Charter Hall Group (CHC) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by, and welcome to Charter Hall Group 2020 Half Year Results Briefing. [Operator Instructions] Please note that this conference is being recorded today, Wednesday, the 19th of February 2020. I'd now like to hand the conference over to your host today, Mr. David Harrison, Managing Director and Group CEO. Thank you, sir. Please go ahead.

Good afternoon, and welcome to the Charter Hall Group 2020 Half Year Results presentation, marking our 29th half year result as a listed A-REIT. I'm David Harrison, Managing Director and Group CEO of Charter Hall. Presenting with me today is Sean McMahon, our CIO; and Russell Proutt, our CFO. Now turning to Slide 4 and the group highlights. The momentum over the last 5 years has certainly continued into the first half of FY '20 with strong contributions from all our segments. Operating earnings post tax for the period was $226 million or $0.485 per security, up 110% on the previous corresponding period. The total platform return or the gain in net tangible assets plus distributions was 23.5% for the year ending 31 December, continuing our leading sector return on contributed equity, something we continually focus on to deliver for our security holders. The property investment portfolio also delivered a strong 12.5% property return for the 12 months ending 31 December. The group's property investment portfolio has now grown to $2.1 billion, up 13.5% since June and provides both an attractive absolute and relative 6.1% PI yield. Funds under management grew strongly during the period, up $8.5 billion or 27.9% during the half to now stand at $38.9 billion, reflecting continued focus on partnering with our tenant and investor customers, delivering positive outcomes for them, which ultimately translates into attractive returns for security holders. That growth saw us undertake $6.3 billion of gross transactions as we continue to actively curate our portfolios to drive performance via acquisitions, divestments and developments. The group's balance sheet remains modestly geared, while the NTA has grown strongly, up 12.1% in the period. Finally, the group's investment capacity of equity and undrawn debt remains at $4.1 billion across the platform, unchanged since June despite strong deployment of capital, which reflects our capacity to replenish equity capacity via equity raisings across all sources. Our focus remains on delivering sustainable growth for security holders, replenishing dry powder, strengthening resilience and a vigilant focus on property fundamentals. Now turning to Slide 5 and our strategy. The group's strategy of using our property expertise to create value and generate superior returns for our customers remains unchanged. Access, deploy, manage and invest has not changed for 10 years as we execute upon these strategic pillars. We raised $3 billion of gross equity during the 6-month period. All sources delivered strong net inflows, but it's worth calling out that it was a record 6-month period for our direct business. Of the $6.3 billion of gross transactions during the period, we acquired $5.7 billion of assets and divested a further $600 million. Our focus remains on ensuring we manage portfolios to preserve capital and drive resilient income returns, optimizing the earnings growth from the assets we manage. Finally, we continue to focus on investing alongside our capital partners. The CHC Property Investment, or PI, portfolio grew $250 million and delivered a 12.5% return for the calendar year. Slide 6 highlights pre- and post-OEPS growth but we also highlight growth ex the CHOT performance fee, which has been a fantastic partnership for both our partners and CHC, delivering our near 20% IRR since inception over 8 years ago, giving CHC a 20% share of outperformance above the hurdle of 11.7%. We continue to show pre- and post-tax OEPS growth to highlight the considerable growth in franked dividends provided to our security holders. Importantly, as you can see in the chart on the right, even when we allow for the impact of the CHOT performance fee and adjusted for both periods, we have delivered strong EPS CAGR. We will now turn to Slide 8 where I summarize activity in the group's funds management platform, and then Sean will summarize the PI portfolio metrics. We remain well diversified by equity source and by sector. The PFM platform comprises over 1,100 properties, generates rental income from over 4,000 tenancies and delivers more than $2 billion per annum of net rental income. We continue to focus on delivering a sustainable and resilient returns through property sector diversity with a focus on long WALE properties and funds, something that is evident when you see that our WALE has increased to 8.9 years. The weighted average cap rate across the platform termed to 5.32%, reflecting the quality of our core portfolio with long-weighted average lease terms and fixed rental increases across the majority of the portfolio. Turning to Slide 9 and our fund growth split by sources of equity. As previously mentioned, we've been active in both acquiring and divesting assets during the period. Developments are an increasingly meaningful contributor to our fund growth with $900 million contribution during the 6-month period and a growing pipeline. Our focus on driving total returns has seen net valuations also lift significantly during the period, equal to previous full year net valuation growth, given the growth in funds under management, value created via developments and continued net valuation growth, predominantly driven by income, with continued support from cap rate compression in office and industrial and long WALE retail portfolios. Shopping center retail continues to deliver income growth and stable cap rates. As indicated in the growth on the right-hand side of the slide, we have seen a compound annual growth rate of 26% in funds under management since June 2015. Our growing scale provides a multitude of scale benefits, including escalating base fee revenue, increased development opportunities, growing leasing activity and resultant fee revenue, escalating multi-lease and sale and leaseback transactions with major corporate and government tenants. Our reputation as Australia's leading sale and leaseback specialist has continued to provide off-market opportunities like the $1.84 billion BP portfolio transaction announced in December. Turning to Slide 10. Previous period strong equity flows have seen us active in deploying proceeds into developing or buying new assets, whilst our capacity to match new transactions with new equity quickly was demonstrated with large transactions such as the BP portfolio; the $1.43 billion Telstra exchange portfolio; the $830 million 242 Exhibition Street Melbourne office acquisition, which is the Telstra global headquarters secured off-market; and our largest single asset now is Chifley Tower. They are close to $2 billion, where we continue to actively manage the tenancy rent roll but also looking to add value from other expansion opportunities in the asset. We've taken the opportunity to sell and divest non-core assets, where such recycling enhances portfolio returns, as evidenced by one of our highest-volume divestment programs in the last 6 months. Active asset management is an integral part of our business. All our sectors have been busy, but we continue to be very focused on long-WALE assets, which preserve and grow capital value while delivering consistent ongoing income streams. We continue to see opportunities to transact favorably for our investors, given our broad reach into transaction markets, both on- and off-market. Importantly, our strong tenant relationships continue to provide us with access to off-market transaction opportunities, which are mutually beneficial to our customers and ourselves. Repeat customer transactions are a healthy sign of delivering on our customer-centric objectives, many of which reflect our capacity to deal with customers in multiple sectors. So let's just look at our development management activity on Slide 11. The group continues to progress various developments across the portfolio, creating investment-grade properties and adding significant value through enhancing both income yield and total returns. Notwithstanding completions, our total development pipeline has grown to $6.8 billion, up from $6.5 billion in June and up from $3.5 billion 3 years ago. Our industrial pipeline continues to grow and reflects our position as the second-largest logistics and industrial line in Australia, and it will exceed $10 billion of funds under management post completion of committed developments. The forward pipeline of committed projects will generate high-quality, long lease assets for our funds and partnerships while providing attractive incremental fund growth for CHC and enhancing our credentials to attract capital. Turning to Slide 12 and our equity flows. 12 funds across the platform generated net inflows during the half to secure our highest half year inflows to date. Our strategy of accessing multiple sources of capital continues to deliver growth in all segments. Within our unlisted wholesale funds, we've raised $450 million across our pooled funds, our office and industrial funds, CPOF and CPIF. Our unlisted partnerships have been very active with newly created partnerships for the -- during the 6 months for 201 Elizabeth Street, Sydney; Chifley Tower; the 242 Exhibition Street Melbourne Complex; and of course, the Telstra Exchange Trust. And in the listed space, CLW raised $863 million during the period, participated in the Telstra Exchange and 242 Exhibition Street acquisitions and, together with CQR, partnered with CHC to close the BP portfolio acquisition. Finally, as I previously mentioned, our direct businesses enjoyed a record 6-month period of inflows and continues to enjoy strong support from investors, given the exceptional performance of the funds, consistent high-quality portfolio curation and multiple offerings to cater for investor demand. We currently have 5 direct funds open for investment, while we have also delivered excellent 21% IRR realized returns for one of our single-asset syndicates during the last 6-month period. Turning to Slide 13, our leasing activity. This slide details our leasing activity across 4 sectors over the last 12 months. Importantly, it demonstrates our reach within the sectors we operate in. We often lease to the same tenant in multiple sectors, and our ability to partner with our tenants and meet their entire property needs sets us apart from many of our peers. Importantly, you can also see the value this adds to our assets, driving returns for our investor customers. Our focus on active asset management and partnering with our tenant customers delivers great outcomes for our investors and Charter Hall security holders. I'll now hand over to Sean McMahon, our Chief Investment Officer.

Thanks, David, and good afternoon, everyone. As David has discussed, our property investment portfolio provides a strong alignment of interest with our investor customers while also ensuring that security holders benefit from our property expertise. Over the period, our investments have grown to $2.1 billion. Occupancy is broadly stable, and pleasingly, the portfolio WALE has increased to 8.9 years as a consequence of active asset management and new investment activity. Our weighted average rent review remained strong at 3.5%, and the weighted average cap rate has firmed at 5.32%, reflecting the quality of the assets we've invested in. The portfolio remains well diversified across sectors and by investment with an 82% weighting to the core East Coast markets. The growth in the property investment portfolio reflects the group's desire to continue to invest alongside our investor customers and ensure a strong alignment of interest. Now turning to the property investment portfolio movement. During the period, our investment property portfolio grew to $2.1 billion, driven by $151 million of new net investments and $97 million of revaluations. Our ability to recycle capital to support new fund initiatives and drive returns for security holders is an important part of the success of the group. The chart on the right-hand side shows the growth of our total property investment. Whilst the PI yield has fallen in line with cap rates, the significant improvement in the quality and composition of several funds has contributed to this fall in portfolio cap rates and the resultant PI yield. Now please turn to Slide 17 and our earnings resilience. And as can be seen in the 3 charts on this page, our property investment earnings are characterized by the high quality of the tenants that provide the income; the diversity of sectors which produce them; and the lack of concentration risk or single-asset exposure in deriving them. With our largest single-asset exposure being 1.2% of the group's balance sheet property investment portfolio and our top 10 assets only representing 6.1% of net income generated, the CHC PI portfolio can be considered a very defensive, well-diversified core investment portfolio. And more broadly, across the platform, we enjoy strong tenant customer relationships where we have a genuine interest in our tenant customers and look to partner with them to meet their property needs. These relationships often span asset sectors and multiple properties. 78% of our tenant customers lease more than one tenancy from us. This also drives tenant retention with 81% of tenants re-leasing with us during the 6-month period. Naturally, it also feeds back into transactions with our significant sale and leaseback activity providing off-market opportunities to also grow our funds. These transactions occur as a result of our ongoing focus on our tenant customers. And importantly, this also benefits Charter Hall shareholders by producing earnings resilience across our property investment portfolio. Now let's turn to ESG on Slide 18. Sustainability, community and governance are embedded in everything we do at Charter Hall. Charter Hall already has the largest Green Star-rated portfolio in the country. However, we continue to look for opportunities to improve. We have now set a target of net 0 emissions across the assets we have operational control over by 2030. In addition, we will work with our tenant customers and contractors to help them reduce their emissions. We're also putting in place climate change adoption plans across our portfolio, and our work on solar rollout continues with 6.9 megawatts of solar PV installed across our assets, up an additional 1.7 megawatts in this period, generating the equivalent of enough power for 314 homes. We are very conscious of our place in the communities we operate in. We've been active in providing funding for bushfire relief, and we helped distribute 27 semi-trailers worth of hay and 50 truckloads of water for drought relief. We also remain committed to engaging with the communities in which we operate, donating staff, time and resources in support of the initiatives that are of benefit to those in need and that directly benefit the communities in which we operate through our Pledge 1% commitment. Finally, we continue to focus on ensuring we operate with the highest level of governance, recognizing our responsibilities to our investors and the community. We are working on aligning to TCFD reporting and have helped pilot the Property Council's prequalification supplier platform to assess and address human rights issues and modern slavery risks in our supply chains. I'll now hand over to Russell to provide details on the financial result.

Thank you, Sean, and good afternoon. As David and Sean have outlined, the business has experienced significant growth in the first half of 2020. This growth has supported the group's strong financial performance reported today. For the half, total EBITDA for the business reached approximately $300 million. Increases in EBITDA occurred across all reported segments of the business. And as shown, the Property Funds Management segment was the largest contributor with first half EBITDA of about $228 million, representing about 3/4 of total EBITDA. On the following slide, I will discuss this segment in greater detail. The group's operating earnings per security is $0.485 per security and, excluding the impact of CHOT, is $0.331. In December, the group announced distribution for the first half of $0.175, which was a 6% increase to the prior comparable period. This is consistent with our prior guidance regarding distributions. Included in this distribution is also $0.03 per security of franking credits. And with a payout ratio of 36%, the business will actively seek to invest undistributed earnings to support further growth in line with our strategy. Now turning to Slide 21 and a review of the Property Funds Management segment in greater detail. As reflected in the table, investment management revenue drove the segment's performance. At nearly 40%, the growth in fund management fees was very strong and reflective of the growth in funds under management. We consider these fees to be highly resilient and a central baseline revenue for the business. In regards to transaction performance fees, as we've noted, the combination of the CHOT performance fee of which $98 million is recognized in the half, and a very active half year of transactions has resulted in an increase of approximately 2.5x that of the first half of last year, which was also a very active period for the business. Now in regards to property services revenue, there is also increases across all revenue streams, which reflects an expanded and active property portfolio. Now with respect to costs, there were increases in PFM and corporate costs, and there's really 2 key factors to attribute to this increase, the first of which is really the share growth of the business and the need to ensure we scale our operations to meet the needs of our investor and tenant customers. However, we do this with a focus on expanding margins and gaining scale efficiencies to drive our return on capital employed. The second factor contributing to growth in costs is that the prior comparable period only had 2 months related to the Folkestone acquisition in those costs and, in this period, had a full half year of costs. The EBITDA margin of 79% is very strong. However, it is elevated by transaction and performance fees for the period. One profitability metric I would highlight is the relationship between the fund management fees and the total PFM expenses, which, at 120%, continues to improve and reflects the operating leverage of the business model. Now moving forward to Slide 22. We have provided a financial bridge of operating earnings to operating cash flow and a comparison to the distributed earnings for the period. The most significant item in the bridge is the change in working capital, which is mostly attributable to the increased accrual of the CHOT performance fee, and this fee will be paid in April. Importantly, there was 120% coverage of the distribution by operating cash flow in the period. Now moving forward to Slide 23 and group balance sheet and return metrics. And as shown, the composition of the balance sheet is largely consistent with the balance sheet reported at year-end. I would highlight that we are continuing to consolidate one of our direct funds known as DCSF, which does impact some of the line items, including other assets and borrowings, and this is referenced further in the footnotes. In terms of borrowings, the composition of the group's capital structure at headstock remained unchanged. There are approximately $230 million of bonds and $200 million bank facility maturing in 2028 and 2024, respectively. At the reporting date, the group's balance sheet gearing was 9%, and recently, the group's Baa1 rating with Moody's was reaffirmed. As a result of retained earnings and revaluation gains during the period, the group's NTA per security increased by 12% to $4.37. And as shown in the Return Metrics section of the table, the business continues to generate very strong returns on invested capital on a pre- and post-tax basis as well as at a security holder and at the property investment levels. And finally, I'll speak to the group-wide funding profile and capacity on Slide 24. As mentioned earlier, in a very active investment period, the group has been able to maintain its $4.1 billion of investment capacity. And as the business has grown, so has our available total borrowings. These have been increased by $3.5 billion with nearly $16 billion of total limits in place at 31 December. The business remains very active and focused on managing structure, pricing and duration of all borrowings and has been successful in completing one $6 billion of new and refinanced debt facilities in the half while achieving a lower cost of debt now at 3% and extending average debt maturity to 4.5 years. Interest rate risk and hedging continues to be managed in line with the treasury policy of our funds and partnerships. As you see, it continues to be easily hedged across the book. The graphic on the lower-right side of the slide illustrates the total facilities by sector, differentiated by drawn and available funds. All sectors have sufficient funding capacity to support their operations and continued growth. And now I'd like to hand over to David to speak to our outlook and guidance for fiscal 2020.

Thanks, Russell. Just before I address the guidance, I did want to make a statement about the terrible impacts of not just the bushfires that we've experienced in the last few months but also the ongoing impacts of the drought, which, whilst there's been relief in recent times, we're very aware of the impact that many of the communities in which we operate have had and have suffered for quite some time. So you're well aware that we have been a member of the 1% Pledge movement for some years where we donate 1% of our funds management earnings in the form of accommodation, cash and staff commitment of their time. Additionally, we've invested in support for the bushfire victims, rural fire services and a variety of different causes such as Rural Aid for supporting the communities in which many of our properties operate and many of our teams, particularly in regionally located shopping centers, operate. So it is top of mind for us, and like the rest of the community, we're pretty focused on helping out wherever we can. So just moving to our guidance. The group's previous FY '20 guidance for growth in post-tax operating earnings was approximately 30% over FY '19. Based on no material change in current market conditions and reflecting recent valuations, updated performance expectations and transactional activity, we are, today, upgrading our earnings guidance to approximately 40% OEPS growth in post-tax operating earnings per security over FY '19. The FY '20 guidance includes $98 million for the CHOT performance fee, which, in addition to the $50 million recognized in FY '19, will generate $148 million cash payment in April 2020. When the impact of the CHOT performance fee is removed from both FY '19 and FY '20 earnings guidance, this implies post-tax OEPS growth of approximately 30% over FY '19. FY '20 distribution per security guidance is for 6% growth over FY '19. So that completes our formal section of the results, and we'll open the line for any questions.

[Operator Instructions] Our first question comes from David Lloyd from Citi.

Congratulations on a pretty strong first half result. Russell, just a quick one for you. I just want to hone in on the funds management margin, if I could. I know you called out the performance fee was -- you're finding it at 79%. But if we take out the [ 98 ] from the revenue and the EBITDA, that would suggest that the EBITDA margin is around 69% and it's quite a step-up and somewhat consistent, I think, with your comments around fund management fee and property fund management fee expense being at [ 64 ]. So where I'm getting at, has the business now reached the size and the scale where you sort of hit that inflection point on margins, and we could expect this higher level of margin going forward for this part of the business?

Look, there's definitely benefits with scale. So we'd expect our margins to expand as we expand our business but also in the composition of how we're growing our business, where we tend to focus on lower-intensity property investments and portfolios, so that the operating leverage we get out of it does also enhance margins. I'm not going to comment specifically on your calculation because I haven't done that exact calculation, but I presume it's right, but we should continue to benefit from strong margins if we continue to execute against this strategy.

All right. So I suppose taking my 65%-ish-type EBITDA margins on funds management should be -- if the environment continues to be the way it is at the moment should be sustainable for the near term?

Yes, let me check up on the last...

3-year average is 52%, and it really feels like it's just really sort of legged up. And I suppose it's going to be quite material for the outer years as we try to forecast the earnings.

From a management perspective, we really look at what our recurring annuity profile looks like. And I personally actually take transaction and performance fees out initially and look at what is our core business's margins and then overlay on top of that what our equity flows is supporting from a transaction activity perspective, but I think we get to the same answer.