Charter Hall Group (CHC) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by, and welcome to the Charter Hall Group Market Update. [Operator Instructions] Please note that this conference is being recorded today, Thursday, 14th of May, 2020. I would now like to hand the conference over to your host today, Mr. David Harrison, Managing Director and Group CEO. Please go ahead.

Good afternoon, everyone. It's David Harrison speaking, Group MD and CEO of Charter Hall Group. We have our group CFO, Russell Proutt; and Head of Listed IR, Phil Cheetham, on the line. What we thought we'd do is following this morning's market update announcement, is to provide a summary of the update. A few comments on market activity as it relates to Charter Hall Group. And then obviously, we'll take questions after that. In line with what's practically been a consistent way we presented our business for nearly 10 years, we provided a summary update of the strategic pillars of our business, which is accessing capital deployment through develop the core strategies and transactions, going through the managed component of what's now just on a $40 billion portfolio. Obviously, topical at the moment the transactions and the impact of the commercial code with SME tenants, and then we'll provide some commentary around our balance sheet portfolio and some comments around the outlook. So as an opening summary for year-to-date in FY '20, we've announced $4.6 billion of equity flows. That continues the momentum of previous years. Obviously, the first half of FY '20 was a significant year or 6 months for Charter Hall Group in both equity flows and transactions. Pleasingly, the equity flows have continued throughout the various segments of our business. I'll just remind everyone, about 65% of our funds under management. Wholesale split roughly 45%, 55% between pooled funds, a large sector-leading office portfolio in CPOF and similarly, a large sector-leading return portfolio and CPIF in industrial and logistics. We also have -- whilst the flows in wholesale partnerships have been a little more subdued, we expect that to be somewhat reversed in the balance of this first half with strong institutional interest from our existing customers. Obviously, year-to-date, transactions of $7.1 billion, $39.2 billion of funds under management, which for year-to-date in financial year '20 is an $8.8 billion growth in our funds. Importantly, I'll talk about it in a little more detail. We've continued the strong momentum of both development completions, increased our pre-leased development commitments in industrial and office and significantly increased the scale of the uncommitted development pipeline to now have a total development pipeline of $7.3 billion, which is over and above the $1 billion of completions we've announced. That gives us with the equity flows and the subdued nature of further acquisitions in the first part of calendar year '20, we're sitting on $5 billion of investment capacity with around $2 billion of that in cash, which more than funds our future development commitments, balance sheet gearing at 0 and luxury gearing at 28.7%. Importantly, given it's a rare commodity in the world of listed stocks these days, we have reaffirmed our earnings guidance for FY '20 of approximately 40% growth over FY '19. If you look at the next slide, in terms of access, that just gives you more granular detail of what I've talked about. I'll start from the bottom, the direct funds or the soft managed super. Retail equity flows have continued into the second half. We've been very pleased with the growth of that business. It's by far the market leader at more than 2x any of the competitors in that space, and that's been very pleasing to see those open for investment funds of 2 office funds and an industrial fund and a smaller consumer stable fund, continue to get strong support from our direct investors as self-managed super funds and importantly, our very large network of financial advisers and wealth advisers that support that business. You're all aware, we've done 2 recent listed equity raisings in CQR and CQE. CQR followed the February equity raising to increase their stake in a BP partnership. And as I said earlier, the wholesale pooled funds have continued to see strong allotments of equity, and we are expecting to see that continue with a recent launch of an equity raising in our industrial fund, which we think will be well supported by both existing and new investors. On the deployment side, as I mentioned earlier, we really see this split between development, where we're funding pre-leased developments in our funds and partnerships. As you can see we've significantly increased our volume of rolling 12-month completions. Committed projects have grown to around $3 billion. Some notable recent announcements that weren't on the ASX, but certainly have been media announcements, 2 15-year pre-leases to Kohl's. For the rollout of their online distribution facilities in Sydney and Melbourne, which will continue to support their growth in online retailing as a fantastic omnichannel retailer. And more recently, we've just announced further industrial pre-leases in Melbourne to Bridgestone, Uniqlo and obviously, Toll for the Mars contract. And importantly, we have, in those industrial funds and partnerships, been able to replenish with further site acquisitions that will, particularly in Melbourne and Sydney that will provide scope in very low vacancy markets to continue that develop to core strategy. Obviously, in the industrial -- sorry, in the office market we would in the next couple of weeks, reached practical completion on the Wesley Place 60,000 square meter premium grade office tower in Melbourne. Pleasingly, the team did a fantastic job in getting 100% of that project pre-leased 12 months from completion through the likes of Aussie Super, Telstra Super, Cbus Super, [ ADCO ], the Commonwealth government tenant and Vanguard in the United Church. So a fantastic tenant roster and in a while of nearly 11 years for a new premium grade project and to have the team and our construction partner did that -- completed through COVID has been a fantastic effort. You also would have seen an announcement that our flagship office on CPOF secured development approval from both Council and the state government in Victoria for a new twin office project at 555 Collin Street and the corner of Collins and King Street, which on completion of the 2 towers, a $1.5 billion new premium grade project. We're in the advanced stages of negotiating with tenants on that project, and we'll look forward to getting an appropriate level of precommitment before we kick that project off. We have a couple of other office projects in the Western Sydney. At Parramatta and Westmead that are also under construction with significant precommitment levels. And they will proceed through over the next 12 to 18 months in that committed project and then obviously rolled into completions. Obviously, on the transaction side, we had a very busy 6 months. And whilst we've chosen to sit out of the market the last few months, there are expectations, particularly in long lease in industrial and logistics that we'll continue to see deployment into Long WALE, high-quality assets over the coming months. Just moving to the managed section of the debt. I think we quite often like to point out that the last few months have highlighted the need for diversification. I think we've got a very well diversified group portfolio and balance sheet portfolio, high quality office, industrial and logistics. We've obviously grown a segment, which we call diversified and Long WALE, which clearly CLW sits into that, and that's now a significant part of our portfolio at around 20%. As you can see from the funds under management, all segments of the equity sources from unlisted wholesale partnerships and pooled funds, the listed REITs we manage and of course, the Charter Hall direct business have contributed at plus or minus 1% or 2% to that consistent 24% from CAGR since June 15 in our funds under management. Very topical at the moment, over 50% of our portfolio is being independently revalued in the last 4 or 5 weeks. You can see there that on average, our office valuations have moved down by negative 0.5%. Industrial and logistics, up 0.7%. Our Long WALE assets increased in value by just over 0.5% with, frankly, the standout being our Bunnings portfolio being recently independently revalued, up 3% from December. I think the other thing that is important is that despite the health crisis we're dealing with and the obvious economic impacts of that, I would say that whilst we're very pleased with the initiatives that state governments and councils are implementing to fast track projects, I think the outlook for new supply is going to be constrained. I really do see a lot less potential developers starting projects, A, without funding and B, without significant levels of pre-leasing. One of the reasons why the Australian logistics market is seen so favorably by international capital is the fact that we virtually have a pre-leased supply of new industrial in this country compared to many other markets in the world where there are much higher speculative built proportion, the vast majority of industrial new construction in this country is pre-leased, and we're certainly maintaining that discipline to move forward with pre-leased projects rather than taking on any speculative development. The other thing I just thought I would point out is that we've also provided not only a sort of diversification of our equity sources, but we've also provided a slide on our balance sheet. As those of you who know, the Charter Hall business model is very much focused on our balance sheet being used to co-invest with our investor partners across all of the funds, the listed REITS, the unlisted wholesale funds and unlisted direct funds. That's an important element of the earnings stream that we're able to deliver for our shareholders. And as you can see from that slide, we've given the market an indication as to the percentage of our total tenant roster that is generated from SMEs relatively low at around 10%. And important to note that many of the SMES, even though they may be defined as SMEs under the code, are actually experiencing good trading conditions, and we've got very low exposure to SMEs and very low exposure to qualifying SMEs, where the turnover has been impacted in industrial and office. And as Greg Chubb from CQR has articulated, in relation to convenience retail, obviously, there would be higher percentages in shopping center retail, but the REIT of the shopping center retail that Charter Hall is invested in is more defensive and very convenient based with this strong percentage from anchor income and a strong percentage of retailers that have still been trading, and I think we'll come through this crisis in reasonably good shape. But we're not oblivious to the fact that some of our retailers have not been able to trade either by government restrictions or have chosen not to, but we still have a relatively low percentage of retailers that haven't been open for trade. You can also see by the composition of our tenant income, we've got a very strong percentage to government and blue-chip covenants and tenants that are prospering or faring reasonably well during this health crisis. I think the last thing I'd say on our balance sheet is that by REIT standards, it's a relatively Long WALE. We are very focused on tenant quality. We still have average fixed rental escalators of around 3.5% across the whole group platform, which I think will hold us in good stead going forward. Just moving to the outlook. Clearly, we're all aware that COVID-19 is having significant impacts on the economy, and we've been actively involved with Property Council of Australia and Shopping Center of Council Australia in working with government, both in the lead up to the announcement of the National Cabinet Commercial Code and then importantly, through the implementation phase. As state legislation has come out, we're very focused on sustaining our tenant customers through this period, and we will continue to be working with those customers to get to a position where they're in the best possible shape to trade through and then trade into what ultimately will be a recovery phase. The other thing I'd just say is that the business is in a very solid position in terms of liquidity at both a balance sheet level and across the funds management platform. As I said earlier, we're reaffirming our earnings guidance, and not just earnings, but also the previously stated for some years, distribution per security guidance of 6% growth. So I think that might wrap it up in terms of my formal remarks, and we might just open it up to the line for questions. And as I said, both myself and our CFO, Russell Proutt, are available to take any questions.

[Operator Instructions] Our first question comes from Stuart McLean with Macquarie.

First question is just on transactions. You made a comment that you chose to sit out of the market. $410 million liquidity [indiscernible] for Charter Hall, $5 billion liquidity in the platform. Was that assuming that you sit out of the market? And the follow-on on transactions as well. Is there any issues at all with the travel restrictions in terms of DD, particularly from offshore co-investments?

Stuart, the first part of your question is no, there are opportunities that we had. We either had deals in due diligence that we've chosen to just extend or sit out for the time being. I think things are becoming far more visible. As I mentioned, we managed to still secure a number of major pre-leases during this period. My personal view is that you're going to see a pretty strong volume of industrial transactions announced in the next couple of months. There's no doubt there's strong demand out there, both domestic and offshore capital, a lot of offshore capital, which we've seen for some years, frankly, is choosing to partner with local managers that have got the skills to access and complete due diligence. Property inspections are happening. There have been some examples of virtual due diligence tools that we've seen as an innovation. But I think the majority of property transactions are still being conducted and physical inspections are taking place. So to -- specifically to your question about offshore, there is no doubt that offshore capital that wishes to invest directly and not via a partnership or a local manager, you're going to find it very difficult. That's created opportunities for us. There's less competition than they would otherwise have been for some very good, high-quality assets and portfolios. So I'm not afraid to take advantage of that opportunity. And I think the other thing that's naturally happened is any vendors that had intended to put their assets on the market have put it on hold. So it's not just a matter of demand. It's about what is available for sales. And I think a lot of assets that were going to be put on the market have been sort of deferred into the September quarter. So I think the second half of this year, you will see a bit of a surge in activity. Firstly, I think you're not going to see a slowdown in the volume of industrial transactions. In fact, probably a couple of more active agents this morning. I think the volume of industrial transactions in calendar year 2020 will exceed what was already a pretty strong year in 2019.

And another question just on the equity raising. Maybe at the wholesale space. Your conversations there, has it been around in that the manager thing is to look at the balance sheet? Or is it more growth against the major going to the funds and saying, lets raise some capital to grow here and take advantage of opportunities, or they're coming to you at the moment? Just talk to the dynamics in that conversation with the wholesale partners?

Well, in wholesale, unlisted fund is 100% of that growth. The average gearing in wholesale funds in this country is about 10% to 15%. And even in our own funds in CPOF and CPIF, which have got a gearing target of up to 30%, we've been averaging 15% to 25% for some years. So I'm not aware of any equity raisings taking place in wholesale funds for sort of shoring up the balance sheet because they've generally been very early geared. Now that's in office and industrial. I don't profess that they're an expert in regional mall wholesale funds. They may have a different set of circumstances. But I think it's fair to say that there's wholesale capital available for growth initiatives that are going to diversify the quality of portfolios and enhance long-term returns. And when you're investing in a wholesale fund that you may not have a liquidity window for 7 or 10 years, you're looking through the current volatility and looking to get set in a low-vol, long-term investment proposition. So they take a much longer-term view. And without stating the obvious, we've got bond yields have fallen. The expectation of average bond yields over the next 5 years have definitely fallen from where it would have been 3 or 4 months ago. So the risk premium to good quality real estate relative to bond yields has risen. And as I said earlier, a great complement to the Australian property markets, particularly Sydney, Melbourne, office and industrial is the fact that there's quite a lot of offshore capital wanting to deploy into those markets. These are people who don't have to invest in Australia. They can invest in any market in the world. So the fact that they're telling us, and I'm sure they're telling other managers out there in the space that Australia looks like on a relative basis, an attractive place to invest tells you a lot about the fact that we've come into this crisis with some of the lowest vacancy rates I've ever seen in my career in industrial and in office in Sydney and Melbourne. So there's quite a buffer for vacancy rates to rise back to decade-long type averages, and that's one of the reasons why you're continuing to see that offshore interest in Australia.

A final one. You mentioned liquidity windows, and you've got one in FY '21. Were there any conversations here in regards to redemption? Can you give an update there?

No, I haven't had a conversation with anyone about redemptions. As we did in 2019, when CPIF had its liquidity window, we would typically run an equity raising simultaneous with that liquidity option. I don't expect there to be too much in the way of sort of net outflows, as we've done with every other liquidity window. I think you'll see us have seeing many more inflows than any sort of redemption demand, but at this stage, haven't had any conversations with office invested in CPOF about the liquidity window in FY '21.

The next question is with Sholto Maconochie with Jefferies.

Just a couple from me. You've seen -- we talked about flows in Australia. You've seen some sort of safe redemptions and canceled projects in office, particularly. Have you seen any pullback from some of the local super investors facing redemptions from the early access of super? And can you talk about that? And also, what's the typical mix of offshore/onshore pensions of Super money?

We're a bit over 50% offshore. It's about 52% 48% across the 2 pooled funds, CPOF and CPIF across the whole wholesale business, including partnerships, it's probably roughly 60% offshore, 40% domestic. And to answer your first question, we've had no talk of redemptions, not that they can get them or desire for liquidity from our funds from Aussie Super funds. The first thing that typically happens in an environment like this is that in the wholesale space, you have voluntary DRPs. And every quarter, an investor can choose whether they keep participating in the DRP or not. As you'd expect, a lot of the Aussie Super funds have decided to turn off their voluntary participation in the DRP. And yes, really, that's the only change I've seen.

Okay. Great. And then on your, the -- you mentioned that you obviously you set an outlook for new supply is constrained. But obviously, funding for the smaller players for pre-leasing. If you look at the pipeline. You've got an almost 80% uncommitted in office. Does that just get pushed back until people are more confident with the leasing market? And the reason I ask is that there are 2 cans on probably in the more positive, the increased social distancing means you can't give back as much space as you otherwise would in a different market, and we did come in stronger. So the 2 could offset each other with also increase retention. But what's your view on that office development cycle given that it's quite large? Do you think that gets pushed back? Or can you give some comment around that?

Look, Sholto, if you look at our uncommitted office pipeline, the 555 Collins and 55 King Street twin tower projects, a big chunk of that. As I said, you've got a sort of 50,000 meter DA approved corner building. We won't go ahead with that without a 50% plus precommitment level. I'll remind everyone, we started at 38% precommitment on Wesley and added 100% pre-leased 12 months from completion. So for the right projects with good floor plates, good light, good locations in Collins Street, Melbourne is probably as good as you get. I think there will be strong tenant demand. I think one of the things that this crisis has elevated in the minds of all occupants is the need to have really good modern premises for their people, high-technology component. So ironically, I think there'll be more tenant demand to go to the state of the art office buildings rather than what I call 30 or 40-year-old clunkers, which I won't name, but we all know what we're talking about, half of you're probably working them. So I think we're probably going to see more supply-constrained, where there's a lack of funding, lack of appetite and much higher level of precommitment required on...

On the new build, you obviously, you have an incentive, but you expect that divergence, for lack of better turn for the quarter, you think the newer, more modern buildings will attract tenants there? Obviously, with the incentives. But the secondary assets will face pressure from face and vacancy and effective rent declines.

Every cycle I've been through, Sholto, the new building lease-up and the buildings that the tenants move out of, which create backfill, they've got the problem. So the B grade and the low A grades will have the much higher vacancy levels than anything that's brand new, whether it's A grade or premium grade. So -- but as I said earlier, there's going to be a lower appetite for new development. And -- but we're not naive. There's going to be pressure on the office market.

Yes. I mean is finally, there's obviously the -- I think the press reporting, the industrial portfolio that all should be closing soon. It would -- if the WALE was long enough, it would suit one of your funds. But are you looking at that or if you -- do you think that will close soon? Your commentary is there'll be a lot of transactions that fit in your [ wheelhouse ]. Is that something you'd look at?

Sholto, if I bought everything that the media speculates we're buying, we would be $150 billion business. So I'm not going to comment on press speculation. All I'd say is there is some good quality industrial portfolios that have been on the market, are coming on the market. I think there's going to be -- I think I've been quoted before, there's going to be an explosion in some leasebacks from corporates. It's how I think people are thinking about it before this, I think, corporate should leaseback is going to become a big feature of the next couple of years in both industrial and in office portfolio. As you've already seen us consummate some big transactions like the self-exchange portfolio, the BP convenience retail portfolio last year. So I think there's going to be more and more of that and we'll be very selective. We see really good quality tenants and they're the best-of-breed in well market leaders in this sector, well -- will be interested.

And just finally for me. You don't really have a big suburban office. When you look at that sort of asset class, given you can get some longer WALEs? Or is it too much tenant risk concentration? Or do you have a view on that?

Well, I'd probably remind everyone we've got the biggest still -- one of the biggest suburban office portfolios in this country, that's $2.5 billion out of $19 billion. We've got fantastic, high-quality office bookings in Parramatta. We've got the Kohl's headquarters in Melbourne. We got -- have developed and sold, but still own the head office of Verizon in Fortitude Valley in Brisbane. So I think we have complemented our CBD strategies with CD premiums and the right suburban locations. As I mentioned earlier, we're just under construction on another 10,000 square meters, 75% precommitted office project at Westmead in a joint venture with Western Sydney University right next to the Westmead Hospital. We think that will be a very successful precinct for corporates. So yes, I wouldn't dismiss us as not being a player in that suburban market, I'm just very selective about the location. But we'll always have a high majority of the portfolio being CBD focused. But at $20-odd billion, you're always going to be seen as one of the biggest players in the suburban markets.

[Operator Instructions] Your next question comes from Grant McCasker with UBS.

David. Just one question from me. You mentioned a few times there about a crisis, but are you saying that actually has seen flow through to distress -- any distressed pricing? Or do you expect to see any distressed pricing? Because I guess you consider that there's parts of the listed market, where you can see some distressed pricing. So can you please just make any comments about how you -- if you're seeing any distressed pricing across the markets you're operating in?

I think you -- now ahead, Grant, this market's reflecting distressed pricing. But we're not seeing distressed pricing in the direct market. I think it's obviously very different by sector. But the sectors that we are playing in, we're seeing convenience retail trading. Obviously, industrial and logistics is very strong. My personal view is people sitting on land if they've got -- unless they own 100% equity, there's probably going to be some correction in land prices for people that have been, what I call, speculated rather than real developers. And we have -- we do have some capital part of our $5 billion of dry powder that is really out there looking for that distress. But my view is there won't be any stress coming from people with long-term leases because the yields versus the cost of debt, the spread is so high you really got to be under-capitalized to be in stress. So the stress is going to be coming in vacant buildings. As I've mentioned to Sholto's question before, I think there will be some stress with people owning backfill office buildings. It'll take a couple of years to play out. And we -- it's happened every cycle I've seen. It takes a while to see whether any real stress will emerge. I think we're fortunate this time around compared to GFC, our banks are well capitalized. They're in good shape. There's no doubt there's going to be less availability of credit than there has been, and I think for those that aren't strong customers with good balance sheets, yes, I think it becomes very stressful for some people trying to access debt. So yes, we'll just sit on the sidelines and see if any of that stuff emerges. But yes, at the moment, I'm not seeing any signs of stress with assets. And as I said, we're seeing a fair bit of liquidity.

Your next question comes from Stuart Cartledge with Phoenix Portfolios.

David, just a quickie on office fit-outs, particularly the development projects that is coming close to completion, like Wesley. Are you seeing, or is it too early at this stage, any evidence of tenants wanting to reconfigure their accommodation, particularly if it's a new fit-out, but also to the extent that you've got an existing tenant who suddenly is worked out with the COVID issue, so they will need to reconsider how they accommodate their staff?

Look, Stuart, it's a good question. I think it's early days. We're not seeing any material variations to fit-outs that were designed and were being implemented. If you sort of think about office fit-outs, 32 years ago, when I started, workspace ratios were about 25 square meters per person, and then we got down to 10 square meters per person, driven by the last 5 or 6 years of a move towards activity-based working or agile working or hot-desking, whatever you want to call it. My personal view is that's all over, that will reverse. I had a debate with some of my office executives about this. I just -- I think it was already creating a lot of strain on the system. Densifications just got too low. And my own view is that we'll see workspace ratio shift back towards sort of 1 to 14 square meters, 1 to 15 square meters. And where we will see some variations as we have this reentry, I think most corporates will have a sort of stage reentry of their people. It's been quite effective for most people being able to work from home, but the strains are starting to show. And certainly, all of our tenant customers are telling us subject to restrictions and subject to doing it in a staged manner, they're keen to sort of get their people better work or working from the office workplace. One of the interesting things, Stuart, that's going to come out of this is how do we all design end of trip facilities with appropriate social distancing, how do we deal with the obvious issues around end of trip facilities, I think we will, as I said earlier, see a greater separation of people. So it will be a bit of an evolution, A, once we sort of get through the immediate health crisis. I think whether or not a vaccine comes along, will have an influence on how extended the anxiety is around social distancing. And I know there's all sorts of theories that we're going to see lots of office demand go to the suburbs so people don't have to catch public transport to CBD and all that sort of thing. There's a lot of theories out there. I think we all need to just live through the next 6 to 9 months and remind ourselves that we've been in this for 2 months before any of us start making predictions. But that is definitely what I think there'll be a greater focus on the safety of our people in office environments. And that naturally, I think, is going to reduce density. It might elongate hours of operation, where many of you people might be starting a range of starting times from sort of 7 to 10 o'clock in the morning and going from 4 to 7, leaving in the afternoon. And that may become a more permanent fixture of the office environment. So there's a lot of interesting things to unfold, but I don't think anyone's got the answers yet.

Your next question comes from [ Damien Dentales ] from [ Autinity ].

Quick, I guess, question from me. Just dovetailing back to, I guess, the wholesale on liquidity update you were giving. Just a question on that part again. Are you seeing any wholesale investors looking to offload any of their units by transfer? Sort of by our off-market means. Because I know with some wholesale vehicles out there, you've got constitutions allowing for other investors to have a preemptive right to selling the units. So are you seeing anything on that front in terms of units being offered or units that have actually sold?

Yes. So all of our wholesale funds. And I think most of the institutional peers have got the same. If you want to do a secondary, you actually have to offer it to your existing investors first, but preemptive. So yes, we haven't seen any secondaries. I think coming into the crisis, there were some what I'd call non-office, non-industrial funds that had secondary queues, but that has nothing to do with COVID-19. So no, I haven't seen that emerge. And as you alluded to, the existing investors have to be offered those units first before an investor's entitled to sell to another. Quite often, that's also managed by the RE or the manager anyway. I've very rarely seen wholesale-to-wholesale trades ever executed without the manager's involvement. So -- and even in the GFC, there was a whole range of new funds called secondary funds raised, and those aren't in any activity at all in this country. So I don't actually think it will be a massive feature. If you're in a redemption queue and you can't get out, then yes, I can see people trying to front run each other by offering discounted units to try to get their units sold. But, I haven't seen any event [indiscernible].

There are no further questions at this time. I'll now hand back to Mr. Harrison for closing remarks.

Okay. Thanks, everyone, for your time. Obviously, as usual, if you've got any follow-up questions, please get in touch with Phil Cheetham. And at some stage in, hopefully, in the near future, we might get an opportunity to have one-on-one, face-to-face meeting. But for the time being, we'll do it virtually. Thanks very much.