Centuria Industrial REIT (CIP) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the Centuria Industrial REIT FY '23 Results Presentation. [Operator Instructions] And finally, I would like to advise all participants that this call is being recorded. Thank you. I'd now like to welcome Mr. Jesse Curtis, Head of Industrial and CIP Fund Manager, to begin the conference. Jesse, over to you.

Thank you, operator, and good morning, everybody. Thank you for joining Centuria Industrial REIT's Full Year FY '23 Results Presentation. My name is Jesse Curtis, CIP's Fund Manager. Joining me today is CIP's Assistant Fund Manager, Michael Ching. Additionally, Centuria's Head of Funds Management, Ross Lees and Group Head of Investor Relations, Tim Mitchell, are also present. I would like to commence today's presentation with an acknowledgment of country. I am joining you from the lands of the Gadigal people of the Eora Nation. Centuria manages property throughout Australia and New Zealand, and pays its respects to the traditional owners of the land in each country, to their unique culture and to their elders, past and present. A robust industrial market and well-constructed portfolio of infill industrial assets resulted in CIP successfully executing significant leasing transactions and delivering value-add projects throughout the year. Rental growth, again, substantially accelerated against a backdrop of record low vacancy and consistent tenant demand. Subsequently, the REIT benefited from market-leading re-leasing spreads. CIP's balance sheet was further strengthened, led by strategic transactions that diversified its sources of lending and maintained gearing. As a result of CIP's strong performance, we delivered financial year '23 FFO and distributions in line with guidance. Earlier today, we published various documents on the ASX, including this results presentation, which we will step you through now. The presentation provides an overview of CIP's portfolio, its financial results and operational performance as well as FY '24 outlook. Let's begin on Slide 4. CIP is an externally-managed REIT that forms part of the Centuria Capital Group family, a real estate fund manager operating under the ASX code, CNI. Centuria is a strong supporter of CIP and provides significant benefits from the group's long and successful track record in property funds measurement. Slide 5 outlines CIP's unchanged strategy to deliver reliable income and capital growth from a high-quality portfolio consisting of only industrial assets across Australia. Our vision is to remain as Australia's leading domestic pure-play industrial REIT. Slide 6 details CIP's key metrics. The portfolio as at 30 June was valued at AUD 3.8 billion, with high occupancy of 98%. Having delivered guidance, CIP achieved a 12-month total shareholder return of 16.4%, double the S&P ASX 200 A-REIT Index. Turning to Slide 7, which outlines CIP's FY '23 strategy execution. Our active portfolio management approach was again demonstrated with over 180,000 square meters leased. Most significantly, re-leasing spreads accelerated considerably, averaging 30% for the year, but recording an average of 37% during the second half of financial year '23. The portfolio remains well positioned with a high east coast weighting and majority of the portfolio within infill industrial markets, where demand for industrial space remains the highest. Over 1/3 of the portfolio expires over the next 3 years, providing a strong growth driver. Market rental growth and leasing success also provided buoyancy to evaluations, substantially offsetting capitalization rate expansion. Proactive capital management through issuance of exchangeable notes and divestment of assets fortified the balance sheet, with gearing remaining at the lower end of the target gearing range and a high percentage of debt hedged. Given the strong position of CIP's portfolio, we are pleased to provide FY '24 FFO guidance of AUD 0.17 per unit and distribution guidance of AUD 0.16 per unit. I will now hand over to Assistant Fund Manager, Michael Ching, to take you through the portfolio overview and financial results.

Thanks, Jesse. Slide 8 shows a snapshot of CIP's portfolio composition and the geographic spread of our assets. As Australia's largest listed pure-play industrial REIT, CIP continues to provide investors with exposure to 100% industrial-only portfolio of 89 high-quality assets, with over 90% weighting to the strong performing eastern seaboard markets. 83% of our portfolio is located in core urban infill markets, close to population catchments and limited future supply. CIP's portfolio comprises 2 strategically constructed sub portfolios, both providing unique characteristics to deliver returns to unitholders, which I will detail in the next 2 slides. Turning to Slide 9. Our active portfolio represents 80% of CIP's total portfolio. This sub-portfolio enables us to utilize our active in-house management capabilities to execute on value-add strategies, to generate returns for unitholders. With a WALE of 4.2 years and approximately 43% of leases expiring over the next 3 years, these assets provide opportunities to capitalize on the strength of the market and access positive rental reversion. Moving to Slide 10. Our long WALE portfolio accounts for 20% of CIP's total portfolio and consists of 2 substantial assets with lease expiries greater than 15 years. These assets are leased to iconic blue-chip tenant customers, providing long-term, secure, reliable income streams. 59% of the income generated from this portfolio is CPI linked, and will generate strong growth for the portfolio with an average rent review of 4.4% for FY '24. Moving to the FY '23 financial results on Slide 12. CIP delivered funds from operations of AUD 108.1 million, or AUD 0.17 per unit, in line with guidance. Gross property income increased by AUD 20.9 million to AUD 220 million, reflecting the growth in the portfolio and strong leasing outcomes achieved during the year. Leasing success contributed to CIP delivering like-for-like NOI growth of 4.4% in FY '23. The AUD 2.2 million of other income recorded in the year relates to the coupon received on our fund-through development projects at Dandenong and Campbellfield. Higher interest rates resulted in CIP total interest cost increasing by AUD 20.8 million to AUD 43.9 million in FY '23. Looking at capital management in more detail on Slide 14. CIP undertook several strategic capital management initiatives to further strengthen its balance sheet while increasing diversity across our sources of funding. We realized AUD 215 million of liquidity through strategic transactions, maintaining gearing at 33.1% as of June 2023, which is at the lower end of our 30% to 40% target range. CIP further diversified its capital structure in FY '23 through the issuance of a AUD 300 million exchangeable note. This note issuance, together with AUD 300 million of interest rate swaps entered into the year, increased CIP's hedging profile to 88%, with a weighted average hedge maturity of 2.7 years. CIP has no debt maturing until FY '25 and over AUD 300 million of available liquidity. CIP's balance sheet remains robust and provides ample headroom to our debt covenants. Slide 15 provides a case study on our proactive capital management approach through our exchangeable note offering in February 2023. The AUD 300 million notes were issued on a 5-year term at an attractive fixed rate coupon of 3.95%. This compares favorably to traditional financing terms, which have an all-in cost of debt of approximately 6% at present. Additionally, the issuance further diversifies CIP's capital structure while increasing CIP's interest rate hedging profile. The notes have a 5-year term with an option to be exchanged into CIP units in 2028 at an initial conversion price of AUD 4.16 per unit. The initial conversion price represented a 2% premium to CIP's prevailing net tangible assets at the time of issue. This strategic capital management initiative further demonstrates our ongoing commitment to strengthening CIP's balance sheet through current market volatility. I will now hand you back to Jesse to take you through CIP's operational performance over the year.

Thank you, Michael. Portfolio leasing was a key driver of performance during the year. Slide 16 details CIP's leasing success with over 180,000 square meters, or 14% of the portfolio leased during the year. Of note was the 40,500 square meters of leasing completed at our development in Dandenong South and renewal of major tenant customers, BlueScope and Yamaha in our Queensland portfolio. I'd like to reiterate re-leasing spreads accelerated on the back of rapidly rising rents, with average re-leasing spreads of 37% for the second half of the year, up from 19% in the first half. For FY '23, average re-leasing spreads was 30%. Of note is 47,000 square meters of financial year '23 leasing volume that is yet to have rent determined due to tenants exercising options. We expect the resulting rent to exceed FY '23 average re-leasing spreads. CIP's strong re-leasing spreads can be attributable to our long-standing portfolio construction strategy, focusing on functional assets in key urban infill locations where tenant demand is highest. Looking forward, the portfolio offers near-term mark-to-market opportunity, with 36% of the portfolio expiring over the next 3 years. Slide 17 outlines our high-quality customer base, delivering reliable income streams. Our customer relationships and network effect is continuing to generate tangible portfolio benefits with average downtime in extremely low 31 days. Additionally, more than 30% of the portfolio is leased to customers with more than one site owned by CIP. Over to Slide 18. CIP continues to deliver value-add projects, leveraging the location of our assets. Recently completed projects include 9 Fellowes Court in Tullamarine, Victoria, where repositioning works and strategic leasing were undertaken and a 66% uplift in value was achieved. Active projects include 616 Boundary Road in Richlands, Queensland, where repositioning works are approaching completion and terms are agreed with a national household name. 30 Fulton Drive in Derrimut is an asset where we have lodged a development application to modernize and expand the area of the facility to maximize the asset's value. Our asset repositioning pipeline provides a key driver of value for CIP unitholders. Extending CIP's value-add activities is our development pipeline, which continues to build. Slide 19 details 40,544 square meters of completed projects and 57,300 square meters of active developments. Both Campbellfield and Canning Vale developments are progressing well, with completion expected in the first half of financial year '24. Leasing interest remains strong for both projects. Slide 20 explains our long-standing site consolidation strategy. CIP has now accumulated 12 individual examples of site consolidation opportunities under this strategy that cover a collective 100 hectares of land or 1/3 of our portfolio. Most recently, CIP acquired an additional asset neighboring its existing Coopers Plains asset in Queensland, consolidating 4.5 hectares of land in a key Brisbane infill market. Similar to other examples in the portfolio, the site creates critical mass to maximize rent on existing improvements while providing a future size of scale for development optionality. In fact, 100% of assets acquired in FY '23 will land consolidation strategy acquisitions. Strategic transactions helped underpin NTA and liquidity for CIP's asset base, in particular, a new strategic partnership with Morgan Stanley Real Estate Investing was established, with a 50% interest in 8 assets being divested by CIP. Additionally, we secured the direct market divestment of 30 Clay Place for AUD 34.5 million, generating a significant premium to book that. Combined, the transactions were sold on an average yield of 4.5%. Under Centuria's management, CIP has a long track record of capital management and improving portfolio quality through divestments, having completed over AUD 325 million of transactions over 14 individual assets. Turning to valuations on Slide 22. During FY '23, CIP's portfolio weighted average capitalization rate expanded 107 basis points to 5.26% on the back of rising interest rates, one of the widest cap rates of its peer set. Reduction in value was primarily concentrated on CIP's long WALE sub portfolio, while the active portfolio saw a small increase due to strong market rental growth offsetting capitalization rate expansion. Over the 12 months to 30 June, valuations adopted an average of 23% increase in market rents. Following valuations, CIP's net tangible assets is AUD 3.96 per unit. Moving to sustainability initiatives on Slide 24. CIP is an externally-managed REIT, has no star and is solely a portfolio of assets. The REIT is managed by Centuria Capital Group and aligns itself to Centuria's sustainability framework. A number of key CIP-specific ESG initiatives implemented during the year include; launching a new sustainability target to have 0 Scope 2 emissions by 2028. We also continued our partnership with Healthy Heads, an organization focused on mental health in the transport and logistics industries. Over to Slide 25, which demonstrates how CIP's portfolio is growing with leading green-certified assets. More than 50,000 square meters of 5-star Green Star certified industrial assets have been delivered to date and a further 57,000 square meters is under construction. Additionally, CIP participated in the NABERS Warehouse and cold store pilot program to create a tool to measure the efficiency of industrial buildings. Moving to Slide 26. Globally, industrial real estate continues to benefit from strong tailwinds. Tenant demand is keeping vacancy rates below the long-term average in major gateway city markets, driving strong rental growth. According to CBRE data, Australia now has the lowest vacancy rate in the world. Yet we still provide relatively affordable industrial rents in comparison to other established global markets. With continued tenant demand and limited supply, the global context demonstrates a long runway of rental growth for industrial rents in Australia. Looking locally on Slide 27. Industrial rents have continued to climb across all major industrial markets as national vacancy hits another record low. Despite the evolving economic conditions, we are still seeing resilient tenant demand, particularly for infill industrial assets. Transport logistics tenants continue to lead demand as they look to manage inventory levels and respond to e-commerce demand. Manufacturing remains a large contributor to demand, with supply chain resilience and onshoring of operations a continuing trend. Proximity to a large population base has been a key driver for leasing decisions, and this is boosting significant demand for urban infill industrial space. Tenant customers are looking to minimize delivery times, reduce transportation costs and provide access to an affordable labor force in a competitive environment. Demand forecasts are expected to continue at a level above the long-term average. However, supply of industrial space is still well short of this demand. 73% of 2023's development supply is pre-committed, leaving a shortfall of only 1 million square meters of uncommitted supply, well short of the level of demand required. This dislocation is expected to continue a slow infrastructure rollout, labor shortages, supply chain disruption and limited industrial zoned land limits the near-term supply. Add to this sub-1% vacancy, and this is creating strong landlord pricing power to drive further market rental growth. Moving into financial year '24. CIP's performance will be driven by 3 key priorities. Continuing to leverage our infill-focused portfolio and high-quality customer base against the strength of the industrial market to drive top line growth; execute on the embedded value-add opportunities to drive both income and portfolio value and maintain a proactive and disciplined approach to capital management to reduce volatility in a changing interest rate environment. To conclude, as Australia's largest domestic pure-play industrial REIT, CIP has delivered a strong set of results in FY '23. Leasing success drove market-leading re-leasing spreads and value-add projects continue to be delivered to the benefit of unitholders. Strategic transactions bolstered CIP's balance sheet strength. And whilst the capitalization rate for the portfolio widened, strong leasing and market rental growth provided an offset. Looking to the year ahead, we will continue to monitor and consider domestic and global economic conditions. Debt remains a headwind, having increased materially over the last 12 months. However, as outlined in this presentation, the operating environment for industrial remains strong. And over financial year '23, we expect CIP to benefit from its portfolio construction to deliver like-for-like income growth on the back of continued leasing success. For financial year '24, CIP provides FFO guidance of AUD 0.17 per unit and distribution guidance of AUD 0.16 per unit. Based on the recent trading price, this equates to a distribution yield of 5.1%. Thank you for listening. And at this point, I'll hand the call back to the operator for any questions.

[Operator Instructions] Your first question comes from the line of Caleb Wheatley from Macquarie Group.

My first question, just around tenant demand and what you're seeing on that front. So we've had some peers potentially flagging, they are beginning to see some softening around the edges. I'm conscious that direct market is very strong at the present. But yes, just keen to hear of any anecdotes on what you're seeing on tenant demand across your major tenant categories, please?

Yes. Look, tenant demand is still extremely strong out there in the market. And I think that's -- we're certainly seeing that across our portfolio. Now our portfolio sits mainly in the infill and last mile, last kilometer style of assets. And so that's the area of the market we're seeing the highest tenant demand. What we have seen though is gross take-up in the market down quite significantly. We're probably at about 2/3 of the gross take-up volume we would have seen in comparison to previous years. And that's really been a function of a lack of available space for tenants to actually lease. So we're still seeing good demand. But certainly, the volume of leasing transactions we're seeing is lower, more so a result of what we're seeing from a vacancy perspective or availability of space and availability of supply.

More specifically around the sort of retail or 3PL space, is there no signal that given the potential for a softening in retail sales and, I guess, the broader macro environment? Is there any indication of that potentially tapering off or still strong from what you're saying?

I mean it's still strong. I think, again, I go back to the sort of composition of our portfolio. We're mainly an urban infill last mile sort of oriented owner of industrial real estate. And so the demand we're seeing in those areas of the market are very much a lot higher than what you may be seeing on the urban fringe for storage space. I think when you look at where the demand is coming from the tenants, transport logistics still make up about 50% of leasing. Manufacturing is around that 15% of leasing. So we're still seeing good demand right across our book. And maybe we don't have 4 or 5 tenants vying for the space. We've probably got 2 or 3 today, but you can only lease the space to one person at the end of the day.

Right. That's really helpful. My next question was just on the development pipeline and what you're seeing on the returns front there. I'm conscious you've seen some improvement as we went into the first half of '23. But just keen to hear an updated view on the trajectory of what the returns look like across the development pipeline, please?

Yes. As I said at the half, Campbellfield, we are looking at delivering a yield on cost of north of 6% to 6.5% on that particular project. As a context, we bought that at the time with an underwrite of a yield on cost of 4.5%, so we've probably seen a 200 basis point increase on the basis of market rental growth. Similar situation with our Bannister Road development. We bought that on an initial yield on cost of 5.75%. That's widened to now north of 6.5%. And we're expecting it to -- as we lease those projects, we're probably expecting those to maybe even come in a little better than those at this point.

Great. And just given, I guess, the success of these development projects that are coming through, should we be expecting a more material addition on developments going forward? I'm conscious there is potentially still a little bit uncertainty around the balance sheet. But are you expecting to restock that pipeline in the medium term?

I think we've always said that we would like to continue some level of value-add activity annually within this portfolio. So whether that's repositioning works, whether that's full-blown development, right now, over 99% of this portfolio generates income. So we're not sitting on a big land bank that we have to work through. We've got highly functional assets sitting on these blocks of land we own that we continue to take the benefit out of the re-leasing spreads on. Alternatively, we carry some optionality with some of these sites that with the balance sheet in its current state and any other activities we might do to improve the balance sheet would provide us with some level of ability to access that in time.

Your next question comes from the line of Sholto Maconochie from Jefferies.

Just a quick one on the -- I may have missed this, did you say the leasing spread to be bigger in FY '24 from an FY '23?

Sorry, Sholto. Ask the question again?

Just on the leasing spreads, I think, did you say they'd be higher, like better spreads in '24 versus '23?

What I said in the presentation was we've got an element of the portfolio that hasn't had the rents determined yet on it. Early indications on what those -- that 40,000 square meters are is probably looking better than that 37% we were talking about in the presentation. So I think if we continue to see the rental growth we're seeing in the market, we will continue to see those re-leasing spreads expand further.

Okay. Makes sense. And what's the level of under-renting again in your portfolio? I may have missed it.

On value or assessment? So external value is marking our portfolio to market. They're calling our portfolio at 15% underlet. Our management view is probably somewhere in the range of 25% to 30% under-rented.

Okay. And then I noticed the hedging went up about 10% on the PC on December from the first half, and you've assumed a 4.6 BBSW for your floating debt. What's your assumption on the all-in cost of debt this year, including the exchangeable?

It's going to be around 4%.

4% all in?

All in.

Your next question comes from the line of Tom Bodor from UBS.

Jesse an Mike, I just wanted to ask about your vacancy on the portfolio, still pretty modest at 2%, but just be interested in just the progress, particularly on the assets where there's 0% occupancy.

Yes, Tom, it's going well. I mean, where there's vacancy, I think I alluded to the fact that one of those vacancies, the biggest vacancy we hold, 616 Boundary Road, we've now got terms agreed on and are awaiting a signed lease. So that will essentially resolve that. That's about half of our current vacancy or 1%. The balance of these sort of tenancies are then smaller sub-5,000 square meter tenancies, which we expect sitting one of the tightest segments of the market, that size range and also the segment of the market, we're seeing the highest amount of tenant demand. So I feel pretty comfortable with where leasing heads on the vacancy.

Okay. That's great. And then just a final one. I'd be interested in how do you see opportunities to continue to sell lower quality assets opportunistically? Or do you feel like you've sort of trimmed the portfolio to a point where you're pretty comfortable with where it sits?

It's something we continue to monitor as part of watching the portfolio. As we get leasing results or as we think we've maximized value on assets, we'll potentially look to divest or recycle that capital into areas of this business where we think we can generate higher returns. You'll probably notice in the statement of accounts, we've identified one asset that's held for sale at the moment. I anticipate we'll continue to look at the portfolio and see how we can improve it.

[Operator Instructions] And your next question comes from the line of Edward Day from Moelis Australia.

Jesse, just on that asset sale. So that's the Westmeadows asset from [ what I could say ], you guys brought that in, I think, 2018. Can you just sort of talk us through the decision to sell that asset?

The asset was identified as one we've added a lot of value to over the last 3 years or 4 years of owning that asset. We've taken rents up about 40% on the asset over that period of time. It's a high churn. Assets got a large number of tenants. We're essentially looking with more small to medium style enterprises occupying it. So as we look to optimize this portfolio, increase the quality of income being paid, that was an asset we've identified that potentially would be a good asset to move on from at this point.

Okay. And then just on your capital expenditure requirements. Could you just outline what you've got left at Campbellfield and then what your expectations are for some of the asset repositionings?

So total development commitments for the balance of this year on Canning Vale and Campbellfield is AUD 34 million. We've then got allocations of about AUD 10 million for other value-add style activities across the portfolio currently in the budget.

Your next question comes from the line of Lauren Berry from Morgan Stanley.

I'm just wondering your comments on how tenants might be seeing affordability of leases at the moment, given you've had such big rental increases and whether any tenants are taking measures to reduce space, move into cheaper areas? What are you seeing on the ground?

Lauren, yes, I think there's a bit we're seeing in that space. I think where we're seeing more cost rationalization from tenants is on the urban fringe. So if you look at Sydney and how supply constrained Sydney is compared to other markets like Brisbane and Melbourne, you've seen a little bit of media around large occupiers potentially looking to move those operations, those urban fringe or large distribution center operations to Melbourne or Brisbane as the rent or occupancy costs, in some cases, are half what they are in Sydney. What we've specifically seen across our portfolio is you can't replace the last mile or urban infill location of our warehouses for their proximity to a large population base within a short drive time. So when we assess the affordability of rent for our tenants, over 70% have dynamic pricing models where they can pass through the rent almost immediately as it goes up. And when you think about the total expense base of industrial tenants, rent still represents only about 5% of their expense base. So we haven't seen any increase in delinquencies across our portfolio that show that the tenant affordability of rent is redlining.

Great. And just on your portfolio, you called out opportunities to improve the balance sheet, which I assume means capital recycling. But do you see any opportunities emerging to make acquisitions? Are there any cheaper pricing come up? Or how are you seeing the market?

We haven't really seen a dislocation in the transaction market occur yet. Definitely, transaction volumes are down across the direct market. And the strongest segment of that market we're seeing is sort of those core plus and value-add buyers. There have been some international groups that have made some pretty big plays in Australia. Some of the Aussie super funds are making some big plays in the Australian industrial market at the moment. So we're seeing pricing hold up. We're not seeing a great dealer value where we have to go and deploy money. I think where our view from a CIP perspective is probably to look at our existing book and make the most of some of the embedded value we're carrying in CIP's portfolio in the near term.

Great. And just last one for me. Those undecided options, have you booked in the higher rents, the leases that you assume you'll get higher rents into FY '23? Or will that be something that will be added back into FY '24 once they're actually determined?

We've made some assumptions in guidance around where we think those rents will land.

And your next question comes from the line of Richard Jones from JPMorgan.

Jesse, yes. So just in terms of what you book in FY '23, Jesse, on those 47,000 square meters, what do you book for those leases that are obviously yet to be determined?

The majority -- Michael, correct me if I'm wrong, the majority, if not all of those leases will only have an impact on FY '24. So there won't be any backdating to FY '23 of any of those exercise of option or undetermined leases. It will all be an FY '24 impact.

Okay. Okay. And just on Morgan Stanley partnership, is that an open-ended partnership? And can you maybe touch on, I guess, the capacity for further sales into that venture?

We've got a very wide relationship with Morgan Stanley right across the Centuria Capital Group. And the mandate we've got with them on industrial currently is a 50-50 between CIP and Morgan Stanley. There's no pre-prescribed way that vehicle can grow, and I'll probably leave it to CNI to make some comments on that vehicle when they report later in the week. But our view is, if that vehicle wants to grow, it doesn't have to necessarily grow with CIP could participate, it might not participate. It's all going to be opportunity led.

As there are no further questions at this time, I would like to turn the call back over to Jesse for closing remarks.

Thank you, everyone, for your ongoing support of Centuria Industrial REIT and calling in today. Please don't hesitate to contact either Tim Mitchell, myself or Michael, for any follow-up questions. Otherwise, we look forward to discussing the results with you over the next couple of weeks. Thank you.

This concludes today's conference call. Please enjoy the rest of your week. You may now disconnect.