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

Ladies and gentlemen, thank you for standing by, and welcome to Charter Hall Long WALE REIT 2023 Full Year Results Briefing. [Operator Instructions] Please note that this conference is being recorded today, Tuesday, the 8th of August, 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 full year FY '23. Presenting with me today is Scott Martin, Head of Long WALE REIT Finance. I would like to commence today's presentation with an acknowledgment of country. Charter Hall acknowledges the traditional custodians of the lands on which we work and gather. We pay our respects to elders past and present and recognize their continued care and contribution to country. 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 '24. We will then offer the opportunity for questions. Turning now to Slide 5. Today, CLW has a best-in-class $6.8 billion diversified real estate portfolio consisting of 549 properties. Our portfolio continues to be diversified by tenant, industry, geography and property type, which contributes to the stability of our cash flow. 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. 52% 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. Turning now to Slide 6. The portfolio features a very long-dated average lease term of 11.2 years, which enhances the security and continuity of income of CLW. 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. 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 51% 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 7.1% 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 year. I am pleased to report that we delivered operating EPS of $0.28 per security, in line with the FY '23 operating earnings guidance provided. Our NTA at 30 June 2023 is $5.63 per security. The portfolio delivered a weighted average rent review of 5.1%, benefiting from the 51% of income of the REIT being CPI-linked, with a weighted average increase from our CPI-linked leases of 7.1% in FY '23. CLW has a long WALE of 11.2 years, providing security and continuity of income to our investors, and the portfolio is sitting at an occupancy level of 99.9% at year-end. We completed $223 million of transaction activity during the year, with $114 million of strategic divestments, which were recycled into $109 million of portfolio-enhancing investments. We remain focused on prudent capital management, with 80% of drawn debt being hedged, providing protection against the risk of rising interest rates. Moody's has reaffirmed its Baa1 investment-grade credit rating for the REIT, and our weighted average debt maturity is 4.5 years, with staggered maturities to a diversified lender pool. 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 investor and tenant customers. As a business, we've taken accelerated climate action. Charter Hall recently announced that it is targeting net zero carbon by 2025, having accelerated our Scope 1 and Scope 2 targets by 5 years. Additionally, CLW has been focused on clean energy, with 2 megawatts of solar installed across the portfolio, an increase of 400 kilowatts since FY '22. Further, the office properties in the portfolio have 100% grid supply electricity sourced from renewable sources. CLW's predominantly modern office portfolio features high environmental credentials, including 5.3 star NABERS Energy and 5.2 star NABERS Water ratings. CLW remains committed to aligning with best practice frameworks to support transparency in disclosure. The fund achieved a score of 79 in the 2022 GRESB assessment, an increase of 7 points compared to the prior period, evidencing 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 to everyone on the call. Turning to Slide 10, which provides a summary of the REIT's earnings for the FY '23 full year. Net property income has increased by 10.6% compared to the prior reporting period and has been driven by a combination of like-for-like growth of 4.4% from the stabilized portfolio and net acquisition activity. The increase in operating expenses has been driven by the full year impact of the REIT's acquisition activity in FY '22. Finance costs have also increased period-on-period, driven by a 0.8% increase in the REIT's weighted average cost of debt from 2.3% in FY '22 to 3.1% in FY '23. Both operating earnings per security and distributions per security for the year were $0.28, in line with our guidance released to the market. Turning to Slide 11 and the REIT's balance sheet position as at 30 June 2023. The $279 million movement in total assets has been driven by $109 million of property acquisitions, $114 million of property divestments, which were sold at their prevailing book value, together with a net property valuation decrement of $363 million. The net property valuation movement has been the main driver of the movement in NTA, which has decreased by 8.8% from $6.17 per security at 30 June 2022 to $5.63 per security at 30 June 2023. Turning to Slide 12, which provides a summary of the REIT's capital management initiatives. The REIT continues to have a mix of debt funding, with 35% of debt sourced from capital markets long-term issuances and 65% from foreign and domestic banks. The REIT has total facilities calculated on a look-through basis of $3.1 billion, which were drawn to $2.8 billion at 30 June 2023. During the current reporting period, the REIT refinanced and extended the syndicated debt facility for the bp Australia portfolio by 4 years. Balance sheet gearing was 32.9%, which remains within the REIT's target gearing range of 25% to 35%, and look-through gearing was 40.1%. The REIT has a weighted average debt maturity of 4.5 years, with no near-term debt maturities other than the ALE capital index bond, which will be refinanced with the $296 million of available cash and undrawn debt capacity upon its maturity in November 2023. As at 30 June 2023, the REIT's weighted average cost of debt was 3.9% based upon look-through drawn debt of $2.8 billion and look-through hedging of $2.4 billion. During the current reporting period, the REIT took out a further $940 million of hedging together with the extension of hedge maturities. These hedge initiatives have increased the level of hedging to $2.4 billion as at 30 June 2023, with a weighted average hedge maturity of 2.3 years. Importantly, the REIT has 80% of its FY '24 debt hedged at an average hedge rate of 1.9%, which provides protection against rising interest rates. I will now hand back to Avi to provide an operational update and portfolio overview.

Thank you, Scott. Turning now to Slide 14 and recent portfolio transaction activity highlights. During the year, we undertook some portfolio curation, divesting some short WALE properties at book value and investing in new, high-quality long WALE investments. The divestments consisted of 2 shorter WALE industrial facilities at prevailing book values. The Woolworths Distribution Centre at Hoppers Crossing was sold for $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 $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 provided support for our book values, and the sale proceeds were recycled into new portfolio-enhancing long WALE investments. These investments were a 25% interest in the Geoscience Australia headquarters in Canberra for $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% annual rent reviews, and the yielded acquisition was 7.4%. We also further extended our relationship with Endeavour Group, acquiring 4 Endeavour Group-leased pubs: the Emu Hotel in South Australia; the Horse & Jockey Marine Hotel and Rainbow Beach Hotel, all in Queensland. All pubs are leased to Endeavour Group with new 15-year triple net leases with uncapped CPI increases. The total combined acquisition price was $17.9 million for CLW's 49.9% interest, reflecting a blended 5% 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. Turning now to Slide 15. In the following slides, I would like to provide an overview of our portfolio and outline some key attributes of the portfolio. Slide 15 is our portfolio overview. At year-end, the REIT consisted of 549 properties valued at approximately $6.8 billion, with 100% of the portfolio independently valued at June. The portfolio average cap rate is 4.77%. The portfolio is virtually fully occupied, with an occupancy of 99.9%, with a long-dated WALE of 11.2 years at year-end. 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%, whilst our CPI-linked leases delivered strong growth with 7.1% growth in FY '23. This results in a weighted average rent review for FY '23 of 5.1%. Turning now to Slide 16 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, Inghams and Coles. The acquisitions completed during the year further increase our exposure to high-quality tenants in government and best-in-class Endeavour Group. Turning to Slide 17 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 year, we increased our exposure to government tenants. We also increased our exposure to the pubs and bottle shop sector, with best-in-class operator the $11 billion Endeavor Group. In the telecommunications sector, we have partnered with another best-in-class operator, the $49 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, Inghams, Arnott's and Metcash. And our bp Australia and New Zealand portfolios of 292 properties on long triple net leases provides us with exposure to the resilient fuel and convenience retail sector. Turning to Slide 18, and 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 11.2 years. We have minimal lease expiries in the next 2 years and we are in discussions with a number of tenants with expiries in FY '26 and beyond regarding lease renewals and extensions. 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 streams for our investors. Turning now to Slide 20. I'd now like to provide guidance for FY '24. Based on information currently available, including current interest rate and inflation expectations, and barring any unforeseen events, CLW provides FY '24 operating EPS guidance of $0.26 and DPS guidance of $0.26. That concludes today's presentation, and I'd now like to invite questions.

[Operator Instructions] First question comes from Richard Jones from JPMorgan.

Just wondering if you can provide us some color on what's in the guidance, just in terms of where the WACD goes, and perhaps whether you are assuming any asset sales in that number?

Richard, thanks for the question. No asset sales are assumed in that number. As we've outlined in the presentation, [ we're ] at 80% hedging at present. And we've provided that average cost of debt at the present time of 3.9% for our weighted average cost of debt. So 80% of it's hedged, 20% is floating, just based on the current interest rate curve, and [ has view ] in relation to CPI assumptions, and that's basically what we've put in the forecast.

Okay. And can you talk about the investment market at the moment and what you're seeing for assets with long-duration leases?

Yes. Look, it's mixed, obviously, across the different asset classes. We're still seeing quite a lot of transactional evidence in things like petrol stations and pubs that's quite supportive of where we see value. Similarly in industrial, it's quite an active industrial market at the present time for industrial assets. There's a lot of investors looking to increase their exposure to that asset class. Across our book more broadly, even assets like the Telstra Exchange portfolio, that's got infrastructure-like characteristics and very strong rent reviews of sort of CPI plus 0.5%, which is very attractive. So I'd say for the sort of assets we own in the main, the investment market is strong and supportive.

Okay. Just one final question. I think most in the market would be expecting there'll be further devaluations in the next 12 months. Just wondering what impact that has on your portfolio composition. And I guess, if you are or were looking to move some assets on, what part of the portfolio do you think would be where you might look to sell assets?

Yes. Well, look, as you saw last year, we sold $114 million of property, a couple of industrial and a few small retail properties. And we recognize that in the short term there'll be some benefit in potentially some asset sales. So we're certainly looking at that. And that could come from a broad range across our portfolio.

Next question comes from the line of Suraj Nebhani from Citi.

So the first one was, again, just following on from what Richard was saying. I think, Avi, you mentioned capital recycling. Is it fair to say that the acquisition markets are probably not that supportive currently, so maybe not many acquisitions in the near term?

Yes. No, fair to say acquisitions is not our primary focus at the moment, Suraj. I think we're focused on extracting the maximum value out of our portfolio as it stands at the moment, and as I mentioned in Richard's question, potentially some selective divestments.

Okay. And maybe secondly, on the ALE portfolio. Is there any further clarity or update that you can provide us on the rental upside that was due in a few years' time?

Look, in relation to that portfolio, and as I mentioned previously, our relationship with Endeavour Group is very strong across our business, and in relation to that portfolio that we enjoy strong uncapped CPI rent reviews across that portfolio. And that open market review is getting ever closer. It's now only 5 years away, and it will come around pretty quickly. So we're working with Endeavour in relation to that. And we still think that's a very high-quality portfolio of what we see as an income-producing land bank of really high-quality assets to a best-in-class tenant.

Okay. And that sounds good. Just finally on the debt cost side, I can see the hedge -- you've done a lot of hedging this period. I'm just wondering like what's the view on interest rates at the moment? And clearly, hedge rates are around 2% whereas spot market is 5% to 6%, including margin. Should we expect more hedging to be put in place over the next 12 months? Or like what's the sort of approach that, I guess, seems more plausible based on how things are looking currently?

Yes. I mean we've -- as you've seen in today's presentation, we have undertaken -- have taken out more hedges. So we're now very well hedged for the next 2 years, and we'll look at continuing to build that hedge profile in later years over the course of the next few months and beyond. And we think that's a prudent approach in the current volatile interest rate environment.

Next from the line, we have the questions from David Pobucky from Macquarie Group.

[indiscernible] and where it currently sits in the context [indiscernible] capital recycling initiatives. How do you think about that, [ do you need ] to push through divestments and hold back recycling just to manage gearing?

I didn't quite catch that question, David. I might get you to repeat. I think your line is a bit -- not very good.

Apologies for that. I'll try again. Just in terms of gearing and capital recycling initiatives, do you need to push through more divestments and potentially hold back recycling the proceeds to manage [indiscernible]?

Yes. I think your question is around if we were to sell assets, how we'll deal with the proceeds. Look, I think it's fair to say that if we're able to -- or if we're able to sort of sell assets at pricing we feel is reasonable, we'll look to do that, and in the short term definitely look to pay down some debt, and that will build capacity for the future when we come out of the other side of this current interest rate cycle. But no, absolutely, we'll -- asset sales will be used to retire debt in the short term.

One more, if I may. What's driving the difference between where operating cash sits [indiscernible] operating earnings, please? Just any color you can provide there.

Look, historically, they're pretty much matched off. I think previously, we've used some of the operating cash flows from our pub portfolio investment to fund the acquisition of new pubs. So that's really been the delta in the past and also moving forward. It's all dependent on if we're funding acquisition activity.

[indiscernible] 19%. What's your view on the New South Wales gaming reforms from earlier in the year and the Victoria ones more recently? Can you talk to the potential risk around that? Do you think it's manageable?

Well, I think the question, again -- I think your line was breaking up there. But I think the question in relation to gaming reforms in New South Wales, well, that's not proceeding any longer under the new government. In Victoria, Endeavour Group have come out and said that they're going to meet the Victorian changes well ahead of schedule, and they were anticipated by Endeavour in any event. We're very comfortable with Endeavour as a partner and very comfortable. We don't take operating risk. We've got triple net leases to a best-in-class operator, but we're very comfortable with their business and where our assets sit and the quality of our portfolio.

Next question comes from Simon Chan of Morgan Stanley.

Avi, during this conference call, in the Q&A section, you've mentioned asset sales you're looking at recycling several times. Can I just ask how serious or how active are those asset divestment programs at the moment in your company? And I'm asking this because if I look at Slide 23, your gearing, your look-through gearing as it relates to debt covenant is like 42.3%, right, versus covenant of 50%. If you cop another a similar deval to what you did in the last 6 months, it's going to take it close to 48%. Just wondering, is it -- how big is your divestment program potentially? And I guess the second part of the question is what other strategies do you have in place to deal with the impact of further devals?

Thanks, Simon. Look, in relation to asset values and sort of where we are relative to covenants, I think we've still got a very good buffer to where covenants sit, asset values need to decline a lot more than what we saw recently for us to be anywhere near covenants. Having said that, we are, as I mentioned, you said I've mentioned a few times, we are looking at some divestments. There's a couple of things we've progressed on at the moment, not something I can talk about now because it's still very conditional. But we are serious about it. It's something we're looking at making some progress towards in the coming months. But having said that, we're comfortable with where we sit at the moment and where we are relative to covenants.

Fair enough. Next question, can you give us an update on Tank Street, because I think that's like the -- that's really the only refi risk you have over the next 12 months, isn't it?

Yes, it is, and it's very small. So we're in constructive dialogue with that tenant, hopeful of extending that lease.

Right. And just last one. I think Scott kind of covered it in his pres, just on Slide 10, operating expense is up a fair bit. What's the mechanics behind it? The footnotes or whatever on the side says full year impact of '22 acquisitions. Is that just simply due to part -- less assets coming in part year in '22 and then you've got the full year impact in '23?

That's right. So yes, we bought -- use the ALE portfolio as the example, we bought that in December '21. So half year impact in '22 numbers and then full year impact in FY '23.

If that's the case, how come NPI didn't have -- didn't see a similar percentage increase there?

You're seeing -- seeing strong 10.6% increase in NPI as well. Like it's not -- I'd have to break that down further for you. I can take that offline. But they're also a different basis of calculation as well. So that's the key driver.

Next up, we have the line from Alexander Prineas from Morningstar.

Just a question on the office section of the portfolio includes a lot of the -- a lot of shorter leases in the portfolio. When I say short, obviously, that's relative. They're still long leases. But as they are sort of overweight among the expiries over the next 5 years or so, can you just provide a bit more commentary on strategy there and a bit of commentary about the specific assets and how you're looking at renewals or what you're thinking about those assets?

Yes. Look, we're working with those tenants well ahead of expiries on extensions and renewals at a number of our office assets at the moment. The office assets are well occupied. We're very comfortable with that portfolio. They're generally modern assets, well located, high proportion of government tenants, and it's -- we're very comfortable with that portfolio. So without -- absent stepping through each one and their characteristics, I think that's probably the answer.

And just on CPI leases, any sort of change have you observed, any sort of different willingness from tenants to sign CPI leases? Presumably, it was easy to get CPI lease agreed back when inflation was low, but is there any resistance now that we're seeing what inflation can do?

Look, we've -- within CLW, we actually haven't had to sign any new leases given the long-dated nature of our portfolio. The lease structures that are in our leases remain those structures, and we haven't had any tenants asking us to review that. So very -- that's sort of where we sit on CPI.

[Operator Instructions] Next question comes from the line of Leanne Truong from Ord Minnett.

Just a follow-up in terms of your hospitality portfolio. It looks like you've devalued those assets by about 10%. What's been the driver of that?

Thanks, Leanne. Look, the main driver of that is actually those -- the assets, both the hospitality assets and also our bp service station assets have a CPI review in the second half of this calendar year that's based off the September print. When the valuers valued those assets in June, they didn't take into account the upcoming review. So when we get those assets revalued in the coming months, that review will get picked up. So that was the main reason for the larger variance in June on those portfolios.

We have the question from the line of Grant McCasker from UBS.

Avi, I was cut off, so I might have -- this question may have been asked, but I just want to check how you're funding the ALE index-linked bond, and if that is done from the balance sheet debt facilities, because that would add a couple of hundred basis points to your gearing, wouldn't it? Just checking.

Thanks, Grant. Look, it's funded from our $296 million of available debt capacity at the CLW balance sheet. It shouldn't have an impact to gearing. Our equity-accounted investment in that ALE portfolio will increase by $88 million because we -- the debt at that level is gone, and then the debt is now put on the balance sheet. So it shouldn't have a material impact to gearing at all.

But you're using the balance sheet debt, which goes up, which is that's how the covenant is calculated. So that's -- I just wanted to just clarify. So then on that covenant, have you started or commenced discussions with your lenders to give you extra headroom?

No, absolutely not. We're very comfortable with the headroom with both ICR and gearing covenants, and there's no need to be renegotiating those with the bank.

[Operator Instructions] As there no further questions at this time, I would like to hand the call back to Avi for closing remarks.

Thank you, everyone. I appreciate you joining the call today and look forward to meeting many of you in one-on-one meetings in the coming days. Thank you very much.