And when you go through incrementally what that looks like across the portfolio, we're getting much better rental growth out of green buildings than we're getting out of nongreen buildings. Some of you may have seen a report by JLL recently in the market that picks up the expected demand for green buildings versus the supply and notes between now and 2030. In Auckland, there's over 160,000 meters of deficit in that green building supply and in Wellington over 100,000 meters of deficit. This is illustrative of what we're seeing in the market with the demand for green buildings going forward. So overall, we expect to see continued rental growth in those green building places. In construction, we expect construction prices to remain competitive for the year ahead with the forward load of construction activity and the supply, we -- all the feedback we're getting from our contractors and QS is that, that market will continue to be competitive. I'll hand over to Dave to run through the financials and then come back and talk about what we're seeing for the future.

Thanks, Peter, and hello, everyone. The first slide from me is the gross property income waterfall. So gross profit income was $132.7 million for the full year, compared to $131 million last year, so that's up by 1.3%. There were some solid rent reviews in the period, and there's more on this in the appendix as usual. 81% were fixed reviews with an annualized increase of 2.9%, 10% were in market reviews with an annualized increase of 8.3%. The other -- sorry, disposals were a bit of a drag on income as usual, notably 10 transport place in East Tamaki, which was sold in January '24. So on to the next slide, profit for the year. Net property income was slightly up on the prior period. The increase in gross profit income was tempered somewhat by an increase in rates on gross leases in Wellington. Positively though, insurance was lower in the second half of the year, and we expect further reductions on renewal in October for insurance. Net interest expense was down on the prior period, and this was due to lower rates and higher capitalized interest in the prior period. So Peter's covered a revaluation gain of $72 million -- $72.7 million, and we'll cover off tax in the next slide. So net profit after tax was $125.9 million, compared to a loss of $54.5 million last year. The next slide covers distributable income. After fair value adjustments, gross distributable income was $64.1 million compared to $61.2 million last year. That's an increase of 4.7%. Current tax was up by $2 million. It's a bit of a broken record, but once more, this is due to the removal of deductions for depreciation and buildings and the tax effect of the reduction for this year would have been $2.8 million. As a result of the tax change, net distributable income was flat at $55.8 million. On a per share basis, net distributable income was $0.0658 per share, the same as last year. The next slide covers AFFO or adjusted funds from operations. On a per share basis, AFFO was $0.0643 per share compared to $0.0690 per share last year. The biggest movement was in net maintenance CapEx, which was up by $2.1 million in the period. And the biggest items there were various office fit-outs. So office maintenance CapEx was 17 basis points or $1.3 million. The dividend was flat year-on-year, so the payout ratio to AFFO was 103% this year, compared to 96% last year. The next slide is the investment property waterfall. So investment property, excluding the right-of-use asset at marketplace of $40 million increased by $135 million during the year. So we've talked about a revaluation gain of $72.7 million or 3.6% on book. The balance was due to spending on developments, principally $40 million on Neilson Street, $8 million on Mt Richmond and $3 million on Springs Road, Allens Road. The portfolio after deducting the right-of-use asset at 39 Market Place was valued at $2.1 billion at March 31. The next slide is NTA, net tangible assets per share. NTA moved up to $1.53 from $1.45 per share at March 31, '24 and $1.46 at the half year. The main driver was the revaluation gain of $72.7 million recorded in the period. Next slide. Debt to total assets, gearing. Balance sheet is in good shape. At year-end, with debt to total assets at 35.7%, down from 36.5% last year and 37.2% at the interim. The property at Forge Way settled for $35.2 million in March, and we have a further 7 properties for sale and they have a total book value or current book value of $147 million. So 5 of these buildings are office buildings with a total book value of $118 million. And these properties are all expected to be sold over the next few years. Next slide covers interest rate management. It was great to see rates starting to decline during the period, and we expect there's more to come through this year. Our weighted average cost of debt, including margins and line fees was 5.1% at March 31, compared to 5.6% last year. The level of cover has dropped slightly to 63% from 71% last year. We had $170 million in forward start swaps at March 31, and we'll continue to take out cover when appropriate. So we'll provide a lot more color on our hedging profile in the appendix. The interest cover ratio moved up to 2.5x from 2.4x last year, which is positive and the bank covenant is 2x. The next slide looks at the debt profile. As we sit at the half year, we refinanced our bank debt, pushing out tenor. The nearest bank expiry now is October 2027, and bank margins remain very competitive, as you'll see from the appendix. The nearest green bond matures in March '26, and we'll need to refinance this at some point this financial year. Some banks are now offering 7-year money. So margin comparisons are going to be very important for that. Green bonds represent 38% of total debt facility, so there is a significant source of funding at the moment. And the final slide for me is on dividends. As per our dividend announcement today, we declared a fourth quarter dividend of $0.016625 per share with $0.002180 per share imputation credits attached. The dividend reinvestment plan remains open for shareholders to participate in. So the DRP is popular with our retail shareholders, and we're applying these funds to our Mt Richmond development. As Pete already mentioned, the metrics on this development are very strong with an IRR of 9.4% on current land values and development margin just under 20% or $44 million. Guidance for FY '26 is for flat divi of $0.0665 per share. As noted in the market release today, the good news is we expect the dividend payout ratio to be within our FFO policy range of 85% to 100% but at the top end. And now I'll pass you back to Pete for leasing update.

Thanks, David. I was just recapping on where we've been with leasing. So I mentioned at the beginning of the presentation, it's actually been a reasonably challenging year. Pretty pleased with the results that we've seen come through. And indeed, with the inquiry we've got, we expect to maintain that level of momentum. It is fair to say that the conversion time period and the difficulty in getting an inquiry over the line is higher than we've seen for a number of years. The -- particularly so in the government sector, where we've been reasonably successful in getting progress in the government, but it takes an enormous amount of time to get there. Most notably, the largest lease in the portfolio in the following slide shows up in March 2027, which is for MBIE in Stout Street. And this negotiation -- well, the commercial terms are agreed and the document is with the tenant for execution. But to be fair, it has taken a very long time to get to that point. And I think we're counting years, not months. Overall, what we should expect to see is tenants looking for more flexibility on their lease terms and shorter lease terms as a result until such time as there's more certainty in the market. The positive is that we're getting some really good lease inquiry, particularly notable for the 39 Market Place building where after a reasonably quiet period and inquiry, we've now got 2 or 3 that we're dealing with. So the market is interesting in that space. And it will continue to take us. We expect time to get conversion of lease inquiry. But at the end of the day, this is when the team do their best work. So not particularly concerned about where we're seeing it sitting. Obviously, not happy that the weighted average lease term has reduced. But overall, we've maintained renewal rates at around 85% of the leases and we expect to be able to continue a high level of that for the year ahead. Looking at the sectors, there's -- what's notable in the industrial sector, which continues to be quite strong, is that just-in-time deliveries remain off the table, larger inventories are still being carried across the market. There is still really good demand for second tier space, which we had not expected. And in the -- as I mentioned, in the situation of East Tamaki Road, the demand for that second tier space is both stronger in volume and in price than we had expected. In the office space, I've foreshadowed the comment that the drive really here is for green office space, not exclusively, of course. But we're seeing better rental growth out of green space than we're seeing out of -- in the market rentals than we're seeing out of non-green. In the retail space, it's very much a location story. And bearing in mind that I'm talking only about large-format retail, and we're fortunate with reasonably well located or very well-located assets. Demand remains quite solid. But noticeably, it's dominated by larger and more secure retailers, we're really utilizing the opportunity of a quieter market to secure a better quality and larger space. It's been particularly useful for us in the Albany Mega Centre where some tenants that are potentially challenged with respect to tariffs are being able to be replaced at higher rental levels and better lease terms with better quality tenants. Overall, that's looking reasonably positive. We have spent quite a bit of time going through the portfolio, talking to the tenants about the potential impacts of the tariffs out of the U.S. that has yielded some interesting results, not always focused on the tariffs themselves, but very much information that we can utilize and add some value going forward. So for the year ahead, it's very much a leasing focus. It's very much a green focus and we have to understand that we will probably continue to deal with a level of uncertainty in the market that is going to mean we have to work harder to achieve those occupancies. Pretty happy with the way the business has come through what's been a difficult period. And the work with the tenants, as I said, will put us in good stead for positioning the business for the future going ahead. Overall, we do not expect tenants in the portfolio to suffer, particularly with respect to tariffs. What is notable is the number of the tenants who are making alternative arrangements where they've been reliant on transactions with the states. That's about it as far as the presentation is concerned. We're both happy to take any questions you might have.

[Operator Instructions] Your first question comes from Bianca Murphy (sic) [ Bianca Fledderus ] from UBS.

So firstly, I just had a question about your weighted average portfolio cap rate. So you're reporting 6.35% compared to 6.37% last year. But if I look at your first half '25 presentation, that shows 6.21% for FY '24 and 6.23% for first half '25. So I was just wondering if you could clarify what is happening there or what I'm missing?

I think that's because we -- it was the inclusion of Mt Richmond at the half year, and that sort of skewed the numbers a bit. So we've taken Mt Richmond out of both periods. So the half year numbers were incorrect, effectively.

Okay. And then just moving on to your maintenance CapEx. So for this year, that was around 10 bps of property values. Could you provide some guidance on what you're expecting there next -- or this year? And also in the long run, what we should sort of think about in terms of debt ratio?

I think historically, the long run has been about 30 basis points or about $5 million to $6 million. And I'd expect us to be starting to increase towards that level this year.

Okay. So sort of 20 bps perhaps this year...

Well, I mean, I think it would be more likely to be $3 million to $3.5 million this year, net.

Your next question comes from Vishal Bhula from Jarden.

Congrats on a pretty solid result. Just on your overall strategy, could you just give a bit more color on how you see your portfolio positioned over the next couple of years? And the March update, you gave some really good color. You said post-Neilson, Mt Richmond and your budget disposals, you'd be about 58% industrial. But do you kind of see acquisitions also forming a part of your strategy over the medium term?

Not really, Vishal. Good question, though. Look, if there's not a resoundingly good reason for an acquisition, I don't think we're going to be easier. The reality is, I think, that the forward pathway is nice and predictable and evenly balanced the way it sits. So if we're not dealing with something that is going to add particular value like complementary site right next door or something, I suspect that we'll be pretty quiet on that front.

Perfect. That's all good. Fair. And then just on Wellington office, there are a few moving parts there. Could you give a bit of an update on the land and key assets and how you're going with the re-leasing and potential divestment?

Yes, I can. Re-leasing demand on 147 is actually very strong at the moment. We've got currently 6 possibly -- 5 possibly even 6 inquiries that we're working through that is at budget levels, not in excess of budget levels, but we're already dealing with a building that's 80% of code. You're dealing with basically 500-meter floors. That seems to be where the market is active at the moment. So realistically, the market is for that uncharacteristically, it's for that 500-meter floor level, and almost exclusively from the bottom of Willis Street through to the Beehive.

And then is there any update you could provide on 143?

Not at this point. The -- there's a lot of gossip around what's happening, but we don't have anything more concrete on that in terms of what's happening on the occupancy. The reality is that it makes a really, really good hotel when our sale interest is nearly focused exclusively in that space.

Perfect. And then just the last one, I think, which you touched on during the press, but you said there was going to be some relief in rental costs in October on lease renewals. Was that correct?

Sorry, I'm not quite sure I got that. What was the question, Vishal?

Dave just said when you talk through the financials about an NPI, there being some cost relief coming in October from rates and insurance.

Yes, it's really insurance. So the -- what we're hearing from the London markets is that there could be up to a 20% rate reduction this year. So I mean that's only part of the story. You've got to look at insured values as well and loss limits. But a big drop in rates is going to be really helpful, I think. Obviously, a chunk of our insurance is in Wellington -- relates to Wellington, and we have gross leases down there. So that should flow to the bottom line.

So when Dave said rates, he meant insurance rates, not council rates.

I don't think council rates are coming down...

Yes, I can't see the council reducing the rating, but somehow.

Your next question comes from Nick Mar from Macquarie.

Just following on from sort of Bianca's question around maintenance CapEx. So you've got a bit of a step-up there, which might be a couple of percentage -- sorry, a couple of basis points impact to your payout ratio. Can you just talk through how you get back to 100% payout ratio for FY '26, especially if you're looking at divestments and some of these assets are obviously above your cost of debt for initial yields that they're holding?

It's rental growth. Obviously, rent reviews is helpful. Interest is coming back. Insurance is coming back. So they're sort of -- this is some of the key things. We've got some -- obviously, some leasing up with developments, Neilson Street. The balance of Carlton Gore Road properties we leased up this year. So a lot of tailwinds at the moment, a lot of under-renting. So the market rent reviews were expected to be quite positive that we have this year, and there's quite a lot more this year than we had last year. So I would say there's a lot of tailwinds coming through.

And some of that rental growth, Dave, we've already got locked in because the rent reviews that have already happened in the tail end of the year -- probably we got the full year...

Yes, you've got to flow through from the prior period as well. So yes, there's some of the things, Nick, that get us there.

And how much -- or how many of those assets have you assumed are divested during this period?

Three in the model this year.

Okay. That's helpful. And then just on the noncore assets, if I look at sort of the amount that you had at the half year and then what you've got now, I see you've sort of -- it looks like you've taken 4 Henderson Place out of noncore and that into core and then you've added in the 2 new market assets which you're currently marketing. Can you just talk through how assets moving in and out of noncore like that through your target portfolio and sort of which assets you like and don't like?

Yes. The Henderson Place, we had an opportunity to add particular value, which we'll talk about at the next result. But there was good reason for putting it in. We had an offer that was well above our book value. That ultimately didn't proceed. And we said, well, okay, if you're only getting book value for it, it makes more sense to do the work and retain it. That's turned out quite positively, we think. And underlying, I got to remember that the vast majority of the value add of that asset is centered around its land value. So it's one of those ones that if you're not going to get paid really well for it, you're better off to retain it.

Yes. And then the decision to put the 2 additional new market assets into noncore, like has there been an interest in it? Or is it just that you...

There is interest in all the stuff that we've got on the market, but the reality is that it is slow. It's not something I expect to happen in a big hurry, but it's something we just want to keep working on. And again, stock selection plays a part as well. And we just need to make sure that we're making the right decision at the right time given the income and value and the asset allocation targets.

Okay. And then just on the revaluation, I guess we're sort of surprised on the uplift in the portfolio overall, but particularly industrial. And if you look at it, there's been a small amount of sort of cap rate firming and again, there might be a little bit of mix in there. But just sort of thinking about that, I don't think any sort of market commentator is seeing market rents lift in the last 12 months for industrial. If anything, they're sort of flat to down on a net effective basis. So I'm just trying to understand how the market rents within your valuations have lifted by enough to sort of support a 5.7% uplift in value?

Yes, it's a bit difficult to say, Nick, that varies right across the portfolio. The bigger focus, though, is the lift in the rental rates for industrial green assets where you've got proper certifications and we're getting better rentals than had been expected coming out of the valuers in those locations. Equally, I think locational variants, for instance, the building in Favona Road in Mangere, we're dealing with what is now a relatively more attractive location than it was considered to be 12 months ago. So that building has been a great property for us over the last decade. And I think it extends the situation when you look back and say, when we acquired that asset, it was effectively in the middle of nowhere, yet now it has become a central and desirable location. So there's a bit of locational gentrification I'd call as far as that's concerned as well. But yes, it is varied across the portfolio. But an answer to your opening remark, I think I was a little surprised it was that firm as well. It was a little bit ahead of where we were expecting.

Your next question comes from Rohan Koreman-Smit from Forsyth Barr.

Congratulations on the stable results. Just a question that I've got is around capital management. On my numbers for Mt Richmond, it looks like about $140 million, $150 million spend. You've got $140 million of assets to sell. So kind of net-net, that kind of funds that. You're trading at a huge discount to underlying asset values, you've got a DRP still on. Why do you need the extra capital? And I guess if you believe book values, why aren't you buying back selling assets and buying back stock?

Yes, that's a good question. I mean I'd like to sort of compartmentalize these things a bit. I mean the DRP wouldn't be on if it wasn't for Mt Richmond. And we're just trying to protect the balance sheet because as you know, as Peter said, divestments is a bit lumpy in terms of getting that cash in. We're not too sure when that's going to come in. So the DRP just helps protect our balance sheet. But if you look at Mt Richmond numbers and you kind of look at things statically and you apply the metrics that exist at the moment, sort of an initial yield of 6.2% and the current share price, which is obviously depressed a little bit. It has a very -- and you can take out some attendant extra debt on that. The extra impact on earnings is very, very minor. In fact, it doesn't move the dial at all. And yet, we've got the significant capital appreciation in that asset going forward. In fact, already, if you look at the capital gain from acquisition, we made about $16 million in 4 years. So we feel that the DRP is, one, something that retail shareholders love. And two, it's very useful small amount of income that we can -- amount of capital that we can get to apply to that asset and protect our balance sheet.

Okay. But you're effectively matching divestments with your capital spend, right? So that feels a bit -- it feels unnecessary. And also retail shareholders can buy stock on market if they want to effectively do the DRP themselves, right? So -- it feels like an expensive source of funding, given where you're trading.

Yes. I mean, you've got to put it in perspective. It's not a significant amount of capital coming in. It's not like we're doing $100 million equity raise funding the development. It's a very measured, slow and very cheap way of getting equity income into the business. And so we're applying it. It wouldn't be on if it wasn't from Mt Richmond. Mt Richmond, we're committed to, and it's just helping us with that development.

Okay. All right. Yes. I guess if you believe your asset values when you do do, I guess, some of these feasibilities, either for acquisitions or development, do you stack it up against buying your own stock? And kind of how do you trade off the two?

We do. I mean if you look at buybacks, first of all, you got to believe your share price is below intrinsic value, and we obviously do that, believe that at the moment. Ideally, you kind of need debt capacity to do it. But in our case, we don't and we're recycling assets. So what we've done is we've recycled the -- effectively allocated the recycled capital into 291 East Tamaki Road. Now the counterfactual for that is quite difficult because it's a future development. It's got reasonable returns, 8.2% now with a lot of conservative numbers in the fees and annual yield of 5.6%. But as I said, there's no real counterfactual. But if you look at Mt Richmond and where that was 4 years ago, we went out to the market and said, "Hey, the IRR is 7% on that and the holding returns 4.7%." And the holding return on the original cost 3 or 4 years later, when we started development was 6.5%. So the numbers moved quite quickly. And obviously, the capital gain on that property already in 4 years is $16 million. The development margin is $44 million. The IRR has gone up to 9.4%. So we kind of really believe that it's a good use of capital buying that asset and that down the track, it will be a fabulous asset for the company.

Okay. But I guess the counterfactual right now is there's 44% gain in the share price back to NTA, assuming you believe your asset values and call it, 6.5% cash yield, maybe more. So that's a pretty significant hurdle. So either, I guess, for you guys to do alternate capital allocation, you need to not believe in your book values. I believe that there's no growth in the share price because the IRR on buying back your own stock plus growth probably gets you on both of those metrics will get you to well above, I guess, any of these kind of high single-digit IRRs that you're talking about right now?

I mean we're not discounting buybacks as a potential capital management lever. But even if you want to buy back shares, you're limited to basically 5% of your share capital, it's $40 million. And there's no guarantee on the execution either. I mean if you look at recent property sector buybacks, there's only been -- there's been 2 of them. They wanted to buy back 44 million shares, and they only executed on 10% over 9 months. And we're pretty low liquidity stock as well. So there's no guarantee. You can just say, okay, we're going to buy back 44 million shares. So even if you thought that was a great thing to do, there's an execution risk as well.

Yes. But to be fair, Rohan, conceptually and in theory, we don't disagree with your point, but we probably can't take it a lot further.

Yes. So we think that where we're going -- I mean, it's hard to say right now. But we think that asset that we purchased with that recycled capital will be an absolute winner for shareholders down the track.

[Operator Instructions] Your next question comes from [ Francois Bernard ] from ANZ.

Just a question for me. So you've got a dividend payout policy of 85% to 100% of AFFO, you're going for 103% payout this year on what arguably is a soft AFFO quality because you've got maintenance CapEx that's much lower than what it should be. So what animated you to go outside of your dividend policy this year?

I guess just first off, from a policy perspective, the Board have been fairly clear, I think, in saying that they understand that a lot of the register is made up of domestic retail investors, that volatility and payout ratios is not attractive to that sector. And as a consequence, they've said they're comfortable in moving outside the AFFO band in the event that they can see us moving back in again in a reasonably short period. So that's our projection for next year. So they were basically smoothing that out and focusing on the domestic retail shareholder in terms of understanding the strategy for that.

Thank you. There are no further questions at this time. I'll now hand back to Mr. Mence for closing remarks.

Well, thank you very much for joining us this morning. Appreciate that. Understanding that there is other noise going on today. So I hope the rest of the day goes well, and we'll look forward to catching up with most of you later on the day. Thank you.

And that does conclude our conference for today. Thank you for participating. You may now disconnect.