Charter Hall Long WALE REIT (CLW) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by. Welcome to Charter Hall Long WALE REIT 2022 Full Year Results Briefing. [Operator Instructions] Please note that this conference is being recorded today, Tuesday, the 9th of August 2022. I would now like to hand the conference over to your host today, Mr. Avi Anger, Fund Manager. Thank you, sir. Please go ahead.

Good morning, everyone, and welcome to the Charter Hall Long WALE REIT Results Presentation for the FY '22 Full Year ending 30 June 2022. Presenting with me today is Scott Martin, Head of Long WALE REIT Finance. I'd like to commence today's presentation with an acknowledgment of country. Charter Hall is proud to work with our customers and communities to invest in and create places on lands across Australia. We pay our respects to the traditional owners, their elders past and present and value their care and custodianship of these lands. The format for today's presentation is that I will start with an overview of CLW and key highlights for the year. You will then hear from Scott, who will provide an overview of the financial performance of the REIT. I will then return to provide an operational update and portfolio overview and provide guidance for FY '23. We will then offer the opportunity for questions. Turning now to Slide 5. Today, CLW has a best-in-class $7.1 billion diversified real estate portfolio consisting of 549 properties with a very long-dated average lease term of 12 years. 52% of the income of the REIT comes from triple net leased properties. This is an important feature of our portfolio given that under a triple net lease, the tenant is responsible for all outgoings, maintenance and capital expenditure. In addition, 80% of our portfolio is now located in markets on the Eastern Seaboard of Australia. These factors enhance the security and continuity of income of CLW. Turning to Slide 6. Our portfolio continues to be diversified by tenant, industry, geography and property type, which contributes to the stability of our cash flow. CLW has a high-quality income stream generated from blue-chip tenants, with 99% of the tenants of the REIT consisting of government, ASX-listed multinational or national businesses. Our largest tenants are government, Telstra, bp and Endeavour Group. Our properties were leased to 81 tenants across Australia and New Zealand and diversified across long WALE retail, office, industrial, social infrastructure and agri-logistics sectors. All the leases in our portfolio have annual rent increases providing strong year-on-year income growth. This consists of a mix of fixed and CPI-linked leases. Our income growth benefits from increases in inflation, with 49% of rent increases across our portfolio linked to CPI. This is a material increase from 40% last year. This is particularly attractive in the current inflation environment with a forecast weighted average increase in income across our CPI-linked leases of 6.3% in FY '23. The average fixed increase across our portfolio was a high 3.1%. Turning now to Slide 7 and the key highlights for the period. I'm pleased to report that we achieved strong operating performance over the year, delivering operating EPS of $0.305 per security. This represents growth of 4.5% over FY '21. Consistent with the FY '21 results, there was negligible impact on the REIT's FY '22 financial earnings as a result of the COVID-19 pandemic, given the very small exposure to tenants entitled to rent relief. Our exposure to major national tenants in nondiscretionary and defensive industries means CLW is well insulated against mandated COVID-19 shutdowns. Our NTA at 30 June is $6.17 per security, up 18.2% from $5.22 at 30 June 2021. Over the year, we delivered $670 million of net valuation uplift for our investors, demonstrating the quality and resilience of the portfolio. We achieved valuation uplifts across our entire portfolio, including our pub, bp Australia and New Zealand, Industrial and Logistics and Telstra Exchange portfolios, vindicating our focus on long WALE real estate. CLW has a long WALE of 12 years, providing security and continuity of income to our investors. 49% of lease rent reviews are CPI-linked with a 6.3% weighted average forecast increase in FY '23. 52% of the income of CLW is from triple net leases. And during the period, we have completed some significant capital management achievements. We refinanced and expanded $1.7 billion of debt facilities in the period. Balance sheet gearing is 29.9%, within our target gearing range of 25% to 35%. And CLW has a weighted average debt maturity of 5.2 years. Turning now to Slide 8 and environmental, social and corporate governance. We remain focused on implementing sustainability initiatives across our portfolio and consider ESG as a driver of long-term value for our investors and tenant customers. As a business, we've taken accelerated climate action. CLW has participated in Charter Hall's renewable power purchase agreement, which secures 7-year renewables in partnership with global energy giant ENGIE, a critical step in the group achieving 100% powered by renewable electricity by 2025. CLW has achieved an approximate 50% reduction in emissions under operational control because of our office and industrial sector being powered by 100% grid-supplied renewables in FY '22. Additionally, CLW is proud to partner with tenant customers to agree on-site solar totaling 5.6 megawatts at Canning Vale at Huntingwood properties. The fund has leveraged its green credentials to execute sustainable finance transactions, including at our 242 Exhibition Street property in Melbourne. CLW remains committed to aligning with best practice frameworks to support transparency and disclosure. The fund achieved 72 score in the 2021 GRESB assessment, an increase of 10 points compared to the prior period, evidence of our commitment to continuous improvement. Turning to Slide 9. CLW is proud to support Charter Hall's approach to creating strong communities. The Charter Hall Group has invested $1.27 million with social enterprise in the period, supporting 191 employment outcomes for vulnerable Australians. Of this expenditure, $579,000 was in support of crisis and disaster recovery to UNICEF, GIVIT and Foodbank. I would now like to hand over to Scott, who will provide an overview of the financial performance of the REIT.

Thank you, Avi. The REIT's key financial metrics for the year ended 30 June 2022 are set out on Slide 11. As Avi just touched on, the REIT delivered operating earnings of $207.2 million or $0.305 per security and declared a distribution per security of $0.305 for the same period, reflecting a payout ratio of 100%. NTA per security at 30 June 2022 was $6.17, representing an 18.2% increase over the 30 June 2021 NTA of $5.22 per security. Movements in all other key metrics shown on this slide result from portfolio-enhancing activities undertaken during the period, which Avi will cover in his presentation. Turning to Slide 12, which provides a summary of the REIT's earnings for the FY '22 full year. Net property income has increased by 32.4% compared to the prior reporting period and has been driven by a combination of like-for-like rental growth of 3.4% from the stabilized portfolio and net acquisition activity. The 3.4% like-for-like rental growth comprised an average of approximately 3.1% on fixed rent reviews and a weighted average CPI print for the REIT CPI-linked leases of 3.7%. The increase in operating expenses has been driven by portfolio growth and new acquisitions, and finance costs have also increased period-on-period as a result of partially debt funding the REIT's acquisition activities together with an increase in floating interest rates. Operating earnings per security and distributions per security have both increased by 4.5% on the prior corresponding period to $0.305 per security, consistent with our guidance released to the market. Turning to Slide 13 and the REIT's balance sheet position at 30 June 2022. The $1.8 billion increase in total assets represents an increase of 38.3% since 30 June 2021, and has been driven by acquisitions transacted during the year and $670 million of property revaluation gains. The $8.7 million increase in the provision for quarterly distribution results from the growth in operating earnings arising from acquisition activity and annual rent escalations. Acquisitions were funded through a content of debt and equity. During the period, balance sheet drawn debt increased by $611 million and $486 million of equity was issued. NTA has increased 18.2% from $5.22 per security at 30 June 2021 to $6.17 per security at 30 June 2022, driven by the $670 million increase in property revaluations. Turning to Slide 14, which provides a summary of the REIT's capital management initiatives. Balance sheet gearing was 29.9%, which is within the REIT's target gearing range of 25% to 35%, and look-through gearing was 37.1% at 30 June 2022. As outlined in the REIT's half year results, the REIT has continued to work closely with the Charter Hall treasury team on a range of debt initiatives that have strengthened the REIT's balance sheet position through extension of debt maturities and reduction of margins. During the current reporting period, the REIT completed $1.7 billion of debt initiatives. The REIT successfully refinanced $1 billion of existing facilities, with an average extension term of 1.5 years, and also secured an increase of $357 million to existing facilities. The REIT has also secured $355 million of new facilities with an average terms of 6.1 years to partially fund acquisition activity. In total, these debt initiatives represent close to 50% of the REIT's debt platform and provide the REIT with secure long-term financing. The REIT has total facilities calculated on a look-through basis of $3.1 billion, which were drawn to $2.7 billion at 30 June 2022. The REIT has a weighted average debt maturity of 5.2 years and a weighted average cost of debt of 2.8%. The REIT has 35% of debt sourced from capital markets' long-term issuances and 65% from foreign and domestic banks, with staggard maturities over a 9-year period from FY '24 to FY '32. The level of hedging at 30 June 2022 calculated on a look-through basis was $1.4 billion, which reflected a hedge position of 53%. Post the reporting date, the REIT has taken out a further $650 million of hedging, which has increased the level of hedging to $2.1 billion, which reflects a hedge position of 77% with a weighted average hedge maturity of 2.9 years. I will now hand back to Avi to provide an operational update and portfolio overview.

Thank you, Scott. Turning now to Slide 16 and recent portfolio leasing highlights. Whilst the benefit of a long WALE portfolio is the long-dated nature of the REIT's expiry profile, we are focused on proactively extending leases ahead of the expiry dates. We are pleased to announce today that CLW has executed a long-term lease extension with Metcash at our Canning Vale distribution center in Perth. As a result, this expiry, which was to occur in FY '24 has been pushed out by 11.3 years from today to occur now in FY '34. Agreement with Metcash includes expansion of facilities on-site and installation of a significant rooftop solar system. This lease extension demonstrates the active and collaborative approach to CLW to achieve mutually beneficial outcomes for investors and tenant customers. And this lease extension was made possible as a result of the deep relationships across Charter Hall's business with Metcash and highlights the significant benefits, which CLW receives by being part of the Charter Hall platform. CLW also recently entered into a 10-year lease with the listed EMECO at our property in Osborne Park, Perth. This takes this building to 100% leased with a WALE of approximately 10 years. Turning to Slide 17. During the year, CLW completed the acquisition of a 50% interest in ALE Property Group, together with investment partner Hostplus, one of Australia's leading superannuation funds. The national portfolio of 78 high-quality pubs and bottle shops is located in predominantly metropolitan locations along the East Coast of Australia. The properties feature triple net leases to best-in-class ASX-listed Endeavour Group, with the portfolio featuring uncapped annual CPI reviews and an open market review in year 6 years' time. The large land holdings and significant under-rented portfolio provides the opportunity for both income and capital growth well into the future. The portfolio of pubs has been externally valued, resulting in a $99 million valuation uplift from acquisition. Turning now to Slide 18. An important part of our strategy is to grow and enhance our portfolio through accretive acquisitions. In addition to the previously mentioned acquisition of 50% of the ALE Property Group during the year, we also acquired 3 modern industrial and logistics facilities for a total consideration of $88 million. These acquisitions include one of Australia's largest waste-to-energy facilities located in Sydney and leased a joint venture between Cleanaway and ResourceCo. The property was acquired off-market and features a long 15.9-year WALE. The Modern Star distribution center in Brisbane and the Toyota Materials Handling distribution center in Brisbane were other acquisitions completed in the year. All properties acquired in the year were independently valued since acquisition, materially higher than their purchase price. The ALE Group and industrial acquisitions demonstrate our focus on transactions offering attractive, long-term risk-adjusted returns, but also mindful of downside protection, investing in properties strategically important to our tenants with strong tenant credit favoring large companies and properties with high underlying land value. Given Charter Hall's strong reputation and strong relationships in the marketplace, we continue to see most deals in the market and also have access to many off-market opportunities as a result of existing relationships across the Charter Hall Group. We're able to secure deals not solely based on price, but also based on our ability to provide certainty of completion and ease of execution to the vendors. Turning now to Slide 19. In the following slides, I would like to provide an overview of our portfolio and outline some key attributes of the portfolio. Slide 19 is our portfolio overview. During the year, we were able to grow and enhance the portfolio through acquisition and positive valuation movements. The value of the portfolio is now approximately $7.1 billion. During the year, we have further enhanced the portfolio with $923 million of acquisitions. These acquisitions have increased the number of properties of the REIT to 549. The portfolio has a long-dated WALE of 12 years at June. This WALE has been impacted by the acquisition during the period of the ALE portfolio, which has a 6.5-year WALE. However, we have a high degree of conviction that this tenant is likely to remain in these properties for the long term. The properties in the portfolio feature a blend of annual lease review structures, both fixed and CPI-linked. Our average fixed reviews of 3.1% while our CPI-linked leases will deliver strong growth with 6.3% growth forecast in FY '23. This results in a forecast weighted average rent review for FY '23 of a strong 4.6%. Our portfolio has occupancy of 99.9%, and the portfolio average cap rate is 4.35%. Turning now to Slide 20 and an outline of our tenant customers and the tenant diversification of the REIT. Our portfolio of long WALE properties is leased to high-quality tenants, including Endeavour Group, government, Telstra, bp, Ingham's and Coles. The acquisitions completed during the period further increased our exposure to the high-quality, best-in-class Endeavour Group whilst the introduction of new tenants in the period further diversifies our tenant base. Turning to Slide 21 and the industry diversification of our tenant customers. Within our overall portfolio, approximately 99% of tenants are ASX-listed, government or multinational or national corporations with the vast majority of these tenants operating in nondiscretionary industries. During the period, we increased our exposure to the pubs and bottle shop sectors with the best-in-class operator, the $14 billion Endeavour Group through the ALE acquisition. The government, including the ATO and Australia Post, are another example of our nondiscretionary tenant exposures. In the telecommunications sector, we have partnered with another best-in-class operator, the $47 billion Telstra Corporation, which includes our portfolio of 37 exchange properties on long triple net leases. We also have a high proportion of tenants operating in the nondiscretionary grocery and food sectors such as Woolworths, Coles, Ingham's, Arnott's and Metcash. And our bp Australia and New Zealand portfolio of 295 properties on long triple-net leases provides us with exposure to the resilient fuel and convenience retail sector. Importantly, all the tenants mentioned and the vast majority of tenants in our portfolio performed well through COVID-19 and paid all rent through the period of lockdowns. Turning to Slide 22. As can be seen from the chart on this slide, the REIT's portfolio has a long-dated lease expiry profile and reflects a low-risk position relative to our peers in the sector. Our portfolio WALE is a long-dated 12 years following the Metcash lease extension announced today. We continue to work to push out our expiry profile as far as possible to the right of this chart, both through acquisition and negotiating lease extensions with our tenant customers. These preceding slides demonstrates the resilience and strength of our portfolio. Our portfolio WALE, quality of tenants and proportion of triple net leases provides better downside protection and more resilient income streams for our investors. Turning to Slide 24. I would now like to provide earnings and distribution guidance for FY '23. Based on information currently available and barring any unforeseen events, CLW provides FY '23 operating EPS guidance of $0.28 and distribution per security guidance of $0.28. Based on yesterday's closing price, this represents a 6.4% distribution yield. That concludes today's presentation, and I would now like to invite questions.

[Operator Instructions] The first question comes from the line of Lou Pirenc from Jarden.

A few questions on debt and hedging. So the 2.8% all-in cost of debt, is that what your guidance is based on for '23? Or is it just as of right now, today?

Lou, the 2.8% is our cost of debt as at 30 June. Going forward, we've provided our assumptions around BBSW in the pack, so we've taken the rate that we know is printed for the first 3 months of the year of 1.89 and consensus for the balance of the year of 2.91, which averages out at about 2.66 BBSW for FY '23.

Great. And what does that mean for an all-in cost of debt for '23 in your guidance?

It will be around the similar level a little bit. That 2.9, 2.9.

2.9%. Yes.

Yes.

Now can you talk about the hedging, that $650 million of new hedging? What do you pay on that kind of protection right now?

So that was -- that hedging was taken out at an average rate of about 1.5%. So the idea behind that, Lou, is really to provide sort of reliable and stable income to our investors for the year and subsequent years. It's over a 2-year period takes a hedging to about 77%.

Great. And then, sorry, last one on the hedging. You're providing your [indiscernible] the hedge profile for the next 3 years. Does the cost change much over those -- particularly the 3 years where you're in the 70s?

It's that 0.96% for '23, '24.

Okay. I missed the beginning. I don't know -- I think.

No, the hedge rate does not change materially over '23 and '24. So yes, we've got a weighted average hedge rate of 0.96%, which will flow into '24 as well.

Good. Final one for me, just more and more strategically. I mean, your gearing is I know in the middle of your range, but with cap rates quite low as a risk, I guess, of gearing going up. Are you considering selling some assets to improve your balance sheet here?

Look, Lou, I might -- I'll just point out that we are seeing some very strong underlying rent growth across our portfolio. So half our portfolio has uncapped CPI, and we've said in our presentation that we expect that to be north of 4% for this coming year. And we're also -- our portfolio is relatively low rents. About half our portfolio is effective rents. We've got some in the future, some strong rental increases coming through from market reviews, including our ALE portfolio. So I think that will provide a good buffer to -- if we see any rising cap rates on the basis of some strong income growth. Having said that, absolutely, the Board, we'll often discuss potential divestments and it's something that's always on the cards and being considered. So yes, that's something we're looking at.

Next question comes from the line of Simon Chan of Morgan Stanley.

Just on the $650 million of hedges that you took post balance date. Can you explain that rationale for that sort of structure?

Sure. Look...

I mean you've paid $21.6 billion upfront, that's all. I'm just trying to work out the rationale behind all of this.

Simon, from our perspective, we've seen quite a run in cost of debt, which is affecting CLW and many of its peers. We're focused on providing investors with stable and reliable income, and the action that we've taken increasing our hedging provides better earnings visibility and security to our investors. So we think the right approach was to increase hedging in the current environment. We think that, that is prudent. Yes, there was an up-front cost associated with that, but it's got a relatively immaterial impact on gearing and the cost of the hedge is recover the life of the swap.

So if I'm interpreting it properly, it's essentially a bit of capital for FFO swap in the scheme of things, is that right?

What it does is, as I mentioned, it provides that better income stability and security for our investors and given the nature of CLW, we think that's prudent in the current environment. And our EPS and DPS has been set at a level we think is manageable and sustainable for the medium term.

That's great. Your overall hedging, I think is only 77% you mentioned, can you give some color as to the balance sheet debt hedging and then the joint venture debt hedging? Is there much difference?

In respect of the -- so there's $2.1 billion of total hedging. It's about $1.795 -- $1.4 billion on balance sheet and the remainder of the $700 million is sitting in the JVs.

Right. Because can you talk a bit about the 242 Exhibition debt facility because I see there's a 3.6% and the covenants at 1.75%. Is that facility pretty much hedged because it's not inconceivable to say interest expense could double over the next 12, 24 months?

Look, that's a relatively small exposure for us. We might come back to you on that one side.

Yes, 15% interest in that. We'll come back -- yes, we'll take that offline, but I don't have those numbers just to hand. Simon, we'll go back with you.

Okay. Another problem. On the Metcash deal extension, to get that out of the way. Is there any insight you can give us as to the sort of leasing spreads you got because everyone we talk to suggest that industrial rent has gone up remarkably over the last couple of years.

Yes. Look, absolutely, Simon, industrial rents have risen significantly over the last couple of years, particularly in Sydney and Melbourne. Perth is rising, but it's a bit sort of delay relative to Sydney and Melbourne. We've said previously our view was that passing rents at that property equivalent to market rents. We still hold the same view, and that's certainly where that property sits. The rents are being kept at current level and increasing in line with the existing lease, which is uncapped CPI. So yes, that's our view of where the market and where that property is.

The next question comes from the line of Stuart McLean from Macquarie.

First question, just looking at the operating cash flows, it looks like about $188 million there versus your earnings of $207 million. What's driving that $20 million spread between the 2, please?

Yes. One of the JVs out of the DRP to pay for an acquisition throughout the year, so we had operating earnings coming through. But rather than pull the operating earnings and then call the capital, the JV just retained some of the earnings. I think it was through the LWIP portfolio to fund a pub acquisition.

Okay. Great. The second question is just on LEP. Just are there any conversations at the moment between Charter Hall and [indiscernible] regarding that 26% under renting, and any progress there?