Centuria Office REIT (COF) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by, and welcome to the COF FY '20 Results Presentation. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to your first speaker today, Mr. Grant Nichols, COF Fund Manager. Thank you, sir. Please go ahead.

Good morning, and thank you for dialing in to the Centuria Office REIT FY '20 Financial Results and Fund Update. My name is Grant Nichols, COF's Fund Manager. Earlier today, we published various documents on the ASX relating to the full year results, including the results presentation, which we will go through this morning. You can follow the presentation by downloading the ASX announcement from COF's website or the ASX website. I am very pleased to share COF's results, which highlight the continued resilience and quality of the COF portfolio. Starting on Slide 4, and we begin with a quick overview of COF's manager. Centuria Capital Group is an established specialist investment manager that operates under the ASX Code, CNI. With pro forma $9.4 billion of assets under management, Centuria Capital Group provides its investors with exposure to quality office, industrial and health care commercial real estate investments across Australia and New Zealand and investment bonds through the Centuria Life business. COF accounts for about 22% of Century Capital Group's total assets under management. Slide 5 further highlights the alignment between Centuria and COF. There are a number of advantages that COF receives from being managed by Centuria. The group that has a long and successful track record in property funds management and substantial -- and has a substantial commercial property platform that is predominantly focused on Australian office markets. Particularly in periods of uncertainty, there is significant benefits of having access to a hands-on proactive manager with in-house property and facilities management and deep leasing capability. Centuria is a strong supporter of COF, and Centuria Capital Group remains the trust's largest unitholder with 19.9% of the register. The capability of Centuria Capital Group and the strong alignment to COF also provides the trust with various opportunities to undertake joint venture initiatives and the potential to access pipeline opportunities for future transactions. Turning to COF, specifically on Slide 6. The portfolio has delivered solid performance during FY '20, especially throughout the recent challenging operating conditions resulting from COVID-19. The performance, including delivering distributions in line with guidance, is a testament to the quality of COF's portfolio, which maintains high occupancy of 98.1%, a WALE of 4.7 years and tenant covenants, with 25.4% of the total portfolio income derived from Australian state and federal government tenants. As Australia's largest pure-play office REIT, we believe COF provides quality, highly connected and affordable office space at a time when tenants are focused on their operating costs. When combined with high occupancy, strong underlying tenant covenants, an average building age of 16 years and ample undrawn debt and debt covenant headroom, COF remains well placed to continue delivering attractive income returns to unitholders, with the FY '21 distribution guidance of $0.165 per unit, equating to a distribution yield of 9% based on the current trading price. Looking at the results summary in more detail on Slide 7. And during FY '20, a number of transactions were completed that reinforced COF as a geographically diversified portfolio of quality, well-connected office buildings with no single market concentration and strong tenant covenants. 3 high-quality assets were acquired, increasing the portfolio size to 23 assets and improving the average building age to around 16 years, which is very young for an office portfolio. The Centuria team has also executed a significant amount of leasing with over 32,000 square meters of leasing completed during the year. It has maintained very high occupancy of 98.1% and increased the weighted average lease expiry to 4.7 years. We have also further diversified our debt position, increasing the number of lenders to 5, while maintaining a solid capital position with gearing of 34%, significant debt covenant headroom and undrawn debt capacity with a very competitive all-in cost of debt of 2.2%. Moving to Slide 8 and the impact of COVID-19, as COF delivered solid performance through this challenging period. Portfolio rent collections remained robust with April to June 2020 rent collections having averaged 92%, an increase from the reported 89% announced on July 2. Included within the outstanding rent is agreed and pending rent relief claims related to the National Code of Conduct on Commercial Leases. These rent relief claims, both weighted and deferrals, totaled about $2.4 million for the same period. External valuations on 13 of the 23 properties within COF's portfolio, representing 55% by value were completed as at June 30, 2020. The remaining properties were subject to internal or direct revaluations. Combined, these valuations showed a marginal 1.1% decrease in portfolio value or $21.9 million compared to the previous book value. The decrease is primarily the result of the valuers adopting lower growth rates with increased downtime in incentives. The weighted average capitalization rate across the portfolio was broadly unchanged as recent sales transactions, though lower than ordinary volume, continue to indicate strong demand for quality office buildings. Where relevant, value was incorporated ongoing rent relief claims related to the National Code of Conduct on Commercial Leases within valuations. As discussed, COF benefits from Centuria being a hands-on proactive manager with in-house property and facilities management. To that extent, Centuria Property Services established a COVID-19 task force that meets daily to ensure business continuity and appropriate measures are in place across the COF portfolio, such as additional cleaning procedures and way-finding to support social distancing. Centuria Property Services and the COF management continue to focus on preparedness in a rapid response to challenges arising from COVID-19, providing safety and well-being to our tenants through greater tenant engagement. Thinking longer about the implications of COVID-19 on Slide 9. We believe COF will be well positioned to meet changing tenant demands that may be accelerated by the circumstances COVID-19 has presented. In the immediate term, the geographically diversified portfolio without single market concentration is a positive. It reduces the portfolio of risk of the market lockdown as currently evidenced in Melbourne. The other immediate benefit is COF's tenant profile with around 80% of income across the portfolio being generated from government, ASX-listed or multinational corporations. There is a common misconception that metropolitan and fringe markets have greater exposure to small- to medium-sized enterprises compared to CBD markets, with SMEs not only being more at risk in an economic downturn, but who currently qualify for rent relief under the National Code of Conduct on Commercial Leases. This is not the case. The greatest concentration of tenants of less than 1,000 square meters are in CBD markets, particularly Sydney and Melbourne, and their immediately adjoining markets of North Sydney and secured road. COF has no exposure to these markets. Over the medium term, we believe tenants will become more focused on health and cleanliness and a building's capacity to provide adequate social distancing, particularly in regards to its usage. As such, we believe there will be a preference towards newer generation office stock, which should benefit the COF portfolio as the average building age is around 16 years. Affordability will also become a key consideration over the medium term as economic circumstances force tenants to focus on their operating costs. Again, we believe COF is well placed as the portfolio provides consistently high-quality office accommodation at an affordable cost. COF's exposed markets average a discount of between 47% to 77% compared to the Sydney CBD market rents. Over the longer term, we believe that there will become a strong employee preference to work close to home. For some time, we said a key contributor to employee satisfaction is the length and quality of the commute to work. This thinking has certainly influenced our decision to acquire buildings in Chatswood, South Eveleigh and Fortitude Valley, all of which have excellent and improving connectivity. While there remains significant concern about the ongoing productivity related to working from home, there is almost universal acceptance that the most efficient thing in relation to working from home is reducing time lost commuting to the workplace. Consequently, we believe businesses will more actively seek hub-and-spoke and accommodation solutions, enabling staff to access workplaces close to home, providing reduced and more pleasant commuting. This workplace change will directly benefit metropolitan and fringe markets that COF is exposed to. Moving back to the FY '20 financial results on Slide 11. COF produced funds from operations of $85.4 million or $0.186 per unit and paid distributions of $0.178 per unit. Funds from operations were impacted by COVID-19 due to rent relief claims and other provisions. Combined, these items reduced funds from operations from $0.193 to $0.186 noting FY '20 guidance was $0.19 flat. Like-for-like portfolio revaluations throughout FY '20 of $23.3 million contributed to NTA of $2.49 per unit. During FY '20, the flattening swap curve adversely impacted the value of COF's interest rate swaps, reducing NTA by around $0.02 per unit. Turning to capital management on Slide 12. During the year, COF raised both debt and equity to fund the acquisition of 3 high-quality office assets to strengthen the balance sheet and further diversify its debt book. Around $460 million of equity was raised, which increased the market cap and further diversified the unitholder base. An additional $325 million of debt facilities were arranged to complement the equity raisings. As at 30 June 2020, COF had total debt facilities of $880 million, with approximately $131 million in undrawn debt. Included within these debt tranches is a new 7-year facility with Crédit Agricole, which further diversified the number of lenders to fund. The weighted average turn to maturity of 3.3 years was maintained. Importantly, COF has no debt tranche expiring until June 2022, providing debt certainty over the medium term. Gearing of 34.5% and hedging of 75.4% are within target levels. The interest cover ratio of 6.3x is well above the debt covenant of 2x. With sufficient undrawn debt, a very competitive all-in cost of debt of 2.2%, significant debt covenant headroom and a diversified debt maturity profile to 5 quality lenders, COF is well placed with a robust capital structure. Moving on to the portfolio on Slide 14. COF has a truly geographically diversified portfolio of 23 assets without single-market concentration and exposure to most of Australia's major office markets. So for those investors seeking access to Australian commercial property, COF is proving to be an attractive option due to its young portfolio age, geographic diversification, quality tenant profile and a distribution yield of 9%. Almost 80% of COF's portfolio income is derived from either Australian, federal or state government departments, listed companies or multinational corporations. As mentioned, the average building age across the portfolio is around 16 years, which further highlights the quality of the COF portfolio. Newer buildings generally have lower capital expenditure requirements, lower operating costs and tend to be more attractive to tenants, offering greater building efficiencies and generally better building immunity. Looking at the leasing story profile on Slide 15. Centuria continues to achieve strong leasing outcomes for COF, with over 10% of the portfolio leased during the year, maintaining high total portfolio occupancy of over 98%, while extending the WALE to 4.7 years. Around 60% of leases now expire at or beyond 2024. As a result of both leasing and acquisitions, the quality of tenant covenants also materially improved during the year. The Australian federal government is now COF's larger tenant, representing over 13% of portfolio income. While the Western Australian state government has increased to the second largest tenant at 4.6% of portfolio income. When all Australian federal and state government departments are combined, they generate over 25% of COF's portfolio income. This meets COF's stated objective of generating quality income returns. In June, Foxtel signed a deed of agreement to surrender its lease at 35 Robina Town Centre Drive, Robina which is in Queensland. Under this agreement, COF will receive a surrender payment during FY '21 equivalent to the rent payable under the remaining Foxtel lease term discounted to the present day. Existing subtenants representing 23.3% of the building's NLA will convert to direct leases. Turning to Slide 16. And the Foxtel lease surrender provides another opportunity to utilize Centuria's strong leasing capabilities to reposition the assets and minimize potential downtime. As noted earlier, one of the key benefits of Centuria's management is the strong capabilities of Centuria's in-house asset management team. With a dedicated leasing team, Centuria has consistently maintained high occupancy across all of its listed and unlisted platforms. Since COF listed in 2014, Centuria management has consistently leased a significant portion of the portfolio year in, year out, maintaining high levels of occupancy each and every year. Maintaining very high portfolio occupancy remains a key management focus, and we are actively seeking outcomes to address the upcoming expiries, particularly at Robina and 818 Bourke Street. Turning to portfolio valuations on Slide 17. Within the portfolio value increased to over $2 billion was a $23.3 million like-for-like increase in property value across the full year. As noted earlier, the 30 June valuation saw a 1.1% reduction to preceding book values. However, valuers have not changed capitalization rates as the recent transactional evidence continue to support prevailing cap rates. We believe this will continue as there appears to be sustained investor demand for quality commercial property, especially in this low interest rate environment. No doubt that the valuations completed as at 30 June, ongoing rent relief claims were accounted for where relevant and the independent valuation of Robina considered the property with the Foxtel surrender in place. Reflecting on how COF has evolved since listing in 2014 in Slide 19, and COF's portfolio has been clearly improved and positioned to meet changing tenant demand to deliver sustainable income streams. Between listing in June 30, 2020, a dramatic transition has occurred. The COF portfolio has not only substantially grown and diversified, but materially improved the quality of the underlying assets with the average age of building almost halving, while the proportion of income derived from government listed or multinational tenants almost doubling. The Centuria team worked hard to improve the COF portfolio by the repositioning of assets, such as 144 Stirling Street in Perth and 555 Coronation Drive in Brisbane and through asset acquisitions, such as Nishi in Canberra. As a result, the COF portfolio completes FY '20 in a much stronger position than the portfolio at IPO. Looking at the strategy on Slide 20. Our focus for COF throughout FY '20 and beyond will be to continue generating predictable and quality income streams. We seek to build Australia's leading office REIT, positioning it to meet changing tenant demands by providing high-quality and affordable office space. With the quality portfolio of robust and diversified capital structure and support from the wider Centuria business, we believe COF is well placed to continue delivering its strategic objectives. Looking ahead on Slide 21. COF entered FY '21 in a strong position, having completed FY '20, meeting many of its key objectives, maintaining high occupancy and delivering quality and sustainable income returns to its investors. While there is continued immediate uncertainty resulting from COVID-19, COF is well placed with the portfolio underpinned by high-quality tenants located in metropolitan and near-city locations that provide excellent connectivity, providing easy commutes for workers while delivering affordable rental levels. Our location and affordability resonates well with tenants at a time when operating costs are scrutinized and workforces' preferences show a trend towards working close to home. For these reasons, we believe that COF -- the COF portfolio will continue to provide attractive accommodations for tenants well into the future. For FY '21, we provide distribution guidance of $0.165 per unit, payable in equal quarterly installments. We note that the distribution guidance is slightly lower than distribution paid during FY '20 which reflects both the ongoing uncertainty arising from COVID-19 and the potential impact on business operating conditions and the desire to reduce the payout ratio during such periods of uncertainty. Notwithstanding a slight reduction, the distribution guidance translates to a very attractive current distribution yield of around 9%. In conclusion, I would like to thank COF unitholders for their continued support. We look forward to continue delivering value in the coming years. I will now hand back to the operator and invite you to ask any questions that you may have.

[Operator Instructions] Your first question today comes from the line of Tom Bodor from UBS.

Just wanted to kind of understand where you're at with the Bourke Street, Docklands asset, what the status of that lease -- where the leasings is at on that asset?

Sure. Thanks, Tom. So as many people would be aware, we first just have an upcoming lease expiry at 818 Bourke Street. They expire in November of this year. So that's 3 core floors, which represents about 10,500 square meters. So that space will be coming back to us. We are actively marketing that space for lease. Given the northern atmosphere, there has been some slowdown in interest on that space right at the moment. But this is something we're seeing universally across Australia at the moment. We are seeing probably greater leasing activity from large corporations and government style tenants than from the smaller and/or the broking style of leasing activities. So there is certainly activity in terms of looking at that space. But as we sit today, we have no formal agreements for a future tenant for that space.

Do you have a view around where the rents will be ought to be maintained there? Or is that sort of still too early to tell?

Well, yes, at this stage, and this is something again we're seeing nationally. The phased rents are remaining pretty static at this point in time. If anything, what we are seeing is there has been an increase in incentives across the majority of markets. Now it's not universal to changing incentives that are occurring. But Melbourne is coming off a very low base. So where incentives were, you're probably coming up to incentive levels that are now getting up over probably 30% in northern severance rounds.

Okay. And then the other one is just on the gearing. You're sort of sitting at sort of around that 35% mark, midpoint of -- sort of range, but it's just sort of a bit of a contrast to CRP that's sort of sitting below their range. Where do you sort of see that trending over sort of the next 12 months? Would you prefer to have it lower, given the uncertainty? Or are you kind of still comfortable in that mid-30% range?

Look, we're pretty comfortable with where gearing sits today. In terms of where we look at gearing, probably the 2 things that we consider most is our difference to where our debt covenant headroom is. So both on an LVR and on an ICR basis, we have significant headroom to withstand substantial valuation and income shocks. So from that perspective, we're pretty comfortable with where we sit today. And as mentioned during the call, we haven't seen dramatic change in valuations. I don't foresee that there will be dramatic changes in cap rates going forward, just given where the cost of capital and interest rates compare. And then from an income perspective, as mentioned during the call, with over 80% of our portfolio leased to very high-quality tenant covenants. I'm pretty comfortable with where our ICR sits in 6.3x against a 2x covenant.

Your next question comes from the line of Ronan Barratt from Moelis Australia.

Look, just firstly, I'm packing a couple more of these expiries. Just turning to Slide 16. Would you mind us commenting on Robina, 100 Brookes Street and Richmond Road, the next 3 largest after Docklands just in terms of your expectations for downtime and leasing spreads on that space? And also for 100 Brookes Street and Richmond Road, if you could just call out which month or quarter those expiries are occurring in?

Sure. So just working down the list starting with Robina. Robina is very fresh. The deal or the surrender with Foxtel happened very rapidly towards the end of June. So we're just getting into the marketing of that space now. Foxtel still have a lease out of that space until the end of August. Now in talking with leasing agents in that market, surprisingly, there is reasonable interest for the type of space that we have at Robina. As everyone is aware, a lot of more things are going online. So that is requiring a greater level of call center type operations. And the Gold Coast is a very good drawer of call center type staffing. So there has been a reasonable amount of interest from call center-type operations, looking at the Foxtel space, particularly given Foxtel operated or the operations at Robina were a call center setup. So there is an opportunity for tenants to utilize some of the existing fit-out that remains from Foxtel and then start call center type operations from that building. So I've been pleasantly surprised by the amount of interest we've had to date at Robina. Moving down the list, looking at 100 Brookes Street, the 3,500 or circa 3,500 square meters doesn't -- is an expiry that doesn't occur until June 2021. So we've still got virtually the full year to look at that space. Again, we are -- so what we're doing at 100 Brookes Street, we are seeking to lease that space at the moment, and we have got some reasonable amounts of interest. So I remain optimistic that we will have something done as we get closer to that. And then looking at Richmond Road, so that is an expiry to RDNS, the Royal District Nursing society. They have 2 full floors in that building that expires in February 2021. At this stage, we are reasonably optimistic that we will get a renewal from RDNS but they may ruling we should -- some of the space will contract it somewhat in size. So yes, I think we're -- across the portfolio, I'm reasonably optimistic by the levels of leasing activity that we've got within our portfolio. And hopefully, we'll be able to address these expiries as they come due.

Perfect. And then just lastly, on the rent collections, you mentioned throughout the presentation, they were revised up to 92% for the April to June period. Could you just comment on how you expect those to perform through this first quarter of F '21 and then your expectations for the balance of the financial year?

Yes. So as mentioned during the call, we -- the collections that we are disclosing here at 92%, the amount that is uncollected includes rent relief claims. So it's basically rent relief claims plus any reason to sit on top of that. For July, we're very consistent with that 92% range. Over the course of July, we've obviously improved from 89% to 92% to the following the third -- the preceding 3 months. So we would expect that the collections would continue to improve over time to get to circa that 95% range. I think the big test will be once we get past September and the national code pulled away and the rent relief claims dissipate. Across a lot of our portfolio, ex Melbourne, we are seeing those tenants that were seeking rent relief claims their activity is improving and the revenues improving. So we would be reasonably optimistic that once we get through that period, save for any potential further lockdowns, that tenants will be able to maintain their rental obligations, and we'll be able to get quite high rent collections going forward.

Your next question comes from the line of Andrew Dodds from Jefferies.

Well done on the great results. Most of my questions have been asked already. But just on the Foxtel lease surrender payment, if I may, we kind of estimate this to be around $11.8 million. Are you able to comment if this is ballpark and also how it's going to be treated in FY '21?

Yes. You're in the ballpark, Andrew, and it will be true as income come through FY '21.

Will it be taken below the line, though, or as a part of FFO?

Look, just the circumstances of what you're looking at is a prepayment arrangement will have to take as rental income, which will form part of FFO, and that's something that we will look at during the course of the year because, obviously, it will be an outlier from normal rent collections.

That's perfect. And then just lastly, on the cash flow. I noticed that you guys spent about just under $6 million to breaking hedges to lower the cost of debt. I mean, is this something you guys expect to keep on doing going forward?

No. Look, we made a call when we did this that we thought -- and it's been advantageous, obviously, given the falling swap curve. If we hadn't done it, it would have been much greater impact to NTA. So at the stage that we did it, we were quite highly hedged. We sought to reduce our hedging profile. And given the circumstances that has come since then, I'm glad we did.

There are no further questions from the phone at this time. I'd like to hand the conference back to today's presenter. Please continue.

Look, if that's all the questions that we have. I thank you for your time today. If there is anyone on the call that hasn't had a one-on-one meeting arranged, please feel free to reach out to me or any of the Centuria staff, and we'll get a time arranged to come via video conference or via other means, via call to have a chat about the COF FY '20 results. But otherwise, thank you, and have a good day.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.