Argosy Property Limited (ARG) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the Argosy Property Limited FY '23 Annual Results Briefing. [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 annual results this morning. You see the cover sheet is a photograph of the new buildings, the [ Statistic Stacked House ] and Willis Street. And if we turn to the next page, that's -- the first part I will refer the internal stairwell. So obviously, the building is finished and coming together pretty well. Tenant is pretty happy with that. So as an agenda for today, I'll run through some highlights. Dave, as normal, will take us through the finance, financial metrics and accounting side. And I will come back, talk a little bit about some leasing, what we're seeing in the market, focus and outlook, and then we'll take some questions. So the vision and strategy page, that again is stair house looking down through the main stairway, that has quite a bit of impact on the way that was put together, that's effectively their design work. Turning to the vision and building a better future. So no big changes in terms of the way we've put this together, diversified by sector, by location, by tenant mix, and also by our staff with the background and skills, the totals in our view is much greater than the sum of the parts. Then looking at the green part, green property, green business practice and, of course, green funding. With the year that we've had, the year that we've got ahead, resilient business and dividend and a time of change, resilient to economic change, social change and climate change. So some summary results. Obviously, the result is dominated by the decline in valuations made up for -- made up with by softening cap rates pretty much across the board, but in varying rates. We are also seeing quite a bit of growth in rental levels, specifically in the industrial sector, but also in green property in general. There's less building activity in the market, which means less opportunity, but also less competition. Net property income line pretty resilient, distributable income, Dave will go through gearing, thanks to the valuation decline moving up towards the middle of that range and reduced NTA at $1.58. Portfolio highlights. Operationally, quite a strong year. The tenant retention rates have been very strong. The very low arrears that we're seeing across the portfolio, surprisingly so, but very low. Solid occupancy numbers and just the 1 tenant failure would EziBuy at the Albany Mega Centre conveniently for us, going under the same week that their lease expired out there. So we did manage to re-lease that space at a higher rental. Overall, then from a portfolio and operating perspective, the numbers are pretty good. Looking at the industrial sector, we've got the data there. Clearly, we're seeing increasing rentals. Inquiry level has reduced slightly, but it's still at a very good level for us -- very much location dependent. I suspect that if your properties are not as well located, you won't be seeing the same level of demand. Interestingly, in industrial, a lot more interest in green and sustainable building practice and green ratings in that sector. So it dragged the chain a little bit from the office sector, but we're seeing quite a bit of interest at that level now. In the office sector, there's now an increase, again, focused on sustainability, and we expect that to continue, especially as many businesses start to move through with their XRB in sustainability reporting. Surprisingly, we're still getting very good inquiry and a pretty good conversion rates, albeit that deals are taking quite a bit longer to get across the line. So they hang around in that conditional phase for longer than we have been used to. And the Auckland vacancy, pleasing to see that reducing in the last 3 to 4 months. And in the retail sector, there are pressures quite clearly in the market. For us, we're again made to look pretty good with the Albany Mega Centre, which is still quite strong for us. As I mentioned, we are leasing the ex-EziBuy space at a higher rental. So those are coming through. In general, in the sector, though, average sales have reduced. That's average number size of sales, increased number of visits, partially making up for that. But from our perspective, that puts increased focus on car parking. Turning to the portfolio in terms of asset allocation, how that fits together. We're on target with industrial and large format retail, a little over in the office sector. Obviously, we'd expect in the course of time as the industrial weighting increases that, that office weighting will come back into line. We're on target by region, and by asset mix. Revaluations, common story across most of the listed entities that have reported. We've seen some good rental growth come through. We remain under rented, but some of those reversions are well down the track by -- caused by formulaic and fixed review cycles. Thus far, we're not seeing any real issues with affordability ratios other than in some of the retail spaces. Probably seeing a little bit more cap rate softening since year-end, maybe 11 to 12 basis points, but our initial assessment of that is that rental growth is topping that up quite nicely. But certainly we're seeing evidence that cap rate softening has slowed down. And some market commentators are now talking about having seen the bottom. And potentially it will be more stable over the next 6 months. For us, is probably a bigger focus on what happens on Thursday in the budget and what happens in October as to what's looking ahead in this sector. Turning to the value-add properties. With Bell Avenue, we're nearing completion on that 105 Carlton Gore Road very close to completion, talk about the leasing there a bit later on. 224 Neilson Street, the tenant has vacated the site, we have demolished the buildings, and so we've got some very good tenant inquiry working with on that. 8-14 Mt Richmond, that's still an income earning asset, and we are flexible enough to be able to delay progress on that site if need be. It's not just about leasing, it's about what's happening in the rest of the market. Just moving to future stuff. We did talk at the half year that we expected to see better renew 1 floor of that building -- of the lease in that building, they've done there floor-by-floor leases. They've extended for 3 years on a single floor, and we're getting surprisingly very good inquiry for the rest of the building on a -- once over lightly repaint style upgrade. The next slide picks up the case study at 8-14 Willis Street. We're still on target for a 6-star green rating there. We've got all the base work done, and that's looking very positive. The NABERSNZ rating are very comfortable with that. And a final yield on cost of 4.8%. This is the project, of course, that we got caught with -- during the COVID period. So our timing and cost was affected by that. Next slide here on 105 Carlton Gore Road, which is going really well. I guess the one -- the area you all want to talk about is leasing. And we've got statistics of the building already leased. We have the rest of the building, we're in exclusive negotiations and conditional agreements with 3 international tenants for the remainder of that building. And on top of that, we've got one domestic tenant who's pretty keen on some space there. We will not be able to meet all that demand in the building. So we're in a good position of having more tenants we're negotiating that with there, and we have space available to lease to them. The building, if you go down that way, it started to look pretty smart, and we're zeroing in on practical completion there on program. And over to Dave to talk through the financials and then come back to talk about what we're seeing in the leasing market. Thanks, Dave.

Thanks, Peter, and hello, everyone. Looking first at the movement in gross property income. The gross property income was $124.3 million compared to $112.5 million last year and that's up 10.5%. Rent reviews contributed $2.4 million, and there's more information as usual in the appendix on that. The annualized rent increase was 3.6%, which is up on the 2.6% achieved at the half year. So we're seeing some acceleration in rental growth through the year. The leasing up and lease vacancy was a positive $1.5 million, and the main contributor to that was the leasing of that Lambton Quay in Wellington. We had a $1.4 million contribution from our acquisition ahead 100 Maui Street in Hamilton, and a net gain of $6 million from developments, and that's mainly resulting from the completed development at Willis Street. The impact from disposals was $1.3 million, and that relates to the divestments of 25 Nugent Street in September and the Albany Lifestyle Center in Omahu Road last year. And thankfully, no COVID rebates this year. Go on to the next slide, profit and loss. Net property income was up by $7.6 million, driven by the increase in the gross property line but offset by increased property expenses at 8-14 Willis Street and higher nonrecoverable rates and insurance premiums in Wellington. Administration expenses were down. As mentioned at the half year, we now have an in-house development team, and their salaries are capitalized to the projects we're working on. The MER is 50 basis points and corporate expenses to NPI is 9.6%. Net interest expense is up by $10.7 million, $6.9 million of this was due to higher rates during the year, $3.2 million was due to a higher volume of debt and $1.6 million was due to lower capitalized interest in FY '23. This covered our revaluation loss for the period, and there was a $3 million payment received in respect to the March 2020 failed settlement of the Albany Lifestyle Center. The loss for the year was $80.8 million compared to a gain last year of $236.2 million. The next slide covers net distributable income. After all the usual adjustments, gross distributable income was $68.7 million, up by $1 million on the prior period. Tax expense was up by $1.5 million as lower capitalized interest and the stat deduction in the prior year were not fully offset by other tax adjustments this year. Overall, net distributable income was $64.2 million compared to $64.7 million last year. Per share basis, NDI was $0.0758 per share compared to $0.0768 per share last year. Next slide covers adjusted funds from operations or AFFO. Amortization of tenant incentives and leasing costs was lower than the prior period, which included write-offs of the centers relating to the Albany Lifestyle Centre. Maintenance CapEx was $600,000 higher than FY '22. Main items related to tenant fit out at Citibank in the Albany Mega Centre and [indiscernible] at 39 Randwick Road in Wellington and 12 Bell Avenue, Auckland. As a percentage of the total portfolio, maintenance CapEx was 30 basis points. We also closed out a receiver swap for $1.5 million during the year. The AFFO was $58.1 million compared to $48.3 million last year, obviously, which included the facade cost last year. On a per share basis, AFFO was $0.0686 per share versus $0.0573 per share last year. Payout ratio was 97% compared to 114% in FY '22. The next slide covers the movement in investment properties. Purchased 100 Maui Street in May this year for $33 million. It was $52 million in capitalized costs during the year. It's been $20 million on 105 Carlton Gore Road, $7 million on [ Bell Avenue ] and $6.4 million on Willis Street during the year. We talked about the revaluation loss of $146 million. And after the deduction for the value of the write-off these asset, 39 Market Place of $40 million, the portfolio is worth $2.1 billion at 31 March 2023. Next slide from me is NTA per share. NTA has fallen to $1.58 per share from $1.74 last year. And obviously, the main reason for the fall was to reevaluation loss booked during the period. Next slide looks at our gearing. Debt to total assets was 35.1% at 31 March compared to 32.5% at the half year and 31.1% at 31 March '22. Biggest driver of the shift was revaluation loss and that contributed about 2.5% of the 4% movement. Both that revaluation loss, we're still sitting right in the middle of our target band of 30% to 40%. Next slide, interest rate management. Our weighted average interest rate increased to 5.39% and 5% at the half year and 4.14% last year. This was caused mainly by the rapid acceleration of the 90-day rate during the period. Interest rate covers a solid 2.8x, well above our bank covenant of 2x. As soon as the fixed rate borrowings has increased to 71% from 57%, we restructured our swap portfolio to take the sting out of any further rises floating rates over the next few years, and we've provided further detail on our maturity profile and also the weighted margins and line fees on our drawn bank debt and bonds in the appendix. We have $100 million in Falstaff coming through from FY '25 onwards at an average rate of 3.8%. Next slide covers our debt profile. We refinanced our debt during the year, pushing out tenor and increasing the facility by $20 million. As I noted at the half year, margin and line fees were quite sharp and similar to the previous refinance. Nearest expiry is now 1 April 2025 and the weighted average debt duration is 3.2 years. The final slide for me on dividends. We've declared today a fourth quarter dividend of $0.016625 per share with imputation credits of $0.0001801 per share attached. Record date is 7 June and the payment date will be 21 June. Full year dividends at $0.0665 per share is in line with the guidance. Guidance to next year is for a consistent dividend level of $0.0665 per share. So now back to Peter for leasing update.

Thanks, Dave. And heading up this part for the first time in a long time, our [ credit ] rates have [indiscernible] which is looking somewhat less unattractive than it has done in the past. So leasing during the year with, as I mentioned, tenant retention rate has been quite strong. We're sitting at around 90% retention rate across the portfolio at the moment, which is a good result, and 97,000 square meters leased. So overall, from a bottom up and operational perspective, leasing has been pretty solid and pretty good. The big one and a good one we were pleased to see there was the extension for -- 80-120 Favona Road for general distributors account that, where they've taken a 10-year extension for the right to terminate to 5 years. So 5 years term certain sitting in there. The lease expiry profile remains around our target, 10% per annum. But if we look at FY '24 and FY '25, the majority of those tenants now are expected to renew those leases. So we expect the tenant retention rate to remain pretty solid. And the large expiries are already addressed. Interestingly, in there, we've also got the Mt Richmond ground lease options. The current occupier basically using it for vehicle storage. So we need to keep that flexibility, but they're not an onerous expiry from a lease profile perspective. Looking to the 3 sectors and what we're seeing in the market. As I mentioned earlier, a lot more focus on sustainability is starting to come through in the industrial sector. We expect that to grow. And there's also more focus on the built environment in terms of staff facilities and amenities and industrial. So starting to see the same sort of things we've seen in recent years in the office sector. Now with the office sector, it's quite pleasing to see the elevated vacancy levels in the Auckland market have been reducing. And for us, vast majority of our inquiry, well over 80% of the inquiry in the office sector is the green space in some form or other. The possible risk to our forecast here is working from home is overstated. And what we're certainly seeing is that flexible working is here to stay, but working from home full time has been overstated, and we're seeing that erode. In the retail sector, that's obviously where we expect to see the greatest challenges. We do expect to see some affordability issues on rental levels in the near term and current activity levels showing -- that leasing activity levels are showing retailers, large retailers looking to position themselves in their words for the other end of the current downturn. So they're looking to secure really good locations. And not going to be surprised if they don't pay them back in the first year or 2. So I think that's interesting. And we're certainly seeing that level of demand at the Albany Mega Centre where we're pleased with the really strong location. As I mentioned earlier on, the average value of each transaction is showing to be reducing in many parts of the large format retail area. Specifically, we note the advice from the supermarket change as their average transactional value was reduced. Average number of visits has increased. We've seen this in other downturns. That's not a surprise. That does put more pressure for bulk retail on car parking and accessibility. And we do expect that, that will continue to reduce total turnover in that space. So that's where we expect to see pressure over the next 12 to 24 months. Turning to focus and outlook. That's the Mighty Ape's building and Silverdale North. We expect to see the change continue, I guess. And whilst we're seeing the inflation numbers coming back, there's still quite a bit of work to come through with a reduced number of people trying to put the handbrake on the economy. Their portfolio was pretty well positioned to deal with that. Our focus will continue to be with customer satisfaction and retention, keep those tenant retention numbers up. We need to be ready to keep changing. We expect to see still more focus on green and sustainability with the XRB reporting and the intent that, that reporting has expanded down to smaller entities. For us, development, timing and flexibility, we don't want to commit to development until we're comfortable with the risks economically and specifically from a stock selection perspective. So maintain as much flexibility as we can around the timing of that pipeline. We're fortunate, as I mentioned, with the Mt Richmond property to have an income coming in from that site that is extendable for us. That's all from us in terms of the presentation, and we'll hand over to pick up any questions.

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

First question just on divestments. Can you provide a little bit more color on the assets how progressed you are and just with a view to a bit of a sense of timing for those sales [ you announced ]?

Yes, fair point, Arie, probably should have covered that off in the presentation, shouldn't I. So there are 3 assets. Those 3 are the building on standing in the 39 Marketplace. The Forge Way, which is currently occupied by the Armstrong Motor Group at Panmure and the industrial facility and Christchurch with the coolstorage at Foundry Drive. So in terms of what are the timings on those, all 3 are currently in the market. The 39 Market Place, the building our offices is in. We've got really good inquiry. We're looking to extend a potential for a change of use, and we've put quite a bit of bottom-up work into that. We've got some very good inquiry. But I do expect that it will take us a few months to be able to get a result on it. I don't expect this one will happen in a hurry simply because the -- quite a bit of complexity and working out how that transaction will fit together. The second one is Forge Way, where we're under negotiations with a party who is interested at the present, and I don't expect that to be a prolonged one and would expect that we'll have a result around the half year on that. And the Christchurch Foundry Drive, that's in the market at the moment, again, through Colliers. And we've got 2 domestic interested retail investors down there that the boards are working on. So in the normal course of events, again, it's a bit hard to tell, but we would expect to see results around the half year for that one.

That's useful. Just on -- I mean your capital commitments at balance date, reasonably low at $20 million. Can you just give a little bit of color just around how much relates to completing Bell Avenues and 105 Carlton Gore? And then also perhaps your expectations for AFFO maintenance CapEx in FY '24?

It sounds like I should throw that question to Dave Fraser, I reckon.

Well, the biggest part -- Arie, the biggest part of the $20 million is Carlton Gore Road and there's about $13 million to go out of the $20 million at Carlton Gore Road. I can't tell you the Bell Avenue off my head, but of that Carlton Gore Road being a good $4 million or $5 million of that is incentives. So the intent of the construction side of things, you're looking at about $6 million of Carlton Gore Road.

And just on the AFFO maintenance CapEx in '24, I mean it was a little bit higher, I think, in '23...

Well, I think we certainly -- there's been a couple of fairly chunky projects towards the latter part of this year, so particularly the [ Carlton Gore Road ] and some tenant works at Citibank as well, and they're really just -- they really sort of just started. So I'd expect maintenance CapEx to be quite a bit lower than FY '24 than the current year.

Yes. And then just on Neilson and Mt Richmond and obviously, you mentioned on Neilson Road that you've been [ well outstand ] and the tenants left. What's sort of the likelihood of investment at those 2 sites in FY '24? And what sort of level, I guess, what should we be factoring in at Neilson, which seems more likely in particular?

Yes, that's a case of how long is a piece of string. But yes, you're right, Neilson Street appears to be moving a little more quickly and certainly we've got more flexibility to defer Mt Richmond. But we are in negotiations, final negotiations with the tenant at Neilson Street. So we would expect that by the time we get through all the requisite design and consenting, but we'll be hopefully making a start on it before the end of this financial year.

And I appreciate you need some numbers. And these are very preliminary. They haven't been approved by the Board. This project hasn't been approved by the Board yet. So with Neilson Street, looking at the land value of about $36 million and construction costs of about $63 million, and then a rent at the end of that of about $5.9 million and a yield on cost of about 5.6% to 5.7%. I mean that project would probably start second half of this year, October, November, and run through until about February '25. So that's just where it stands right now, hasn't been Board approved yet.

That's the best guess.

And from that stage unlikely to be making a commitment -- a start at Mt Richmond in FY '24.

I think that's the most likely scenario, yes. Unless the economy changes significantly from what we're looking at, at the moment.

Sure. And then just a final one back to Carlton Gore. Dave, you mentioned the incentives. I guess just putting aside Level 1, just your confidence, I guess, on having tenants and the balance of the building by calendar year-end and just whether -- just something on sort of the -- sort of lease term you're looking at for those floors?

Okay. So the current year agreement shows some lease terms in excess of 60 years each. We're targeting 10-year terms and we're doing pretty well on that. I'm very confident that with the current deals that will have commitments in the next 2 or 3 months and commencement before the calendar year is out.

Your next question comes from Bianca Fledderus with UBS.

Just firstly on your gearing. So at 35%, I know that's still within your target range and well below bank confidence as well. But just wondering how comfortable are you with the increase we saw and especially given we may see further devaluations going forward. Where do you sort of see that peaking?

It's a bit difficult to say. But we're comfortable with where we're sitting at the moment. What I'm seeing at the moment is the degree of cap rate softening since year-end, made up for by the rental increases across the portfolio. On a portfolio-wide basis, our assessment is if we did a revaluation today, it would be flat from year-end. Probably more depends the anchor on what Grant does on Thursday, what the next lot of inflation numbers look like. But overall, I would say that there's some good transactional evidence coming through. We're seeing institutional investors and offshore investors back making inquiry in the market. And some of those are at cap rates that are relatively -- well, from my perspective, surprisingly soon. So not expecting a challenge. And prior downturns, the ones that hurt are the ones where you get declining rents and softening cap rates. We've got quite very strong rental growth, and we've seen that accelerate in the second half of the year. We expect to see that continue. The numbers that we've got across the portfolio are looking pretty strong for market rentals. So I think we can handle a bit of cap rate softening without necessarily seeing significant declines in value. Overall, pretty happy with where we're sitting. Pleased that we did reduce our range so that we're now sitting in the middle, not at [ sort of 37% ] but the number is looking pretty solid and comfortable with where we're sitting.

Just in terms of sensitivity, $100 million further loss would drop our gearing by about 1.6%.

Okay. And I guess, with the upcoming election in October, you touched on it briefly before, but with, I believe, 34% of your portfolio exposed to government. Historically speaking, if a national government is elected, what sort of impacts that you see there on your office portfolio? Was it significant, or what sort of...

Good question though. I guess, first, again, tied to leases. What we tend to see when we have a change of color on government, certainly, a red government increases an absorption significantly in Wellington. A blue government doesn't actually decrease it significantly. It tends to remain largely static. So certainly, the degree of net absorption decreases. And one of the reasons we've been conscious of making sure that we get our lease deals done, agreed prior to the shutdown for October. So reasonably well positioned. If we go from red to blue, then we're not expecting to see issues in Wellington because your new supply has been very limited. And there is still a shortage of really well-located, good quality green building. So for us, not so bad. If you had a lot of properties setting up in Victoria Street and the [ Ti Rakau ] precinct, then you might be a little more concerned.

Your next question comes from Nick Mar with Macquarie.

Just on the FY '24 dividend guidance, can you just confirm that the stable dividend is within the target policy range of [ 85x to ] payout?

I guess, it is.