Argosy Property Limited (ARG) Earnings Call Transcript & Summary

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

Good morning. Welcome, and thanks for joining us for a review of the first half results. Unsurprisingly, we're dealing with what has been another somewhat difficult 6 months with a relatively sluggish economy. We can see though that the corona has effectively been turned, and we're seeing more positive signs ahead since balance date. With valuations, we've actually seen a small lift. While the volume of that lift is inconsequential, the change in direction is significant. Lease inquiry, as expected, was fairly sparse during the period under note, but there's been a notable increase towards the end of the period, and certainly post balance date. We've had 7 post balance date transactions, relatively small in terms of size, but good activity coming through. Overall, values certainly look as though they've turned with positive changes post balance date and transactions in the market coming through looking relatively positive. And we're seeing leasing coming to life just in time in my view. It's interesting to see that rentals have actually been maintained for us anyway during that period, focused on good quality property and well-located property. And that's on a net effective rental basis. In most cases, our transactions are actually showing marginally better than the valuation. So turning to the strategy summary slide. There's no change to that slide from our perspective. What is really interesting is we have been busy leasing 105 Carlton Gore Road, 6-star Green building at the same time as 101 Carlton Gore Road. 105 is now, fully list, post balance date, save half a floor and 101 Carlton Gore Road, fully lit, save 1 floor with active negotiations in play. It's a very interesting case study to be leasing a building that has been upgraded to green, 2 buildings away from 1 that is not, both of the same age, similar design, same developer at the same period. So it's -- what we've seen is more than $100 a square meter difference in the net effective rental between the 2 assets, somewhat underpinning the conversion costs to green to a large extent. So we're still focused very much on sustainability commitment where we're going with that, irrespective of changes that have happened in the environment around us. We're still seeing very good demand for green buildings. We're seeing better tenant retention, lower vacancy and lower absentee rates. You can see from the pipeline of work that we've got coming through. We're easily going to achieve that 50% rating -- 50% by the portfolio in green buildings. We've achieved some -- you might say notoriety. We've achieved some great results externally with our work at 814 Willis Street and elsewhere across the portfolio. It's been a long time coming and a long journey for us. But it was great to see the 814 Willis Street building pick up the Supreme Award from the Property Council for the year. And more recently, we've been Highly Commended in the World Green Building Council Awards for Asia Pacific for the same building, quite rewarding to see in that circumstance when we were competing against people who are developing cities for 1 million people. Dr. Georgia Warren-Myers produced a report, which many of you might have seen, but is for the first time, really giving some solid evidence of the benefits of being green and what they're seeing. So we've included a slide with some highlights from that. Certainly, that's backing up our own experience. With the 224 Neilson Street development, I think most people are aware that's under construction. And we've just this week been -- had the 6-star design rating confirmed for those buildings. So that's going quite well. We expect to see -- we have been fielding some good demand. We expect to see some increased urgency, and hopefully an early result -- early in the New Year. Looking at the other properties on the value-add list. The 224 Neilson Street is the only one where we actually have current activity. The Bell Avenue and 90 Springs Road properties, they are also waiting for lease expiry, so they will be 5 to 6 years away. The Roscommon Road and Unity Drive properties, they are bare land, lease but bare land. And 101 Carlton Gore Road is going to be at least 5-years away for us now. 143 Lambton Quay, our assessment says best value for that is a change of use, and that's moved into the sale category for us, so unlikely we'll be doing the development there. The summary of the results, you've seen net property income, which is flat, and interestingly, we've seen lower delinquency than we had expected, tenant failure rates have been much lower than we had expected and the arrears levels are kept nicely in control right through the year. $8.7 million is not much, but it is good to see the change in direction for the revaluation. As I say, post balance date evidence in the market suggests that, that has continued to show firming. Net result of that is the NTA up by $0.01. It's hardly a big change, but like I say, at least it's not down. And given the environment we've been working in, it's quite pleasing to see the gearing staying well within target. Portfolio highlights. Obviously, the negative there is the level of vacancy in the portfolio, which is an opportunity for us going forward. A lot of that as I've mentioned is related to change of use so we've still got some work to do with that, but we do expect that next year will continue to give us some growth in that space. Looking at the portfolio and the target weightings, you can see that with the activity that we have on, with both sales, leasing and development activity, you'll see that we will be moving in the near-term into those target bands in the portfolio by value and by region and asset mix is already where we need it to be. Turning to the re-valuations, this was not a full valuation nor was it a full desktop valuation. It was a bit of a hybrid in between. Under the new valuation standards, a pure assessment is not any longer acceptable. So the majority of the portfolio were modeled by Colliers. The remainder were assessed to give us a reassessment of the valuations. This starts with a management assessment, where we use the research predominantly from CBRE to adjust where income levels or market rentals and cap rates have moved. That showed us a very minor decrease in value. Collier's assessment of that showed a similar increase in value. And as you'd be aware, the auditors have required us to book that. The portfolio remains nearly 12% under-rented. And I guess, the important driver out of that is our transactions during the term and post-balance date have reinforced that as a reality. I'll hand over to Dave to take us through the financials.

Thanks, Peter, and hello, everyone. First slide from me is the gross property income waterfall. The gross property income was $66.6 million for the half year compared to $65.8 million last year, up by 1.2%. Some solid rent reviews in the period and there's more detail on that in the appendix as usual. Most reviews were fixed with an average annualized increase overall of 2.6%. Offsetting this was the impact of divestments in the prior period, notably, 10 Transport Place in January of this year. The next slide, the profit and loss. Net property income was flat on the prior period. The increase in gross income was tempered somewhat by an increase in insurance and rates on our gross leased properties in Wellington. Admin expenses were flat on the prior period, so small increases in staff costs and the doubtful debts provision were offset by lower professional fees, particularly relating to the setup of our insurance captive and in ESG Consulting. Net interest expense was also flat compared to the prior period. Lower overall debt levels and slightly lower rates were offset by $400,000 lower capitalized interest in the period. Peter has covered the revaluation gain. We'll cover current tax off in the next slide. So net profit was $33 million for the period compared to a loss of $19.3 million last year. Next slide covers distributable income. After the usual fair value adjustments, the gross distributable income was $31.6 million compared to $31.7 million last year, so flat again. The current tax expense was up by $1.9 million, and this is mainly due to the removal of deductions for depreciation on buildings. The tax effect of the deduction this year would have been worth $1.4 million, a sizeable impact from the change in tax policy by the government. On a per share basis net distributable income was $0.0325 per share compared to $0.0349 per share in the prior period. This slide covers adjusted funds from operations or AFFO. The AFFO adjustments were again all reasonably consistent with the prior period. So AFFO was $26.8 million compared to $29.5 million last year. The biggest contributor to the difference being higher tax in the period. Per share basis, AFFO was $0.317 per share compared to $0.0348 per share last year. This slide covers the movement in investment property. Investment property value increased by $32 million in the period compared to March '24, and we talked about the revaluation gain. The balance was due to spending on developments, principally $14 million on Neilson Street, $2 million on Mt Richmond, and $3 million on the 2 Carlton Gore Road properties. Portfolio after deducting the right-of-use asset in respect of 39 Market Place was valued at $2 billion at 30 September. Next slide is net tangible assets per share or NTA. There was a small gain in NTA in the period, driven by the revaluation gain of $8.7 million. Peter said, NTA moved up by $0.01 to $1.46 per share. The next slide covers debt to total assets. Balance sheet is in good shape, and we have capacity to complete developments and acquire assets as evidenced by the recent acquisition of 291 East Tamaki Road, which is a very exciting future development opportunity. This acquisition is expected to settle in August next year. Debt to total assets ratio was 37.2% at 30 September, slightly up from 36.5% in March. Property at 8 Forge Way, which was sold last year, is expected to settle in March next year. So that's another $35 million -- in addition, there's a further $116 million across 6 properties that we regard as non-core and they're available for sale. Next slide covers interest rate management. Weighted average cost of debt decreased slightly during the period from 5.6% in March to 5.5%. Interest coverage ratio remained at 2.4x and well above the bank covenant of 2x. Level of fixed rate cover was 69% at 30 September. We had $340 million in forward swaps at 30 September, and we continue to add and cover when appropriate -- 30, September, we've added another $60 million in cover. We provided more color on our hedging profile and also the weighted margins on our drawn debt in the appendix. This slide looks at our debt profile. We refinanced our bank debt during the period, pushing out tenor. The nearest bank expiry is now October 2027, so FY '28. Bank margins remain very competitive, as you'll see from the appendix. Nearest green bond matures in March '26, and we would expect to refinance this with another green bond, subject to margins being acceptable. Green bonds represent 38% of the total debt facilities, providing important diversification. Final slide from me is on dividends. We announced this morning a second quarter dividend of $ 0.016625 per share with reputation credits of $0.002463 per share attached. The record date is 4 December and the payment date is 18 December. There's no change to our guidance for the full year '25. We've also reopened the DRP for this dividend, and there's more information on that in the separate dividend announcement released this morning. I'll pass you back to Peter for some leasing commentary.

Thanks, Dave. So as I mentioned, a difficult 6 months. It has been -- leasing has been slow as we have projected, but progress has been made. And as I mentioned earlier, post balance date, there's been some further progress with some good momentum being developed there. We are expecting to be a bit busier coming back after the Christmas break. Tenant failures and arrears have been much lower than anticipated through this phase. And interestingly, particularly in the retail space, we've seen where we've needed to move tenants on. We've seen international corporate retailers taking their place. And for us at the Albany Mega Centre, that's generally been on better lease terms and higher rental rates. The lease expiry profile going forward is actually pretty good. The remaining expiries through F '24 being The Warehouse in Albany, Farmers in Albany and Carr & Haslam at Mt Richmond. The latter, we need to keep short term so that we can keep control of the ability to do something on that site, if we get a lease in place. The former 2 are both expected to renew. So pretty good from that perspective. Further forward into F '25, Te Puni Kokiri at 143 Lambton Quay. We do expect that they will vacate, albeit exactly when, it's somewhat unsure. The work that we've done on that property shows us that there is a highest and best use conversion to accommodation, and indeed we're negotiating with 2 current parties and we expect to sell that property in due course. Further out, New Zealand Post in the 7WQ building. We expect to retain New Zealand Post there, but we do expect that we will be able to get back from them some of the space that they're using on the ground floor, which will give us some value lift, courtesy of getting some increased leasable area back out of that space. So, that we expect will come in our favor. The other large one is again the warehouse in Cavendish Drive. And again, the indications are that, that will be a renewal. So current year and forward year expiries, not looking too uncomfortable. Turning to the 3 principal sectors and a quick summary of what's going through there. In the industrial space, we are seeing inquiry recovering, and we are in the fortunate position of having one of the few opportunities of really good quality space in that precinct. So we're expecting some reasonably good results out of that. Do expect increased activity across the sector in the first part of calendar '25. What we've seen is where you have good quality property, well-located property, rentals have certainly been holding and land values for well-located sites have held up reasonably well, but construction costs have come down. In the office space, we're certainly seeing less working from home. So occupancy rates have recovered somewhat. We're continuing to see demand for green space. And specifically in Wellington, the forward vacancy levels are going to depend on the impact of the government's return to office edict, which we're advised is not really going to hit the ground until February next year. But we have noted an increase in forward inquiry levels in that space. In the retail space, most of our exposure, of course, is the Albany Mega Centre, which has continued to show really good demand, increasing rentals. In fact, rentals increasing beyond those which have been assessed by the valuers. So we've had some great leasing results over there post balance state with JD Sports and the Chemist Warehouse. And certainly for us, and certainly for us at least, we've seen less blood on the carpet in the retail sector than we had expected. So the outlook, a little brighter, we've got quite a bit of activity post balance state, as I've mentioned. We do still have some challenging headwinds, but it's certainly improved and we expect that to continue in the New Year. What we're expecting to see for our portfolio anyway is a fairly good recovery, because there's a lack of any significant good quality oversupply, and we're able to respond fairly quickly. Overall, we think Argosy has come through the last few years relatively well so far. As I mentioned, arrears have remained really well under control, failure rates have remained low, tenant retention rates have remained high. Forward risks, certainly central government policy and planning, and geopolitical risks along with everybody else, albeit that Argosy is possibly relatively less impacted by those. We're happy to take any questions. That's all we've got in terms of commentary. There's quite a bit of information sitting in the appendices, if you want to go through that in due course.

[Operator Instructions] Your first question comes from Bianca Fledderus with UBS.

Thanks for the update. Firstly, the further 6 properties moved to non-core. Could you share which assets they are? And are you actively trying to market and sell all of those at the moment? Or are some more medium-term, I guess?

Okay, so we've got active campaigns with 39 Market Place, the building I'm sitting in right now, with 147 Lambton Quay at the moment. The others are in the future base, 147 Lambton Quay, the property in Taupo that is currently occupied by the warehouse and the property in Christchurch, which is a Woolston.

Well, there's also a warehouse property that we're looking at as well.

That's 4 Henderson Place.

Yes. Okay. And then moving on to your full year EPS guidance, which wasn't changed, but you are again talking about challenging conditions, occupancy is lower, rental growth is slowing. So firstly, I'm wondering, are there any other levers you may be looking to pull during the year to achieve the flat dividends year-on-year? And secondly, could you provide any guidance on what AFFO payout ratio you expect this to reflect?

Yes, well, full year, I think we've indicated in the past that this year, we expect to pay out higher than 100% of AFFO. So our earnings will be below $0.0665 per share.

Yes. We do have quite a few rental reviews still to do during this part of the year. So we're doing everything we can to minimize the degree of overpayment, of course.

Your next question comes from Vishal Bhula with Jarden.

Congrats on a good 6 months to start that hard backdrop. Just on the Lambton Quay assets, 147, you mentioned it's now non-core. If you don't kind of get it away at the sales process, kind of what's the other options for that property?

Good question, Vishal. We've got a current leasing campaign on it. We do have some early inquiry. So we will continue to try and lease it. Obviously, the sale and leasing lines are closely related in that building. It's just over 80% of code from the recent assessments, so it's well positioned for government overflow, for workspace, for the current issues with government returning to work and not having space available. And it's also well positioned in terms of being able to put domestic corporates in.

Has the current tenant, TPK, I believe -- not TPK, sorry, Parliamentary Services, have they kind of indicated if they want to stay longer-term? Because I think their lease comes up in '27?

Yes. So Parliamentary Services, we understand have been instructed that they'll be relocating.

And then just on the under-renting, which I think is now just under 12%, what was the driver for the increase from FY '24 when it sat at under 9%?

Well, the increase is in our industrial portfolio.

It'd be industrial in Auckland specifically.

Yes.

And part of that will be gentrification where we've had a relative improvement on the location of the likes of the Favona Road property.

I guess just to take a step back, and maybe I might be missing something, but industrial market rents have been pretty slow over the last 6, 12 months. So are you kind of saying the reviews you've gotten for over the last 6 months or so have actually been lower than that to drive your under-renting increase? Because previously you were closing that gap. So it's just a bit odd that it's kind of shot up quite materially.

That will just be the mix of fixed reviews versus market reviews.

Yes. That's right. And we don't have -- I don't have the March stuff in front of us in terms of -- all we can really say is that at this stage is that industrial has gone up by 16%. It's under-rented by 16%. So we'd have to have a look at the previous data to analyze it better for you.

Cool, no worries. And then just lastly for me, I think at '24, when you gave guidance, that was including the sales of 39 Market Place, and you've removed that statement from the current guidance. But at 39 Market Place, you can't get it away this year or early next year. What are your kind of plans for that asset? Like, are you running a leasing campaign at the same time?

Absolutely, yes. We're -- doing nothing's not a good idea, obviously. So it's about trying to make sure that we're not compromising a sale, we're not compromising the highest and best use, but still managing to get appropriate income and work done.

Are you able to get any interest at the moment? Or is it still pretty tough for that asset?

Interesting. Post balance date, inquiry levels have increased significantly. Obviously, it's a great location. It's a case of what product are you offering. But we've got some really good lease inquiry that we're working with at the moment.

[Operator Instructions] Your next question comes from Nick Mar with Macquarie.

I'm sorry to sort of label the point each time, but just on the dividend policy, in the text, it says the policy is paid between 85% to 100% of AFFO earnings. Have you guys -- and then sort of caveat it around being outside limited periods. Have you guys sort of removed the 3-year rolling piece? Or where are you kind of thinking on that at the moment?

Yes. It caused a bit of angst last time, as you're aware. And so at the annual meeting, it was clarified by Jeff that really that 3-year rolling period is gone now. So, the overall policy is the same, 85% to 100% of AFFO. But the Board are happy to look through that in the very short-term and be slightly over on occasion.

So is that just when you said very short-term, is that literally only 1 year?

I would say 1 or 2 years max, Nick.

Yes. Okay. And if things don't improve, is what's the trigger point of then deciding to cut the dividend?

Well, we need to be under 100%.

Yes. So you said by FY 2027, you need to be back with it?

Yes.

Yes. That's right. Absolutely. And by FY '27, certainly. So what we'll do is we'll be looking at this very closely over the next 6 months and just making sure that we can deliver a dividend that is under 100% of AFFO.

Okay. No, that's fine. And then just on the acquisition, can you just talk me through sort of rationale behind that and some of the kind of details, the first piece is it's got a lot of a settlement and you expect it to be leased by or fully let by then. Is that -- are you helping in the leasing there? Or is that the vendor's obligation? Is there any underwrite on it? And secondly, what's your sort of view on time frame and sort of target returns on the site, when you look to develop it?

We probably should have covered that, Nick. It's a good question. So we've got a 9-month settlement period that is made up of work that we're requiring the vendor to do to get the building into a leasable position for us. So there's 6 months’ work there. Then there's a further 3 months of early access for us where we get to do our work on the property prior to settlement. And we are controlling and driving the leasing on the way through. So that campaign has already started and pretty positive signs early on. So that's the driver there. So obviously, it's a redevelopment site. The location is great. The site is very good, very good access to the site from a number of locations. So, very happy with the site. It's about maximizing the holding income in the interim period. And as I said, thus far, it's looking pretty positive. It is quite nice to not have to settle it for 9 months, though.

Yes. So just to answer the question, is this like a 3-year redevelopment or a 5-year or is this a 10-year kind of horizon?

2028, so in the middle of that, about 5 years.

Yes, FY '29 we're looking at.

Cool. And when you look at the sort of business case on this, where do the target initial yields and IRRs sit take into account that a site that you bought a few years ago Neilson Street is sort of 5.6%, which most people would say is not worthwhile from a development perspective?

Yes, we're looking at about 5.6% initial yield, IRR about 8.1%. Probably a capital spend of around about $78 million. That's on top of the $61 million acquisition cost. So those are kind of the metrics, the rough metrics at this point for the development down the track.

Okay, no, that's cool. And then just on Neilson Street, I see the total NLA target has sort of come down a little bit on the warehouse and the initial yields sort of come down a little bit. Can you just talk through what's driven that?

So the changes, and that may vary because it's tenant dependent. So we've gone with base case scenario and which of the tenants that we're working with we get may change that area slightly, and therefore, the yield slightly. So it is a building on-site answer to your question.

Okay, that's fine.

We'll catch up with you a bit later.

There are no further questions at this time, and I'll hand it back for closing remarks.

Okay. Thanks very much for joining us. Most of you will catch up with a bit later on in the process. But if there's anything you think of later, please don't hesitate to drop us an e-mail. Thank you.

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