Argosy Property Limited (ARG) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the Argosy Property Limited FY '21 First Half FY '22 Interim Results Call. [Operator Instructions] I would now like to hand the conference over to Mr. Peter Mence, CEO. Please go ahead.

Good morning, and thanks for joining us for the Argosy interim results in a half year that has not exactly been devoid of any challenges to keep us interested, but we're pretty happy with the results that we've come through with here. Just an agenda, as normal, I'll run through vision and strategy highlights, some discussion on what's happening in the portfolio. Dave will take us through the financials, cover off on leasing and then focus on outlook going forward. So turning first to the vision and the strategy. This has been good for us in the half year. We're talking about, with the diversification weighted into government tenancies into Wellington property and industrial property has meant us some good resilience across the portfolio. And with the structural changes, more on that later, that we're seeing in the property market, that focus on green is really important with the working environment becoming part of the encouragement or the attraction to people to come into the office. So that's worked well for us going through them. The business case for green, obviously, quite strong. And we've got to quote, there are 7 in 10 companies in APAC willing to pay rental premiums for green building, and that was from Jones Lang. From JLL in June '21. And so obviously, this is still growing. And we've seen just recently, the New Zealand government at a central level now requiring new builds to be green-rated, which is filling in the gaps with the already announced requirement to have a performance rating under the neighbor's existing building tool. So we're seeing this grow still further. Business case for green is obviously based around energy savings, a value uplift and reduced staff costs. It's probably fair to observe that, while we're getting longer leases, better engagement with tenants and less vacancy with green building. Green buildings are probably not going to be discretionary in the longer term, and it will be more a case of what you lose if you don't do that. Just a quick case study for 82 Wyndham Street, which is New Zealand's first zero carbon building, quite proud of that. And particularly given that we created that from an existing asset, a solid increase in rentals, a good development margin and a general rate of return of 8.3%, quite positive. We look at the highlights from the results. We've got good rental growth. We've got good value growth, solid profit growth and a safe dividend. And you could look at that and say, "Well, what was the lockdown, what happened?" But the reality is the portfolio was in good shape before lockdown, and we expect that the impacts of lockdown will continue through the second half of the year. Portfolio highlights. That pictures the recently completed Big Chill industrial development in Jamaica Drive in Wilmington that's worked rather well for us. We're getting solid well -- solid occupancy and solid well set through to the end of the year with some rental growth on reviews still coming through and looking quite solid. Just turn through to the sector summary. That's all pretty self-explanatory. I just note that the contract yield in the office sector is weighted for some allowances and the valuations for pending expiries, lease expiries and capital projects on the way through. The next slide shows the asset allocation. And you can see that that's largely on target across the 3 charts there. Next slide picks up the CBRE July 21 property market monitor, and it shows the little exposure that we have, the portfolio has to CBRE's top 3 ticks. Obviously not looking too bad for us there. And moving on with the -- obviously, the biggest sector for us is industrial and the biggest location there is in Auckland, showing the -- a graphic that's a put-together of the industrial portfolio across Auckland by location, spread from 98 in the north through to the warehouse distribution center in the South. The next slide is the same but just looking at it on a different angle from the south going through to the CBD. Turning to the value-add properties. Obviously, we've got quite a bit of work underway with the Bell Avenue properties. That development is going really well and very pleased to be able to get that through with a 0 vacancy. We've got some more data on that to follow. I think the one that we want to pick out of that list is 25 Nugent Street, which has a current book value of $17.3 million. And we -- last -- following the close of the Board -- we finalized an unconditional sale on that building at $22 million. So obviously, a fairly big lift. And we're in a situation of securing virtually all the profit margin that we were looking for out of that development without taking any risk at all. So that property will now be a sale, will transfer to held-for-sale and will settle on the 28th of September in 2022. The only other thing out of that list I'd really point out is the only building that's not earning out or the unleased property that's not earning an income on that list is 105 Carlton Gore Road, where we're about to start a redevelopment. A couple of value-add case studies here. Obviously, we've already talked about Mt. Richmond in prior presentations. This is a really solid sign for us, and the site value has gone up since settlement. We are getting a hold in return off that site. Our target is a carbon-neutral development trying to maximize the year September across the development, if we can get it, of course. Tender is a bit hard to get hold of at the moment. The next one -- next slide picks up the Bell Avenue PBT development. So that development, again, is underway. It's just across the Great South Road from the Mt. Richmond site. It's a really good development for us. The tenant stays in occupation and there's not one day of vacancy running through that. So very pleased with the way that's put together and targeting a 4-star green-built rating across that. The next one -- next slide is the 105 Carlton Gore Road development. This is the building that Tonkin + Taylor had just moved out of. We've got quite a bit of work going on with pulling that development together, but we haven't started on cycles yet. We're negotiating with 2 single-core tenants. And we have -- our strategy for this building, obviously, is to target a 5-star green rating, and that's where we see the demand from tenants. Thus, over the next couple of years, there's a lot of tenants with leases expiring in this precinct. And just on that level of demand, we're putting the building together so that we can divide floors into 2 because there's quite a bit of demand that fits into the space between 1 and 2 floors of the building. Turning to the development projects that are currently underway. 8-14 Willis Street, where those of you on Wellington are well aware that we are well advanced with that. It's starting to look like a building or REIT. The leasing for that has gone particularly well under lockdown, and we are -- currently the only vacant space that we have is one small retail tenancy and the offices of the old Stewart Dawsons at 360 Lambton Quay. Both of those were now in exclusive negotiations, and we expect to get those leased prior to completion. So that's going relatively well. The missing one-off that list is Macpac for one of the large retail spaces that was declared unconditional late last week. I've talked about 18-20 and 1216 Bell Avenue. I won't go through that in any great detail. There's no vacancy in that. So looking at the valuations and there's quite a bit of data that Dave and Steve have put together in the appendices on this. But just to note that really, if we see -- as we expect to and end to the cap rate firming cycle, that's a positive for rental growth. And I expect that we will see the level of under-renting improve as -- particularly in the industrial sector, rentals start to grow. I'll hand over at this point today to go through the financials for us. Dave?

Thanks, Peter. The first slide, I'm in the gross property waterfall. Gross property income was up to $56.4 million from $53.9 million last year. Some key points to highlight. Rent reviews contributed $2.2 million. Fixed reviews in the first half were 80% of reviews undertaken. 6% for CPI and 13% from market. And looking forward to the second half of the year, we have $19 million fixed reviews coming up, $6 million of CPI and $3 million market reviews. For next year, FY '23, we have 42 million of fixed reviews million CPI and $18 million of market. So we should see some reasonable rental growth from reviews over the next 18 months or so. Even when what we achieved was down due to the fact we received $600,000 from insurance last year, again, looking ahead, the Teacher's Council lease commenced on 1 June. MHUD lease commences 1 December and the new FishServe lease will start on 1 April next year. So the FishServe lease that's a 9-year lease on Level 12 at $515 gross. So from that one out to next year, Waterloo Quay is fully leased. The acquisition then comes from the Mt. Richmond Drive purchase to be this year. Another then comes from 54 Jamaica Drive, which completed in October last year. Looking forward, again, we're expecting all Willis Street 360 Lambton Quay leases that commenced either 1 April or 1 May next year with the biggest being Steps in 1 April. We had a few sales in the first half of last year, but the biggest impact is the Albany Lifestyle Center at $2.6 million of that $4.2 million and this fund will continue through FY '22. Finally, rent rebates. This year, we've provided for $800,000 in rent rebates in the first half. This was actual and estimated. And I expect we'll need to provide a bit more in the second half given the extended lockdown. But full year forecast is $1.5 million, and I think this will be plenty. Moving through the next slide, financial performance. Net property income was up 5.1% to $53.1 million from $50.5 million. Admin expenses were up only due to increases in holiday pay provision again and staff salary increases. We also spent more on tax consulting. We had a few -- had to work through this year with insurance asbestos removal. We had a health and safety work this year of some asbestos related extra costs. So there was a bit more consulting costs in the first half of this year compared to last year. Another point to make here. We've moved our property management team cost above the line to match income received from tenants. So we transferred $700,000 in the first half related to property managers, our Head of Health and Safety and our boarding services engineers comparative also been adjusted by $600,000. Our NPI was 55 basis points compared to an adjusted 53 basis points last year and admin expenses NPI was 11%. Interest expense was down due to lower debt levels and higher capitalized interest on Willis Street 360 Lambton Quay with a gain on [indiscernible] this year and solid valuation gains Peter mentioned earlier. I'll talk about tax in a minute. Overall, net profit after tax was $127 million versus $114.6 million last year, and this is a record interim net profit after tax for Argosy. Next slide, our distributable income. So after adjusting for evaluations, derivatives and the loss on sale, gross distributable income was $34.1 million compared to $35.6 million last year. In a note that last year included the forfeited Albany Lifestyle deposit of $4.5 million. Current tax is higher than last year. In some way, you may remember that last year, we took the largest asbestos removal deduction with reinstated project at 7 Waterloo Quay. Net interest income was $0.392 per share compared to $0.0435 per share last year. Next slide is the AFFO slide. Amortization of tenant incentives was up, mainly due to the amortization of some large increases recently and also the write-down of seeing some leasing costs on the sale of the Albany Lifestyle Center. The large incentives recorded in the first half of last year related to 107 Carlton Gore Road in 7 Waterloo Quay. This level of incentives simply didn't reoccur this year. I'd like to also note that, as a policy, we will now exclude incentives and leasing costs on developments in line with the rest of the sector, and this will definitely reduce volatility on this timing difference going forward. Maintenance expenditure was up from the prior year. The biggest expense was 800... [Technical Difficulty]

Pardon me, this is the operator, one moment and we'll just get reconnected.

Hello, everyone. Sorry about that. I think I'll stay boring at operating -- I think I was talking about AFFO per share. I'm not sure whether you got is or not, and I'll carry on the last little bit of the slide. So AFFO per share this year, excluding the facade $0.0364 per share. And just looking at last year, if we adjust for the forfeited Albany deposit and the incentives related to 7 Waterloo Quay and Carlton Gore Road of $4 million, AFFO would have been $0.0368 per share. So it's roughly flat if you adjust some of the abnormals that we've had over the last few years. And the payment ratio last year would have been 86% on an adjusted basis. So moving on to the next slide. Our investment property value increased from $2.05 billion at 31 March to $2.13 billion at 30 September. $19 million was spent on to 8-14 Willis Street, 360 Lambton Quay in the period and $8.6 million on 7 Waterloo Quay, including the facade works. Disposal of our former property in Omahu Road in Hastings. The main driver of the increase was the revaluation gain of $92 million. On to NTA. As usual, the big driver here was revaluations, which contributed $0.11 per share to the NTA increase. NTA increased by 7% to $1.64 from $1.53 at 31 March. Next slide. Gearing has dropped during the period, thanks to the sale of the Albany Lifestyle Center in April and Omahu Road in September and, of course, the revaluation gain. The sales contributed approximately 3.2% of the decrease and the revaluation gain of 1.3%. For 30 September, gearing was 31.7% towards the bottom end of our target range. Sentiment of 25 Nugent Street will drop gearing further to 31% on a pro forma basis. Next slide shows a bit of history with gearing. And as I said, we're currently at 31.7%. If we spend $150 million, that gearing would go up by about 4.5%. So we do have plenty of capacity currently. And moving on to interest rates. Our weighted average interest rate has increased to 3.88% from 3.69% in 31 March. And the fixed rate borrowings has also increased to 59%. We currently have $400 million of active swaps and $55 million of full cover. We still had quite a bit of cover going forward and only $55 million of our swaps drop off over the next 3 years. Interest cover remains steady at 3.3x. Next slide is our debt profile. The weighted average duration of our debt is 4 years. During the period, we refinanced $215 million of our bank facilities, pushing our tenure and reducing our margins further. The last slide from me on dividends. No change from our previous guidance here at $0.0655 per share. As noted in May, we're moving to the new AFFO-based policy from 1 April '22. And we're also getting AFFO numbers audited now given this pending change in policy. Second quarter dividend of $0.16375 per share has been announced this morning with imputation credits of $0.072 per share attached. Record date is December 8 and the payment date of December 22. DRP is operating for this dividend, but we've turned the tap further on this, and we won't be offering any discount this time around. I'll now pass you back to Peter for a leasing update.

So just going through the leasing. Obviously, we've had quite a good run with leasing. And it's really pleasing, as Dave noted, the 7 Waterloo Quay fully occupied or fully leased. So pretty happy with that. The completion of that facade project will take it off our primary agenda. So it's gone rather well. The other big league of course, was the Peter Baker Transport, PBT, one that I mentioned earlier on and that's gone really well. But there's been a number of other smaller leases, particularly with the retail space in Wellington, that have pulled through for us pretty well. And other than the 105 Carlton Gore Road, which is, as I mentioned, ending vacant, and we're working on the upgrade to that building. We look at the lease expiries coming forward. The major ones we think we've pretty much gotten the bag. So again, I'm not expecting the next 6 to 12 months to cause us any particular angst in the vacancy stats. The largest single expiry is still the MB lease at South Street and Wellington. And as you'd expect, we continue to work with them on our way through, albeit that, that's not up until March 27. The market insights, we've got, obviously, still a very strong industrial sector. And if we think about potential issues coming through with that, they're few and far between. But some of the industrial growth has been contributed to by supply chain issues where the standard average 5,000-meter warehouse is now a standard average 8,000 meter warehouse as the supply chain constraints mean industrial warehouses are scoring more than they used to. Obviously, that could reverse in due course if the supply chain is corrected. We've also got the potential impact of 3D printing in the industrial sector to keep a watch on. But at the moment, we've got strong demand, and we've got limited land supply. Rental growth is continuing, land price growth is continuing and it's hard to see this sector struggling. The office space, the -- obviously, the COVID-19 lockdowns have had an impact. And we've seen a number of properties coming on to the market for sublease. That appears to have stabilized in the last 4 months. And the uptake is back in line. So that's pleasing to see. And we're still dealing with a deficit of good quality space in the Wellington market as well. Forward with offices, we're still looking at the -- a change in the way the offices are used and increased focus on green and environmental factors through there and an increased focus on the amenity and common area that the building offers as an incentive to get people back into the office. The retail sector has actually been reasonably tidy for us, and it was certainly pleasing that we managed to complete the settlement on the lifestyle center prior to the latest round of lockdowns, which means that the majority of our retail space in large format, of course, was reasonably well able to trade online as soon as that was allowed, so relatively muted. And really the modest provision that Dave outlined for rental discounts as a result of the lockdown has been contributed to by the makeup of the portfolio. So then looking at the focus and outlook for the period ahead. There's no big changes here. Obviously, we'll keep looking at key expiries and leasing up any remaining vacancies, focus on delivery of the development program. We'll continue to progress the large green value-add industrial opportunities at both Nielsen Street and Mt. Richmond and finish off the development that we've got underway for PBT. Property market fundamentals still remain fairly sound, and we're not looking at a large amount of negative net absorption. We're not looking at significant levels of oversupply. Structural changes in the way property is used, as mentioned, will continue to provide some challenges. We see, over the 12 months ahead, an increase in focus on green and environmental, an increase in the focus on common facilities even to the point of providing a tenant club type area in-building. With industrial, we see increasing focus on technology, on AI and on the quality of the data network through those buildings. And as I mentioned on the prior slide, keep a watch on what's happening with the supply chain and on the ultimate impact of 3D printing. That pretty much covers off the presentation. I won't run through the appendices. They're there for basic information, and we can cover that off with any questions a bit later on.

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

Well done with the progress on leasing during the half. Just a few questions for me. Just firstly, on 25 Nugent Street, just the reason for the long settlement and then just the amount and timing of deposit.

The deposit's payable immediately, Arie. So we'd expect to get that in the next 3 working days. It's a 10% deposit. The reason for the long settlement is that the sale is to an owner occupier, which helped us getting that special value premium. And the space and question is occupied by Schindler Lifts through until September next year. So we wouldn't rule out bringing the settlement forward. The purchaser has indicated they'd be keen on that. But at this point, that's where we've got it set.

Great. Just on 101 Carlton Gore Road, can you just sort of provide a little bit more color to your thinking on the timing for committing to that development and sort of starting works? And then just also kind of whether you'll commence there, what sort of leasing commitment you'd want before starting, if any?

Well, obviously, the things are going to be vacant Arie. So we need to get on to it and get it going. We've got really quite good leasing inquiry for it at the moment with 2 solid tenant occupants that we're working with. But as soon as you start to get down to 1.5 floor type areas, the tenants do want to see a commitment that you're actually going to get this thing done and a delivery date to move into. And both the tenants we're working with on the building at the moment want to see that. So we will be pushing ahead with getting that done, getting it represented to the market. But with the amount of tenant demand we currently have and the number of leases we've got an opportunity on that are pending, we're not expecting to have a vacancy issue with it.

Sure. And then will you be -- I mean, do you sort of see sufficient demand and I don't know whether the time frames allow for it and that, but whether that will be able to sort of dovetail in with 101?

Yes, it does. Obviously, 101 has still got some time to run on the lease. So we've got the opportunity to bring that forward if possible. But the biggest benefit to us, to be fair, is that you're putting a green building together. We will have, by the time we get to 101, we'll have a complete data set of energy usage per square meter, and we'll be able to save quite a bit in terms of design and time on the second building when we get to that level.

Right. And then just in terms of -- and I think you've laid out really well sort of some of the reasons for your lower exposure to COVID relief, which is great. Could you just sort of -- have you had a chance to settle much at this point, probably not. And then just with reference to the legislation as well, just what's sort of giving you comfort with your office tenants in particular?

Yes. Obviously, the legislation was pretty disappointing from our perspective because I think we were faced with the legislation that's trying to fix a problem that doesn't exist anymore. We kept fairly well in touch with our tenants. And as Dave said, we're -- one, that's quite modest. Two, we think the provision we've made there is going to give us plenty of room. But with the deals we have done across the portfolio at the moment, to be fair, I think both Dave and I have been surprised that it has been more modest than we had expected.

I can give you a bit of an update, Arie, on that. So we've concluded deals for $900,000, and that's right through to sort of the 10th of November when you sort of -- in retail, we opened again. So $900,000 has been spent. The rest is just an estimate at this stage, and that's $1.5 million. And I don't think we'll need all that.

Yes. And the deals that you've concluded are rather a very good representative portion of the portfolio as well.

Yes. They're mainly retail, as you'd expect, some office and a small amount of industrial.

Your next question comes from Nick Mar with Macquarie.

Just on the development at Bell Ave. Can you just talk through exactly how the kind of rental uplift this year between any kind of market view that went through on the lease negotiation and straight in a redevelopment aspect of it?

Sorry, can you repeat that for me? I lost you in the middle there.

Sure. Just in terms of the Bell Ave. redevelopment you've obviously got some new leases entered into, Was there an aspect of market review at that point in time as well as obviously some additional rent from the development expenditure?

Yes, it's a bit of both, Nick. Obviously, the market's moved. So we did a market catch-up, but the green initiatives, the upgrade to the building and the upgrade to the office space across there as well.

Okay. Great. And then just looking at the Carlton Gore asset, really kind of crude math based on the incoming yield and the kind of return on total project costs. It seems like the yield on the incremental $35 million is about 3%. Can you just talk through how you set out against your return objectives and kind of capital allocation framework across the portfolio?

Yes. Look, I think, let's first understand that we couldn't not own the building. We already have it. So it's a case of given where you are, what are the best of the options. So obviously, with every asset like that, we look at what the options are in terms of either disposal, a minor upgrade, no upgrade at all or a more significant upgrade. So the NPV analysis of that takes us down the path that we're on. So that's how we get to that logic scenario. Bear in mind, we don't have it leased yet, and we're hopeful that the return numbers will look a little bit better as a proportion on the way through, but the profit is relatively modest on it at this point.

That's great. And then just on the -- finishing up on development stage in Willis Street, the leasing there, were those in line with expectations? And are you happy to kind of maintain the cost and the yield forecast number from the previous update?

Yes. So the value has been preserved across that but there are a couple of moving parts. Obviously, the retail rentals were lower than the initial. The cap rate is firmer. Overall value has stayed the same. Since when we did the last update for you, we've already reduced the retail expected rentals. The deals that we've done since that are some up, some down, but overall on balance, on the way through. So as we expected it to be.

Yes. And the total project is still in line with the kind of May update?

Yes, that's right.

Great. And then could you just walk us through the 39 Market Place, what's happened there in terms of that and what the strategy is for that building?

39 Market Place. We've made a -- we've had an initial structural assessment that indicates that we've got about $11.5 million to spend on the property. We're doing the same as we would always do. We're doing an exercise at this point. I want to confirm what the costs are, what the work needs to be done, what the program is, how we do that and then analyzing the differences between the standard of upgrade that we would look to achieve or indeed a sale and analyzing on a discounted cash flow basis as to which way is the best way to go forward from that point. We do know that we've got strong tenant demand for the assets, so we're not expecting a vacancy issue. But what we have to be clear on is how we actually complete upgrade work with the tenants that we already have on the asset.

[Operator Instructions] Your next question comes from Jeremy Kincaid with UBS.

First one for me is just on the greening of the value-add properties. Could you give an idea of what the total spend could be on all of those projects and the average yield on cost or IRR that you're targeting on those?

Don't think I can. It's a bit too far out. Let me have a look later in the day, Jeremy, I'll see what I can drag through, but that's a bit -- a challenging call.

Okay. Sure. The other thing as well, just on your portfolio mix, you're obviously sitting at sort of the bounds. You have quite a lot of industrial. And clearly, you made some comments that you still like industrial, but you also said that we may be at the end of the cap rate firming cycle. I suppose I'll just be curious on your thinking around your portfolio mix and how you think about that going forward and whether or not it may need to change if we do start to see the end of the cap rate firming cycle.

I think as we see interest rates go up, obviously, the high degree of correlation between cap rates and interest rates. That doesn't necessarily equate straight through to value, of course, because you -- as you see rental growth come through, you're capitalizing a higher rental. For us, we're still focused on the industrial sector. We like the way that looks. And we think that there is less volatility and less risk in that sector going forward. Having said that, I want to make sure that we keep a watch on potential negatives as I outlined in the present. At this point, end to the cap rate firming cycle will impact all 3 sectors, of course, and indeed sectors that we're not involved in as well. So for us, I don't think that changes, and I don't expect it to change that asset allocation bottom-up basis.

Sure. That's very clear. And then just finally for me, on your DRP. You obviously have a stronger gearing ratio relative to history. Does that change your thinking around the DRP going forward?

Yes. We've got a 0 now. We'll just see what happens over the next probably 2 quarters. And depending on what happens, we may well turn it off in March or June next year.

So when you say you've got it, do you mean the DRP doesn't apply or the discount is 0?

The discount is 0 now. It was 2%. We're not offering a discount on the DRP now. So obviously, we're keeping it in place because retail -- some retail [ key adds ] quite like it. And we'll just wait and see how much comes in and as to what we do next. But it's possible, given this recent sale of 25 Nugent Street that we may not need it next year.

There are no further questions at this time. That does conclude our conference for today. Thank you for participating. You may now disconnect.