Argosy Property Limited (ARG) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the Argosy Property Limited FY '21 Interim Results Briefing. [Operator Instructions] I would now like to hand the conference over to Mr. Peter Mence, CEO. Please go ahead.

Well, good morning, and thanks for joining us run through the interim results. We've got what we think is a fairly solid result once you strip out the forfeited deposit and depreciation changes that Dave will run through in detail. I'll run through the portfolio bits and pieces in the same manner as normal. Dave will cover off the financials, get into the meeting stuff. And then I'll talk about what we're seeing with leasing and outlook for the portfolio going ahead. So just touching on some of the highlights out of the interim result. Obviously, the net distributable income increase is quite pleasing. Rental reviews during the year or the half year have been quite good. And you'll see later the like-for-like rental growth even better at 5.2%. Revaluations. We'll talk about that in a bit more detail, but obviously, the increase in the NTA was driven by a fairly healthy interim valuation gain. We did get the third green bonds away successfully; very pleased with that, and further diversifies the funding. The dividend increase. Obviously, we came out of the COVID lockdown slightly better than expected, and it's pretty pleasing to see the portfolio demonstrating some good resilience going through there. Turning to the Create, Manage, Own slide. There's not a lot of change here, but the pandemic lockdown gave us some timing impacts with the Create section and the delivery. And you'll see later on, we'll talk about some of the delays that were occasioned there. But the Manage and Own sectors really worked for us quite well during the pandemic. With the Manage area, we had early and effective communication with the tenants, and we've already done deals with the tenants well before the government issued the arbitration assistance package worked for us pretty well. And in many cases, we probably ended up with a better relationship with the tenants afterwards than we had before. So that's all pretty good. The Own section works for us reasonably well in terms of the number of businesses that were exempt from lockdown by essential services and obviously, Crown-based tenants. So overall, that works fairly well for us in the Manage and Own section and the Create has shown some delays. Turning to the next slide, working through those. We're continuing to focus on the green sustainable development opportunities and particularly with the Mt Richmond new acquisition. We're working on that to try and get the whole development very much into a green focus. I'll talk about that a bit later as well. In the Manage area, we've got really good interest at the moment with Waterloo Quay leasing the remaining space there, and we've got current negotiations underway. In the Own sector, the thing to note there is the continuing firming of cap rates. Continuing demand for property stock means that sale activity is still very positive. Looking at the portfolio highlights. You can see some fairly solid statistics there. Weighted average lease term still up towards the 6 years. Occupancy very solid at the end of September. That like-for-like rental growth that we're very pleased with, 5.2% is quite a good result. Portfolio remains slightly under-rented. So you should expect to see some more room going ahead, albeit I'll note later, we expect to see softer deals in commercial office in Auckland and particularly, in retail where we're seeing rental declines in that area. The desktop revaluation, I've mentioned that, and we'll talk about that a bit later in terms of the makeup of what went on there. There's not a lot to note on the portfolio charts. You can see the Albany Lifestyle Centre is still sitting in the large-format retail area. Once that sale goes through, we'll see that drop below the 10% level. I won't get into the sector summary in any great detail. You can see the numbers that are sitting there. It's just interesting to observe the shorter lease terms in the large-format retail and the strongest lease terms in the industrial sector. Looking at value-add opportunities. The 224 Neilson Street industrial property, obviously, that's heavy industrial, pretty well located. Steelpipe are currently sitting in there paying us rent. It's a holding return going through that. The probability is that they will wish to remain on the site longer than initially thought. So it may be that works for us quite well in terms of giving some more time with the COVID lockdown there. 101 and 105 Carlton Gore Road, that's Tonkin & Taylor and Vector, both those developments are expected to be pushed out -- well, have been pushed out, and we expect to see those come back to us in 12 months to 24 months in terms of when we see that going. 8-14 Willis Street, obviously, well underway. We did have to close the site down for a reasonable period of time. Supply chain issues, difficulty in distancing. Working on a crowded site mean that the completion date is pushed forward to February '22. You'll see that we've added a floor to that development and looking pretty positive in terms of the holding return at over 7% there. Turning to Mt Richmond's strategic Auckland industrial investments. Obviously, this is a really well-located site, sitting between our Bell Avenue existing properties and the Mt Wellington Highway. So the site actually fronts off the Mt Richmond Drive and Doraval Place, which is straight off Great South Road and has through access right through to the Mt Wellington Highway. And it's just immediately to the south of the successful busy drive, good quality industrials sitting in there. So good opportunity for us there. And we think that the -- we can put about 40,000 meters of industrial onto that site, and target is to go fully green through that. Turning to more information on the current developments. The 7 Waterloo Quay, we've talked about -- I've talked about a little bit before that. So we've added an 11th floor. Incremental yield on cost, over 7%. And the delays as a result of COVID pushing the program out to February '22. Within Waterloo Quay, I should mention the additional work on the exterior facade of the building. We had projected that to be a $10 million spend. But while the scaffold is up, we're going to complete additional work to reduce ongoing nonrecoverable maintenance on that property. So that's going to be a $15.5 million spend before we take the scaffolding down. But the avoided maintenance cost is going to save us some ongoing nonrecoverables there. The insurance claim. We don't have a result on the insurance claim yet. We're still working that through. And obviously, insurers have no real motivation to move quickly on that. But hopefully, we'll be able to get some progress on that in the year ahead. With the revaluations, there's a mix of the -- the obvious change there was the unwinding of the provisions made for COVID. And you'll see in Dave's presentation that we ended up having to support tenants less than we had expected at the beginning. So we're unwinding some of that. Those cap rates we're earning across the board, driven by the lower debt costs and some rental reviews that were ahead of expectations at the last revaluation, 31 March. So those 3 really drove the revaluations: cap rate firming, unwinding of the COVID allowances, rental reviews ahead of expectations. At this point, I'll hand over to Dave to take us through the juicy financial stuff.

Thanks, Peter. So the first slide for me is the -- I'd just look at the gross property income. Like-for-like rental growth was a very solid 5.2%. The annualized increase in rent reviews was 3.8%. And the highlight there was one particular review in Wellington, which picked up the Wellington, the market and the office numbers, to quite strong numbers. And there's more detail provided in the appendix, as usual. As leasing up was $1.3 million, largely due to Citigroup 99 Khyber Pass Road and 80 Springs Road. 7 Waterloo Quay was also up, despite the fact that we exceed lease insurance income in the period as new tenants commenced in the building. We had additional income from acquisitions at 244 Puhinui Road and 224 Neilson Street, and we completed developments, particularly at 107 Carlton Gore Road. So the sale of a property in [ Favona Road ] December last year was the biggest contributor to the drag from disposals. And finally, there was a hit from rent abatements and deferrals. To break it down further, it was $3.3 million in abatements and $0.6 million in deferrals. And half of those deferrals will be recovered by the end of the year, and the balance will be in future years, mostly next year. Of course, we're hoping that this will be the end of this. But obviously, we don't know yet. So if we split the $3.3 million by sector, 57% was large format retail, 23% was office and 20% was industrial, and 95% of that was in Auckland. Just moving on to the profit and loss. Admin expenses were up slightly due to manager staff costs going up, in particular, increased provisioning for holidays, actually, as people wouldn't take holidays during COVID. Interest expense was up by $3 million. We had higher bank debt, but this was offset by lower weighted average interest rate. But the big driver of the variance was lower capitalized interest, mainly at 7 Waterloo Quay. We will not capitalize interest on this property anymore. The big capital revaluation gain, and as signaled previously, we have included the forfeited deposit on the sale of the Albany Lifestyle Centre gross income. We also realized $1 million in gains on sale of 2 properties during the period. And profit before tax was $115.9 million compared to $81.3 million last year. The next slide is distributable income. So if we strip out the usual adjustments, gross total income was $35.6 million compared to $34.3 million last year, and the big change compared to last years on the tax line. A couple of things here. Tax depreciation of buildings has been introduced, as you all know. And the impact there was $1.4 million tax effective or $4.9 million gross. And we've now quantified a very significant adjustment for asbestos removal and the Section DB 46 of the Income Tax Act. And there are also further deductibles for demolition costs and disposals at 8-14 Willis Street. So a really solid tax number driven by, effectively, tax depreciation on buildings and asbestos deductions. So the net result is a $6.4 million increase in net distributable income for the period. Net distributable income was $.0435 per share compared to $0.0359 per year last year. Next slide is just the investment properties slide. Capitalized costs were mainly at 8-14 Willis Street, $20 million there, and at 7 Waterloo Quay, $8.3 million. Two buildings were moved into held for sale. That's Hutt Road and 80 Springs Road, and now both scheduled since 30 September. On the other side, the Albany Lifestyle Centre has been moved back from held for sale. The net movement was, therefore, $46.4 million. We sold 2 noncore properties, 960 Great South Road and the Corner of Wakefield and Taranaki Street in Wellington during the 6-month period, to which we adjust for the NZ IFRS 16 Lease, depending on marketplace. The portfolio was valued at $1.92 billion at 30 September. On to NTA. As you see, we've moved to $1.41 per share, up from $1.30 per share. And as usual, the prime driver has been the revaluation gain recorded in the period of $79 million. Next slide up, the balance sheet and gearing. The debt-to-total-assets is 36.6% at the end of September compared to 38.8% at March year-end. As noted on the previous slide, since 30 September, we've scheduled on 2 held for sale properties. So this has had the effect of dropping our gearing by a further 1.2%, as we sit here right now. The next slide, funding and interest rate management. Our weighted average tenor was 3.2 years through September, but that since increased following the green bond issue in October. The weighted average interest rate was 3.74%, which is down only 3.95% at 31 March. Interest cover ratio has improved to 3x, and that should continue to improve as development is complete. We have a number of expensive payer swaps, around $295 million, have all rolled off over the next 4 years. So that's going to provide some nice earnings for medium for Argosy in the future, providing interest rates remain depressed. Just on our debt profile, our current debt profile. And this shows where we end up post the green bond in October. Our tenor increased to 4 years, and the diversification increased to 38% nonbank-to-bank debt from 23%. And we'll complete another round of bank financing over the next 2 or 3 months. Last line for me on dividends. So we declared our second quarter dividend today of $0.016375 per share with imputation credits of $0.0709 per share attached. The DRP will continue to rise previously with 3% discount applied. We've also updated our FY '21 dividend guidance to $0.0645 per share, and that's 1.6% up on FY '20. So now I'll pass you back to Peter.

Thanks for that, Dave. Just talking firstly about leases, leasing activity and expiring profiles. When we end up in a market that's showing a level of uncertain, what we normally see is shorter-term renewals, short-term leases, but a higher level of tenant retention. So we're starting to see that already. What's worked for us is some fairly good transactions: 147 Lambton Quay, Parliamentary Services, new lease there; Citibank renewal for 5 years; and Customs Street, and a couple of others that we've noted through there. So leasing activity has remained relatively strong, but you'll note shorter lease terms since COVID coming through. The lease expiry profile has remained relatively stable. I've mentioned Steelpipe. We expect to see a renewal there, albeit for a shorter term. Freedom Furniture at the Lifestyle Centre. Hopefully, by the time that lease comes up, we won't own the property, but we're in the process of negotiating a lease extension there. Iron Mountain as a new lease -- is a lease coming up in Wellington at Jamaica Drive. Again, very confident that we'll be getting a renewal out of that, well advanced with negotiations there. And the other large one is the Tonkin & Taylor lease and 105 Carlton Gore Road, where we're working with Tonkin & Taylor on a green upgrade of that building. So I don't think there's a lot of big news coming through here. As I mentioned, expect to see shorter terms but an improved retention rate coming through. If we look at what's driving things at the moment. There's over 100,000 square meters of office space in Auckland for lease or sublease at the moment. That is resulting in some softer deals, not in terms of base rentals but increased incentive levels. And that means our net effective rental, of course, is down. That 100,000 meters on a normalized basis of net absorption would be about 5 years supply to the market. But at the moment, net absorption remains negative. So it's not moving significantly at that point. Just turning briefly to the sector summaries and what we're seeing in each of those main sectors. The industrial market, that's easily very much dominated by scarcity of available land. The market is still growing, good strength and good rental reviews coming through there. So not seeing any big risks in the industrial sector. The excess supplies resulting in softer deals in the office sector in Auckland, I think this is beginning to -- we're beginning to see some suggestions that the working-from-home trend may not be as long-lived as had initially been expected. And in Wellington, of course, we're still in a shortage of space for offices down there. So tale of 2 cities, I guess. In the retail sector, ours is principally large format, relatively less affected. But we are seeing rental reductions in that area. And our expectation is, in general, across the retail sector that rentals could soften by around 10%. Also focused on what the structural change looks like as the COVID lockdown has hastened the move to e-commerce. And we're yet to see an equilibrium level with online retailing. It was quite apparent during the COVID lockdown, but many retailers were ill-equipped for the onslaught of the e-commerce thing, and that we're unable to deal with what was happening there. So we're expecting to see some spillover into industrial retail, more showroom, more industrial, gray stores and dark stores coming out of that. In general, a lot of our retailers have been pleasantly surprised how quickly things have picked up again post lockdown. It will be interesting to see how long that lasts. So turning to what we're expecting and working on for the period ahead. Obviously, the economic environment remains somewhat uncertain and will stay that way until we get the vaccines across the world, I guess. But we do expect that monetary policy settings will remain stimulatory. We do expect that values will remain sound. In fact, anecdotal evidence since our revaluation suggests that cap rates have firmed further from 30 September. So from a valuation's perspective, expecting that to run through quite well, but softer net effective rentals in the office space and retail space, particularly in the Auckland market. And finally, it's good to get through a year as tempestuous as this and have the confidence to look at the dividend projection for the year ahead. So I think we can move on to questions.

[Operator Instructions] Your first question comes from Arie Dekker from Jarden.

And you have a very solid result. Just on 7WQ and the remaining leasing there. I mean, a year ago, you sort of reported strong interest in those remaining 3 floors, and it hasn't quite converted. Can you just sort of talk about what the dynamics are there in terms of just sort of leasing that up? And what's kind of, I guess, delayed the conversion?

Yes. Good question, Arie. I guess the big thing that's delayed the conversion has been an election sitting in the middle and unwillingness for, particularly, Crown tenants to commit in that period. And in that vein, we are not expecting to get a clear drive on that until February. But we do have negotiations for more space current than we have available in the building. So pretty confident going forward.

Sure. And just -- I mean, there was an increase in incentives in the period, and I think that was associated largely with 7WQ and in Carlton Gore. Do you think in terms of incentives to kind of get that remaining space away sort of expecting anything abnormal there? Or just in line with what you've sort of observed in terms of just, generally, incentives being a little bit higher in this environment?

Yes, I'm not expecting any change in the Wellington market. The dice is pretty much loaded. Yet on the one hand, you've got market rentals sort of looking slightly stronger, and on the other, people that obviously don't want to spend money moving in at the moment. But I think that washes through to more of the same and no big changes.

Great. And then just turning to the Albany Lifestyle Centre, hopefully, not far away from closing that out with the party. Just in terms of the capacity that you'll have on the balance sheet post that, you're able to just sort of talk to we might be most likely to deploy that in this environment, particularly with you looking to push out a couple of the value-add opportunities for now.

Yes. We'll probably end up carrying a lower gearing for a while, but we've got a lot of good green projects that we're working on coming through. So we'll be redeploying that back into lifting further the quality across the rest of the portfolio.

And are you very active in terms of on the hunt for acquisitions at present?

I'm not -- we're certainly looking at a lot, but finding a lot of things that are quite expensive. The syndicators are probably pushing the market beyond levels that we think are sustainable in some areas. And it's probably fair to observe that a lot of purchases are going to be doing less due diligence than we will. So getting an acquisition is challenging at the right levels. One of the reasons we were so pleased to get the Mt Richmond acquisition away is that a good hold in return on a really good quality site, nicely located with good demand already. So that will keep us busy for a while.

And then just last one, just on Willis Street. Obviously, you've got a bit more time with completion pushing out to February '22. But just an update on sort of approach to leasing up the remaining space there.

Well, that's specifically relating, Arie, to the site that the -- that was Stewart Dawsons Corner because, obviously, the new tower is pretty much committed.

Yes. I was talking about that. Yes.

Yes. So with that, there's a little bit of office space there. We've got some inquiry for that at the moment. And with -- just interestingly, in the last couple of weeks, inquiries from retailers, good quality retailers, for the ground floor space has picked up again. So it obviously went flat with the COVID lockdown. A lot of Lambton Quay was driven by the international tourists and the big rentals sort of disappeared for a while. But we got good inquiry for it at the moment, and we'll be putting office space, may end up occupying some of that ourselves for the levels above.

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

Apologies for the complicated name. Just a couple of questions from me. You can blame my parents for that one. Just a couple of, hopefully, quick ones. First of all, the -- you said your retail would be below 10%, and that's kind of outside the target band. Should we expect you to be adjusting that just given your development focus looks like it's more office and industrial?

Not in the short term, Rohan. The reality is that we're happy with the level we've got. We obviously have potential to add industrial office and retail already in the Albany mega center site. But that's going to be further down the path. So that's a future opportunity. Short term, you shouldn't expect us -- to see us going out buying retail.

Perfect. But you won't be kind of adjusting the band. So like a lower allocation to retail for longer, 10% [indiscernible]. Did that go to 0 to 10% or something?

Not at this stage. We're just looking at it as a longer-range target. But obviously, these things are always up for a strategic review.

Perfect. And then the additional works at 7 Quay West (sic) [ 7 Waterloo Quay ], the facade, you said, is maintenance CapEx. Should we be adjusting near-term numbers in the AFFO for that? Or is it going to be something that's not run through the P&L?

Well, I think probably, it's maintenance CapEx, the [indiscernible] $10 million is. The additional amount is just going to reduce net operating costs. So we're trying to work through what percentage of that was maintenance CapEx and what isn't. But all I'd say, the vast majority would be maintenance CapEx that would go through the AFFO account. There will be [indiscernible] in the second half of the year. So the extra cost now is saving us about 280-plus a year on normal maintenance. So that pushes things out quite well.

Your next question comes from Adam Lilley, a private investor.