Arena REIT (ARF) Earnings Call Transcript & Summary

Good day, and welcome to the Arena REIT FY '26 Results Presentation. [Operator Instructions] And finally, I would like to advise all participants that this call is being recorded. Thank you. I'd now like to welcome Justin Bailey, Managing Director and CEO, to begin the conference. Justin, over to you.

Thanks very much, and good morning, everyone, and welcome to Arena REIT's financial year 2026 annual results presentation. I'm Justin Bailey, Managing Director of Arena. I'm joined today by our CFO, Gareth Winter; and our Head of Investment and Portfolio, Carla Hayes. For today's presentation, I'll start with an outline of our FY '26 results. I'll then provide an update on the Edge portfolio. Gareth will talk to our financial results, and Carla will provide an update on the Arena portfolio. Finally, I'll provide a commentary on the early learning sector and the economics of our portfolio before providing our outlook for FY '27. Our focus over recent weeks has been on the Edge portfolio, which was the subject of our announcement to the market on the 10th of August. We are committed to providing investors with as much information as we can under the circumstances. As you'd appreciate, there are limits on what we can discuss today as we continue to work with Edge in relation to their lease obligations and potential pathways forward in respect to the portfolio. I want to clarify upfront that our FY '26 net operating income and distributions are not affected. We delayed the release of our full year results to allow us time to complete an independent valuation of the Edge properties, which we saw as prudent under the circumstances. The outcome of the revaluation is reflected in our FY '26 results and reflects a $24.4 million reduction or approximately 10% for the properties from our June 2026 market update. We strongly believe in the real estate fundamentals of the Edge portfolio. It's important to distinguish between operator-specific issues and the underlying real estate. These are well-located, modern, high-quality properties in attractive catchment areas that were selected using the same disciplined investment criteria we apply across the broader Arena portfolio. We remain confident in the long-term value of these assets. Given the current uncertainty of the timing of rent from the Edge portfolio, we've adopted a prudent approach to our FY '27 guidance, which is outlined later in the presentation. Turning to our financial highlights on Slide 3. Today, we report net operating profit of $79 million, which is up 8% on FY '25. Earnings per security increased to $0.196 for the period, up 5.7% Net asset value per security increased to $3.60, up 4% on June 2025 and total assets increased to $2 billion, up 8%. We maintained Arena's disciplined approach to capital management in the period with hedging in place over 100% of borrowings and gearing at 24.5%. The final installment of our FY '26 distribution was paid earlier in August, which brings our total distribution to $0.1925 per security, in line with prior guidance. We've continued to actively manage our portfolio in the period. We divested 11 assets for $53.5 million at an 8% premium to book value. We acquired 3 newly completed properties, and we completed 11 early learning center developments in the period for a total of $161 million. Our pipeline has remained stable at 29 projects, which we anticipate completing over the next 18 months. These transactions are all focused on improving the quality of our portfolio. Our weighted average like-for-like rent increase for the period was 4% with 36 market rent reviews completed at an average increase of 7.6%. The value of the portfolio has increased by $47.4 million or 2.7% over the period. And the passing yield for the portfolio is now 5.56%, an increase of 9 basis points. These movements are inclusive of the Edge portfolio revaluation. Sustainability remains a key focus for the business. Our solar program means we now have solar on 93% of our portfolio, and we're on track to meet our 2030 interim emissions intensity target. We've had our first Reflect RAP formally endorsed by Reconciliation Australia. And it means our initiatives over the year helped us achieve our full margin discount on our sustainability-linked loan. Turning to Slide 6 on the Edge portfolio. As we announced on the 10th of August, Edge failed to pay rent when due on the 3rd of August. We issued default notices under the relevant leases on the 4th. Edge and its lender have up to 21 days to remedy the default. I note that not all properties are subject to the full lender cure period. So on Wednesday this week, we took control of 2 development properties, which were completed but have not yet commenced trading. In parallel, we've signed term sheets with a leading national tenant for both centers at equivalent rents over the initial 20-year lease terms. We continue to engage with Edge in relation to its lease obligations and potential pathways forward on the balance of the portfolio. But we are prepared to take action to protect our rental income, preserve asset value and act in the best interest of Arena security holders. If needed, we will look to replace Edge with new tenants that can deliver safe and sustainable childcare services to those communities. All of our legal rights remain in place, and we're actively assessing the full range of options available to us as landlord. But I want to emphasize, it is the quality of the underlying real estate that gives us confidence in the range of options available to us. Touching on the portfolio itself. The Edge portfolio comprises 31 properties across Queensland and South Australia. The properties are among the most modern in our portfolio. We're confident in the fundamentals of the real estate, including the locations, proximity to primary schools, the catchments and contemporary book form and believe they will be attractive to a range of operators. It's why we chose to invest in these locations. Arena has over 30 childcare tenants across our existing portfolio, and we have very good visibility on the growth ambitions and requirements of major operators across the market from our network. If needed, we're confident we can find replacement tenants for each of the properties in the portfolio. We will look to keep investors informed when it's appropriate to do so, whilst we work to resolve the Edge situation. I'll now pass over to Gareth to provide detail on our financial results.

Thanks, Justin, and good morning, everyone. Just turning to Page 9 of the presentation, you'll find a summary of Arena's operating income statement, which shows an 8% increase in net operating profit to $79 million and a statutory profit of $132 million. There is a reconciliation of net operating profit to statutory profit included in the appendix of the presentation with the most substantial reconciling items being the periodic revaluation of investment property and interest rate hedges. FY '26 operating EPS of $0.196 is 5.7% higher than FY '25, with the key driver of the increase in operating profit in the relative 10% increase in property income from a combination of periodic rent reviews and capital deployment. Like-for-like rent reviews averaged 4%, which is a combination of the minimum annual rent escalations and the market rent reviews. Also contributing to the increase in operating profit with the acquisition of operating ELCs and income from Arena's ongoing program of investment in the ELC developments, including 11 completed in FY '26. Looking at some other line items. Other income is interest income, slightly higher than the prior year due to holding cash proceeds from property sales during the year prior to being reinvested into the development program. $100,000 increase in property expenses. These largely comprise independent valuation and property inspection costs and there's been more activity in that area in FY '26. There's been a $1.3 million increase in our cash-based operating expenses compared to FY '25 of which approximately $1 million is nonrecurring and primarily from the management succession plan and the crossover of the transition of our retiring CEO, the Chief Investment Officer role and the Head of Investment and Portfolio roles. We also had some IT project costs, which we'd expect not to be recurring. The change in underlying operating expenses was otherwise incremental and generally in line with inflation. The increase in finance costs is primarily volume driven with an average drawn debt in FY '26 being $70 million higher than FY '25, plus incremental loan fees on the $100 million facility expansion from the refinance completed in February '26. The overall cost of debt was relatively stable during the period. Capitalized interest on developments is $4.3 million, which is slightly higher than the comparative period, and this is due to greater volume in the development book during FY '26. In addition to the higher operating profit, the higher statutory profit of $132 million is primarily due to higher asset revaluations of $47 million compared to $24 million in the prior period and a $12 million positive revaluation of the hedge book. We have paid a distribution of $0.1925 for FY '26, which is in line with our initial guidance and represented growth of 5.5% on FY '25. Just turning to Page 10, a waterfall chart of EPS for the period. The chart demonstrates the relativity of the individual items supporting EPS growth, noting the key drivers of growth remain the periodic rent reviews and the deployment of capital into acquisitions and developments. The main offset being some asset recycling prior to those funds being deployed into new investment and as I noted earlier, the nonrecurring increase in current period operating expenses from the management succession program. Turning to Page 11, a summary of Arena's balance sheet. The full balance sheet is in the appendix of the presentation. The key points here are an 8% growth in investment property being primarily due to $161 million invested in acquisition and development CapEx during the period, positive asset revaluations of $47 million, offset by $67 million of asset sales and transfers to assets held for sale, which will be recycled into the development program. Net assets per security increased 4% to $3.60 in comparison to June '25 and gearing at 24.5% remains relatively low and stable. Turning to Page 12, capital management summary. We completed a debt refinancing in February '26, which increased the facility by $100 million and extended all maturities with additional weighting to 4- and 5-year terms, providing a weighted average term of 4 years and no expiry before 31 May 2029. Margins were also reduced across all maturities. We have immediately available liquidity of $189 million from the debt facility, which fully funds our development commitments of $121 million and our relatively modest gearing provides balance sheet flexibility and resilience. Overall hedge cover was increased during the year, including additional forward cover with active hedge cover of 100% at 30 June. The chart illustrates the high level of cover across FY '27, FY '28 and into FY '29. We will add to the hedge profile for FY '29 and beyond over time and blend that through the interest rate cycle. The result of the activity in FY '26 is a small increase in our all-in weighted average cost of debt from 4.1% to 4.2% at June '26. And finally, I note that Arena continues to operate with substantial headroom in our banking covenants. I will now pass to Carla for an update on Arena's property portfolio.

Thanks, Gareth. Good morning, everyone. I'm Carla Hayes, Arena's Head of Investment and Portfolio. Today, I'll provide an update on Arena's portfolio valuation and investment activity for FY '26, starting on Slide 14. As at 30 June, the portfolio comprised 307 assets with a total value of approximately $2 billion and a WALE of 17.5 years, reflecting the long-dated nature of the income profile. Early learning represents 91% of the portfolio by value, including developments, with health care representing the remaining 9%. The portfolio is well diversified nationally and across 36 tenant partners with no single tenant contributing more than 20%. Together, the portfolio's national footprint, tenant diversification and long-term triple-net lease structures provide a good foundation for long-term rental growth. Moving on to the lease expiry and rent review profiles. As mentioned previously, occupancy for the portfolio was 100% with a WALE of 17.5 years. There are no lease expiries in FY '27 or FY '28 and only 0.7% of income expiring through to FY '32. During FY '26, like-for-like rental growth was 4% with 36 market reviews completed at an average increase of 7.6%. The portfolio benefits from CPI linkage with over 95% of the portfolio subject to CPI-linked or market rent reviews. Portfolio valuations remained stable during the year and reflective of prevailing market conditions. At 30 June, the total portfolio recorded a valuation increase of 2.7% on 30 June '25. The weighted average passing yield expanded by 9 basis points to 5.56% as passing rental growth outpaced valuation growth during the period. Following Edge's request for rental relief and default notices being issued, the 31 Edge properties were independently revalued as at 30 June, resulting in a reduction of $24.4 million or 10% from our initial 30 June valuations. The reduction in value is predominantly due to below-the-line adjustments for letting up allowances. The direct market for early learning real estate also remained active throughout FY '26. During the year, 154 early learning centers traded for a total value of approximately $860 million at an average passing yield of 5.4% with Queensland and New South Wales providing the deepest markets. Volumes have increased from 98 transactions in FY '24 (sic) [ FY '23 ] to 154 in FY '26, demonstrating a deep, liquid and actively traded asset class. Importantly, the market -- that market depth provides strong look-through support for our carrying values with the 5.4% average transaction yield closely aligned to our portfolio yield of 5.5% over the early learning portfolio. Completed transactions reflect our disciplined approach to capital recycling with a clear focus on improving the long-term quality and growth profile of the portfolio. During FY '26, we acquired 3 early learning properties for a total purchase price of $19.6 million at a weighted average yield of 6.2%. These acquisitions comprise brand-new purpose-built centers acquired on completion with new 20-year leases to existing tenant partners. In parallel, we divested 11 early learning properties with lower opportunities for long-term rental growth for total proceeds of $53.5 million at a weighted average yield of 5.3%. These transactions achieving an average premium to book value of 8%. These outcomes demonstrate the continued liquidity for early learning real estate and allow us to recycle capital selectively into higher-quality opportunities and our development program. Turning to the development update. Our develop-to-own strategy continues to be a key contributor to portfolio quality and growth. During FY '26, we completed 11 developments for a total cost of $87 million at a weighted average initial yield on cost of 6%. At 30 June, the development pipeline remains stable at 29 developments with a total forecast of $228 million, spanning 7 development partners, 5 tenant partners and 6 states. The pipeline has a weighted average initial yield on cost of 6% with $121 million of capital expenditure remaining. The 5 most recent developments were secured at an average yield on cost of 6.1%. Our approach to development remains highly disciplined using a fund-through structure with capital committed only after the land development and lease agreements have been secured. There are no Edge centers in the pipeline. Over the past 12 years, Arena has delivered 99 developments. This has represented less than 2.5% of new market supply, demonstrating our disciplined approach to development. We continue to hold 92 of these properties with the 7 divested over the 12-year period due to changing market conditions within the relevant catchments. This track record demonstrates the capability of the team to consistently source and deliver well-located purpose-built properties while remaining highly selective on real estate fundamentals. I will now hand back over to Justin.

Thanks, Carla. Turning to Slide 20. Our early childhood education care is an essential community service supported by social and economic policy settings and long-term demographics, social policy in terms of gender equality and improved learning outcomes for children and economic policy through productivity, economic growth and tax receipts. It explains why successive governments have expanded investment into the sector over time. The scale of the sector is significant, over 800,000 children and 160,000 staff involved in long day care alone, and it's forecast to grow further. The population of children aged 0 to 5 is projected to grow 14% over the next decade, reversing the largely flat trend seen over more recent years. Female workforce participation is up 6% since 2020, which has historically been the major driver of growth in long day care utilization. The dual working parent household is now an accepted structural and societal norm, which relies on childcare as an essential community service. In the short term, we can see a small decrease in the number of children in long day care in the year to March 2026 of around 1.5%. Feedback from operators is this is at least in part due to parents' current concerns about the safety of the system arising from widely reported issues in 2025. The government is continuing to invest in the sector and is itself forecasting 3.6% growth per annum in the number of children in approved care over the next 4 years, highlighting the potential for near-term growth in demand. Our perspective is that it's important to distinguish between the current changes happening in the sector and the fundamental drivers that underpin it. We see long-term demand and social and economic policy support for the sector, which supports the long-term value of our portfolio. The government continues to invest in a range of measures to enhance quality, accessibility and affordability in the sector. CCS spend is forecast to grow at 8% per annum from $15 billion today towards $21 billion by 2030. The Three Day Guarantee and Building Early Education Fund widen access and address undersupplied catchments. This is all about improving access. Extensive safety reforms implemented over the last 12 months are all designed to strengthen safety, quality and oversight across the sector, which is expected to increase confidence in the system. The extension of the worker retention payment reinforces the government's focus on affordability for parents, but also the economic sustainability of the sector, which is a major employer. Our view is that funding is expanding and the regulatory requirements are rising, both highlight the importance of modern purpose-built real estate, which supports the delivery of safe and efficient early learning services. Turning to Slide 22. Our analysis shows net new supply is moderating in response to market conditions. FY '26 net new supply of 244 centers is below the prior 5-year average of 286 centers. Over FY '26, there have been 210 center closures, which compares to the prior 5-year average of 120, highlighting an increase in the number of centers coming out of the system. Newly developed supply typically has a 12- to 18-month lag due to construction commitments. So it's likely there will be further slowing of supply into the market as new construction starts ease. Overall, we expect new supply to slow and there to be a higher-than-average number of centers leaving the system, particularly poorer quality centers, which ultimately supports greater overall balance in the system. We expect modern, well-located purpose-built real estate will continue to perform well as the focus on quality and efficiency from tenants and families increases. Slide 23 provides a summary of key metrics across our portfolio. The purpose of this slide is to highlight the ongoing rent affordability and resilience of center economics. Net rent to gross revenue, our measure of occupancy cost remained stable at 10%, highlighting the continued affordability of our rents. Average rents per place have increased by 6% to $3,212 per place, which remains well below the economic costs for new childcare centers. The average daily fee, which at $164 has increased by 5.8% (sic) [ 5.7% ], remains below the CCS daily fee cap of $167. As we reported last week, average tenant occupancy across the portfolio has softened from 79.3% to 76.7%. It's worth noting that this is 2 percentage points below the 5-year average of 78.7%. Average rent cover calculated on an EBITDAR to rent basis is above 3x. This is higher in FY '26 than the 5-year average of 2.8x. As a guide on center level operating margins, I note that Arena's center level operating margin is generally in line with the ACCC's childcare report, which reported an 18% to 20% margin for large operators. The data highlights the resilience of the operator economics in our portfolio even at current lower levels of reported tenant occupancy. Turning to the outlook. Long-term fundamentals for Arena remain positive. Expanding access to affordable, high-quality education and care remains at the center of government policy. Long-term population growth and rising community expectations for access to childcare as an essential service continue to underpin the sector. In the near term, we expect the current market dynamics and increased regulation to temper new supply and heighten the number of poorer quality centers coming out of the system. We expect these conditions will highlight the importance of quality and resilient assets in Arena's national portfolio of childcare properties and our disciplined approach. Our operating data highlights the ongoing affordability of our rents and resilience of center economics in our portfolio. Access to that operating data and our proprietary market information positions us to be able to make informed portfolio management decisions. Our priorities for FY '27 are clear: working to resolve the Edge portfolio to preserve long-term value for our security holders and minimize loss of rental income, closely monitoring market conditions and focusing on transactions which improve portfolio quality, progressing our current development pipeline and selectively considering new investment opportunities consistent with our disciplined approach and maintaining our existing conservative approach to capital management. Our FY '27 distribution guidance is for not less than $0.18 per security. This approach is considered prudent given the range of potential outcomes relating to the Edge portfolio, which at this point are uncertain. The distribution guidance will be updated as further information on rental income on the Edge portfolio becomes available during the course of FY '27. In closing, I'd like to thank you for your ongoing interest in Arena, and I'll now pass the call back to the operator to open for questions.

[Operator Instructions] Your first question comes from the line of Cody Shield from UBS.

Just a quick one on this new detail on the tenant operating metrics there. So look, I guess one item that's not captured is the interest burden that your tenant operators might be facing. So how do you think about the sustainability of your rents for operators where leverage might be a bit of an issue at the group level?

Yes, Cody, great question. And look, we thought very carefully about the information that we were choosing to provide today about sort of the tenant economics. And what we were trying to do there is to give you the visibility at a center level that ultimately we see profitable tenants that translates into a good amount of rent cover and that ultimately, that rent cover has been sustained over a long period of time. So I think that was the main purpose of I guess, providing the information that we have. You are right in saying that every tenant has a different business model and every tenant will have a different capital structure in-house supports that business model. We look at the operating data to give us confidence about the profitability and I guess, the positioning of our portfolio, but we do have regard to how the wider corporate picture of a tenant is placed. We can, like you look at the disclosed financial statements of tenants and try to form a view as to whether there are issues that we need to be cognizant or aware of. When we look at the portfolio today, I think what we see is tenants other than this Edge matter fully paid up and compliant with their leases. We see robust economics in our portfolio for each of our tenants, and that ultimately gives us confidence in the underlying value of the real estate that we hold.

Your next question comes from the line of [ Leanne Truong ] from CLSA.

My question, I guess, how much of your developments are committed? And why didn't you consider an equity raising given where you're trading?

So in terms of the developments that we've got on foot, so you're right, we've got 29 developments on foot today. We have excess capacity in our current funding to cover all of those developments and a considerable margin. There is no need for us to seek to raise capital to fund any of our developments at this point in time.

Sorry, I didn't mean equity raise. I meant buyback, sorry.

Buyback. From a capital management perspective, we're always cognizant of options available to us. Obviously, that's one that's going to be under consideration, but we have made no decision in respect to that at the moment.

Your next question comes from the line of Murray Connellan from Moelis Australia.

Just hoping you could give us a little bit more color on your guidance, please. Is the current modeling that, that is -- that's covered by FFO? And I suppose what assumptions do you have for the income from Edge or from those centers, please?

Yes. So it is covered by FFO. So the payout ratio would be similar to historical levels, which have been pretty consistent if you look back over time. We have assumed for the purpose of prudence in the guidance that we have received the July rent but no further rent is received for the balance of FY '27, and then we'll update the market as the year unfolds and we have more information available to us. From a core assumptions perspective, we usually talk about -- we just picked up the 5-year swap rate in the forward interest rate curve, call it about 4.5%. But obviously, with high levels of hedging, we're not that exposed to underlying interest rates. And from a CPI perspective, we basically picked up an average of 3.5% to trending down to 3% during the course of the year. I think it's important to note also from the guidance perspective that we are holding approximately $4 million of bank security in respect of the Edge leases. And we assume if that rent is not collected in accordance with the leases that we will collect on that during the course of FY '27.

Your next question comes from the line of Carl Braganza from Jarden.

A few questions for me. The first one was, I know it's probably a wide range per asset. But can you give more color on how long average downtime has historically been for your childcare portfolio?

Carl, great question. I think what you will have known from Arena over a long period of time is we manage our forward-looking lease profile very carefully. So it is very rare that Arena finds itself in a position where it's having to deal with a vacant property. So I'd say a good first point is it's a very rare occurrence. Where we've had instances where we've needed to assign property from a tenant to another tenant, we found we can do that reasonably efficiently, but we don't necessarily think that is representative of this situation. Here, if we've got a large number of properties that we are looking to re-tenant at a point in time, that potentially could take longer than those scenarios that we've seen in the business in the past. I think, at this point, what we've tried to do with the guidance is just, I guess, provide a prudent message around the $0.18, acknowledging that we will be working hard to obviously minimize any gap in rent over FY '27, but I can't give you specific metrics or guidance that would help you form that view.

Sure. And then just a final question for me. You've got multiple tenants who like Edge are PE-owned, such as Green Leaves and Affinity. Do you see more risk in those tenants? And how do you plan to manage that risk?

Yes, Carl, I think, again, coming back to the lens that we take, we're certainly very focused on how those tenants operate in our properties. And so by providing the, I guess, the additional information on the tenant metrics today, what we're giving you is a level of confidence that ultimately, those tenants in running those services out of our properties are running profitable, successful businesses. We look at that and take a lot of confidence from that in that it speaks to the quality of the underlying real estate, and that means the locations, the properties themselves as well as the performance of the tenant. So I think from our perspective, that is where we spend our time really focused. Ultimately, we've got all of our tenants other than Edge across our portfolio that are compliant with their lease terms. We will, of course, monitor the sort of corporate position of our tenants. But at this point in time, we're very focused on the performance of our portfolio. And I think that's what the tenant metrics provides you confidence in today.

Your next question comes from the line of Callum Bramah from Macquarie.

I just wondered if you can share what you think the drivers were of the failure of Edge as an operator. Is it really the operator? It has nothing to do with the catchment or the built form design? So in essence, you can simply re-lease them to a different operator and get a different result?

Cal, I think the question is a really good one. I think the way that I'd answer the question is to say we fundamentally believe the real estate is good real estate. And what we're trying to do in providing the slides on the portfolio today is to give you a little bit more color around that real estate. This out of our portfolio, this is amongst the newest centers in our fleet. We've got good proximity to the sort of things that are really important in childcare around proximity to primary schools, for example. So ultimately, the value that we see in the portfolio comes from the real estate. I don't want to comment specifically around Edge. Edge is obviously a business that has been on its own journey in terms of growth. It's, I guess, publicly reported that it has -- its investors have provided additional capital over time into that business to support that growth. But ultimately, for us, when we are looking at the situation, we are looking at the value of the underlying real estate in those communities.

And I think because normally in those catchments or when you're developing, you would look at ratios of number of places to number of children in a catchment, et cetera. So I just wondered if those metrics look as favorable as potentially other catchments that you've got as a follow-up. And one other one, just around the income at risk, can I just clarify, so it's 14% of annual rental income. When we're thinking about that number, is that the sort of $101 million number? And is there any other impacts that we need to be aware of through the P&L? Any costs that Arena would need now to bear if those were to go vacant?