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

Ladies and gentlemen, thank you for standing by, and welcome to the Charter Hall Long WALE REIT 2023 Half Year Results Briefing. [Operator Instructions] Please note that this conference is being recorded today, Tuesday, 9th of February 2023. 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 first half FY '23. Presenting with me today is Scott Martin, Head of Long WALE REIT Finance. I would like to commence today's presentation with the acknowledgment of country. Charter Hall is proud to work with our customers and communities to invest in, develop and manage properties on land across Australia. We pay our respects to the Traditional Owners, their Elders past, present and emerging and recognize their continuing culture and contribution to this country. The format for today's presentation is that I will start with an overview of CLW and key highlights for the period. 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 update for FY '23. We will then offer the opportunity for questions. Turning now to Slide 5. Today, CLW has a best-in-class AUD 7.2 billion diversified real estate portfolio, consisting of 550 properties with a very long-dated average lease term of 11.8 years. 53% of the income of the REIT comes from triple net lease properties. This is an important feature of our portfolio given that under a triple net lease structure, the tenant is responsible for all outgoings, maintenance and capital expenditure. In addition, 79% of our portfolio is 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 84 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 annual increases. Our income growth benefits from increases in inflation with 50% of the rent increases across our portfolio linked to CPI. This is particularly attractive in the current inflation environment with a weighted average increase in income across our CPI-linked leases of 7.2% in FY '23. The average fixed increase across our portfolio was a high 3.1%. Turning now to Slide 7 and key highlights for the period. I'm pleased to report that we achieved strong operating performance over the half year, delivering operating EPS of AUD 0.14 per security, and we are on track to deliver FY '23 operating EPS guidance of AUD 0.28. Our NTA at 31 December, 2022 is AUD 6.23 per security, up 1% from AUD 6.17 at 30 June, 2022. Over the period, we delivered AUD 65 million of net valuation uplift for our investors, demonstrating the quality and resilience of the portfolio. The valuation uplift was predominantly driven by Metcash Canning Vale following finalization of the lease extension at that property and our Endeavour leased pub and BP Australia portfolios as a result of these properties uncapped CPI-linked rent reviews. CLW has a long way of 11.8 years, providing security and continuity of income to our investors. 50% of lease rent reviews are CPI-linked with 7.2% weighted average increase in FY '23. 53% of income of CLW is from triple net leases. And we remain focused on prudent capital management with 74% of drawn debt being hedged with a weighted average hedge maturity of 2.6 years. Balance sheet gearing is 30.2% within our target gearing range of 25% to 35% and CLW has a weighted average debt maturity of 5 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 investor 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 100% grid supplied electricity sourced from renewable sources for CLW's office properties under our operational control. Additionally, CLW has 1.8 megawatts of solar installed across its portfolio with future projects totaling 5.4 megawatts at CLW's Canning Vale and Huntingwood assets. CLW's predominantly modern office portfolio features high environmental credentials, including 4.9 Star NABERS Energy and 5 Star NABERS Water ratings. CLW remains committed to aligning with best practice frameworks to support transparency and disclosure. The fund achieved a score of 79 in the 2022 GRESB Assessment, an increase of 7 points compared to the prior period, evidence of our commitment to continuous improvement. I would now like to hand over to Scott, who will provide an overview of the financial performance of the REIT.

Thank you, Avi, and good morning, everyone. The REIT's key financial metrics for the FY '23 half year are set out on Slide 10. As Avi has just touched on, the REIT delivered operating earnings of AUD 101.2 million, a 3.5% increase compared to the prior corresponding period. NTA per security at 31 December, 2022 was AUD 6.23, representing a 1% increase over the 30 June NTA of AUD 6.17 per security. The REIT's gearing metrics have remained stable during the current reporting period, and I will cover these in more detail later in my presentation. Turning to Slide 11, which provides a summary of the REIT's earnings for the FY '23 half year. Net property income has increased by 16.9% compared to the prior corresponding period and has been driven by a combination of like-for-like rental growth of 4.1% from the stabilized portfolio, together with net acquisition activity. The increase in operating expenses has been driven by portfolio growth and new acquisitions and finance costs have also increased period-on-period, predominantly driven by an increase in floating interest rates. Both operating earnings per security and distributions per security for the period were AUD 0.14 per security, in line with our guidance released to the market. Turning to Slide 12 and the REIT's balance sheet position at 31 December, 2022. The AUD 0.1 billion increase in total assets has been predominantly driven by AUD 105 million of property acquisitions during the year and AUD 65 million of property revaluation gains. These were offset by AUD 112 million of property divestments, which were sold at their prevailing book value. NTA has increased by 1% from AUD 6.17 per security at 30 June, 2022 to AUD 6.23 per security at 31 December, 2022, driven by the AUD 65 million of property revaluations. Turning to Slide 13, which provides a summary of the REIT's capital management initiatives. Balance sheet gearing was 30.2%, which remains within the REIT's target gearing range of 25% to 35% and look-through gearing was 37.3%. During the current reporting period, the REIT refinanced and extended the syndicated debt facility for the BP Australia portfolio by 4 years. The REIT has total facilities calculated on a look-through basis of AUD 3.1 billion, which were drawn to AUD 2.8 billion as at 31 December, 2022. The REIT has a weighted average debt maturity of 5 years and a weighted average cost of debt of 3.2%. The REIT has 35% of debt sourced from capital markets long-term issuances and 65% from foreign and domestic banks with staggered maturities over a 9-year period from FY '24 to FY '32. During the current reporting period, the REIT took out a further AUD 650 million of hedging, which has increased the level of hedging to AUD 2.1 billion as at 31 December, 2022, which represents a hedge position of 74% with a weighted average hedge maturity of 2.6 years. I will now hand back to Avi to provide an operational update and portfolio overview.

Thank you, Scott. Turning now to Slide 15 and recent portfolio transaction activity highlights. During the period, we undertook some portfolio curation, divesting some short WALE properties at book value and investing in new high-quality investments. The divestments consisted of 2 short WALE industrial facilities at prevailing book values. The Woolworths Distribution Center at Hoppers Crossing was sold for AUD 74 million, reflecting a 4.5% cap rate. The property had a 3-year lease term remaining at the time of settlement in December '22. The Toll Altona North property was sold for AUD 38.3 million, reflecting a 4.75% cap rate. The property had a 2.9-year lease term remaining at the time of settlement in December '22. These sales provide support for our book values and the sale proceeds were recycled into new portfolio-enhancing long WALE investments. These investments were 25% interest in the Geoscience Australia headquarters in Canberra for AUD 91 million. The property is a life sciences complex, comprising office, specialized laboratory storage and warehousing. The property was acquired in October '22 and featured a 9.6-year WALE with 3% of fixed annual rent reviews and the yielded acquisition was an attractive 7.4%. We also further extended our relationship with Endeavour Group acquiring 2 Endeavour Group leased pubs, the Emu Hotel in South Australia, the Horse & Jockey in Queensland. Both pubs are leased to Endeavour Group with new 15-year triple net leases with uncapped CPI increases. The total combined acquisition price was AUD 14.1 million for CLW's 49.9% interest, reflecting a blended 4.8% cap rate. The Geosciences and Endeavour pub 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 government and large companies and properties with high underlying land value. Given Charter Hall Group's strong reputation and strong relationship 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 were able to source deals not solely based on price, but also based on our ability to provide certainty of completion and ease of execution for the vendors. Turning to Slide 16. In the following slides, I would like to provide an overview of our portfolio and outline some key attributes of the portfolio. Slide 16 is our portfolio overview. In the first half, we were able to grow and enhance the portfolio through acquisition and positive valuation movements. The value of the portfolio is now approximately AUD 7.2 billion. During the period, we have further enhanced the portfolio with AUD 112 million of divestments and AUD 105 million of income enhancing property acquisitions, which contributed to improving portfolio quality, sector diversification and lengthening the portfolio WALE. As a result, the number of properties of the REIT has increased to 550. The portfolio has a long-dated WALE of 11.8 years at December. The properties in the portfolio feature a blend of annual lease rent review structures, both fixed and CPI-linked. Our average fixed reviews are 3.1%, whilst our CPI-linked leases delivered strong growth with 7.2% growth in FY '23. This results in a weighted average rent review for FY '23 of 5%. Our portfolio has occupancy of 99.9%, and the portfolio average cap rate is 4.41%. Turning now to Slide 17 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 government, Endeavour Group, Telstra, BP, Ingham's and Coles. The acquisitions completed during the period further increased our exposure to high-quality tenants in government and best-in-class Endeavour Group. Turning to Slide 18 and the industry diversification of our tenant customers. Within our overall portfolio, approximately 99% of our tenants are ASX-listed, government, multinational or national corporations with the vast majority of these tenants operating in non-discretionary industries. During the period, we increased our exposure to government tenants. We have also increased our exposure to the pubs and bottle shop sector with best-in-class operator, the AUD 12 billion Endeavour Group. In the telecommunications sector, we have a partnership with another best-in-class operator, the AUD 48 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 non-discretionary grocery and food sectors such as Woolworths, Coles, Ingham's, Arnott's and Metcash. And our BP Australia and New Zealand portfolios of 295 properties on long triple net leases provides us with exposure to the resilient fuel and convenience retail sector. Turning to Slide 19. 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 11.8 years. 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 demonstrate 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 stream for our investors. Turning now to Slide 21. I would now like to provide an update regarding earnings and distribution guidance for FY '23. Based on information currently available and barring any unforeseen events, CLW reaffirms its FY '23 operating EPS guidance of AUD 0.28 and distribution per security guidance of AUD 0.28. Based on yesterday's closing price, this represents a 6.1% distribution yield. I would also like to acknowledge and thank the teams of people across the Charter Hall platform that contribute to the performance of CLW and the results delivered today. The Charter Hall Group provides the REIT with access to a high-caliber team of experts across all areas of the REIT's management and provide CLW with access to a best-in-class management platform. That concludes the presentation, and I would now like to invite questions.

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

2 questions for me. First of all, you clearly made some good progress with asset recycling. What's in the plans for second half '23 and beyond this? Is this something that you're actively working through? Or was that more opportunistic in the first half?

Lou, yes, there's nothing firm at this stage for second half '23. We'll continue to review opportunities as they arise. But yes, there's nothing further to announce in relation to that at this stage.

And then can I just ask about cap rates and the assumptions there, particularly your 3.9% on the logistics portfolio, what kind of assumptions around long-term cost of capital are you making to keep those cap rates so low compared to your current marginal cost of debt?

Well, I think the industrial portfolio, what's not -- what doesn't come out in that summary table is the fact that we actually did see cap rate expansion across the industrial portfolio of around 15 basis points. And what resulted in the cap rate firming was the Metcash valuation because of the lease extension, that value -- that property was revalued with a sharper cap rate that brought the average down. So look, I think that's fairly consistent with what we're seeing across the board this results season. We're seeing, particularly in industrial, you're seeing very strong market rental growth, which is underpinning or offsetting some of that cap rate expansion. And then more broadly across the portfolio, we have very relatively low rents, best-in-class tenant registers, very low CapEx and obviously, the triple net leases and uncapped CPI are drivers that should limit -- well, or limiting the sort of cap rate expansion at the moment.

Maybe a quick follow-up on it. Can you give an indication of how under rented you feel you are across the portfolio or by asset class?

I feel that on average across the portfolio, we are under rented. As you're aware, when we did the ALE deal, we published the fact that the portfolio was circa 30% under rented. Similarly, a number of deals that we did do in recent years were done at effective rents and rents that were set low by the tenants in those sale leasebacks, particularly Telstra Exchanges, the pub -- our regional pub portfolio, the service state, BP service stations. So, I think -- and obviously, what we've seen with market rents in industrial means that we're probably under rented across that whole portfolio. So, I think on average, we're under rented. And I think that they're probably the main drivers of that.

[Operator Instructions] Our next question comes from the line of Stuart McLean of Macquarie.

Just on similar themes. So, the acquisition of the Endeavour pub at 4.8%, can you just maybe talk to what is your marginal cost of debt? And do you feel that, that acquisition is therefore going to be accretive to earnings?

Yes. Look, as you are aware, Stu, we've got a really good relationship with Endeavour and are able to access those sort of long lease opportunities as a result of that relationship off market. Those properties are all 15-year triple net leases with uncapped CPI. So, cap rate is one aspect. But I think when you factor in the rents are set, the levels the rents are set out and also the fact that we have uncapped CPI and no CapEx obligations and those properties are fairly important for the tenant's business, we really like those assets. So, we've taken the opportunity to recycle out of some sharper cap rate short WALE properties into some longer WALE high-quality opportunities with best-in-class tenant. In terms of marginal cost of debt, it's much lower than that. Scott, do you want to...

That's around that 4%, I believe we would have drawn the debt out.

But we're already paying line fees, so the incrementals...

That incremental is about 4%. So, that's -- that was accretive, so.

And then just on best use of capital, in your presentation, you note that the dividend yield for CLW is 6.1%. So, choosing to acquire at 4.8% as opposed to investing in your own portfolio that you currently have?

What do you mean by investing in your own portfolio?

Do a buyback instead of acquiring assets at 4.8%, invest in your own portfolio with a 6.1% dividend yield.

Look, there are many there are many aspects, other factors, I guess, involved with the buyback. And obviously, buyback is something that's always discussed at Board and continues to be depending on sort of where we're trading. But I think you need to also bear in mind that if we take proceeds from asset sales and invest in a buyback, obviously, we're not going to get the earnings growth that we're getting from those properties. And similarly, there's other considerations, including what it does to our gearing, et cetera. So yes, that's -- yes, we have to take a number of factors in considering that.

And just a final one for me, just around ESG, just in relation to the bit more scrutiny that is clearly coming towards Coke machines, I understand Endeavour is 19% of the portfolio. And just do you have any comments there on what that could mean for the outlook on cap rates, asset values, cash flows coming from assets that are led to gaming?

Yes. So, I think you're referring there to sort of the New South Wales reforms that were announced recently. So look, in relation to that, it's something we obviously monitor. Those reforms have recently been announced, and we've reviewed those. It's still subject to an election in New South Wales. And importantly for us, we don't take any operational control, would have any operational control in those pubs. We have triple net leases. We collect rent from Endeavour Group. It's a AUD 12 billion listed entity. Gaming is a small -- one part of a much larger business, and we're very confident sort of in the Endeavour business and its continued growth. And finally, as in terms of our overall pub portfolio, New South Wales is only about 10% of the assets that we have. So, when you factor in -- when you combine all those factors, we don't see it being a significant impact on our portfolio.

And no ESG-related concerns and your sales continue to hold these sites back on a go-forward basis?

We've had pubs since day 1 of CLW. So, it's always been part of our investment sort of thesis and what we do.

[Operator Instructions] Our next question comes from the line of Grant McCasker of UBS.

I just wanted to check how much leasing and maintenance CapEx was spent over the half? And then also if you can provide a little bit more detail in regards to CapEx required for the net cash lease extension?

Yes. We spent about AUD 5 million on leasing maintenance CapEx between AUD 5 million and AUD 7 million, and we spent about AUD 20 million, AUD 25 million on -- in relation to Metcash in terms of the CapEx that we're doing there and have to do there as part of our lease renewal. So, we have to bring that facility up to modern standard for the next sort of 11 years and part of the deal. We're spending some CapEx there.

So, just checking, is that spent in the half or what you plan to spend in future periods as well?

That's still in the current half.

And so what's the total amount for the net cash, please?