Charter Hall Retail REIT (CQR) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by, and welcome to the Charter Hall Retail REIT 2021 full year briefing. [Operator Instructions] Please note that this conference is being recorded today, Tuesday, the 17th of August. I would now like to hand the conference over to your host today, Mr. Greg Chubb, Retail CEO. Thank you, sir. Please go ahead.

Good morning, and welcome to the Charter Hall Retail REIT full year results presentation for the period ending 30 June 2021. My name is Greg Chubb. I am the Retail CEO for Charter Hall and an Executive Director of CQR. Joining me this morning is Christine Kelly, Head of Retail Finance and Deputy Fund Manager of CQR. I would 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, develop and create property assets on land across Australia and New Zealand. We pay our respects to the traditional owners, their elders past and present, and value their care and custodianship of these lands. Now turning to Slide 5 and our portfolio highlights for the period. I'm pleased to report that CQR's portfolio continues to demonstrate its resilience. The operating performance of our portfolio was strong in FY '21. We experienced strong MAT growth and increasing portfolio occupancy, continued positive leasing spreads and a significant increase in portfolio value and net tangible assets. Supermarkets are the foundation of our portfolio and achieved MAT growth of 4.3%, continuing a strong growth in sales across our portfolio. Total comparable MAT growth across the portfolio when including specialty sales was 5.4%, up from 3.9% at June 2020. Over the year, we had a record leasing activity with 457 specialty leases completed in the period, achieving positive leasing spreads of 1.6%. This activity translated into improved portfolio occupancy with the convenience retail portfolio occupancy lifting to 98.3%, up from 97.3% at June 2020. Additionally, specialty sales productivity is now more than $10,000 a square meter, and specialty occupancy costs decreased to a very sustainable 11.2% in FY '21. During the period, we expanded our partnership with bp with the acquisition of an interest in 70 long WALE convenience retail properties across New Zealand. We also grew our relationship with Coles via the acquisition of the Coles distribution center in Adelaide. Both these acquisitions have delivered significant valuation gains, materially increasing in value over the year. Additionally, they provided a secure and growing income stream that has been unaffected by the COVID-19 pandemic. These acquisitions, combined with valuation gains, has seen the portfolio value increased 12.1% over the year to $3.647 billion. Net tangible assets have also increased from $3.75 per unit to $4.01 per unit. These results translated into operating earnings of $156.2 million for the year, and that's up 9.5% on the prior comparable period. Operating earnings per unit were $0.273, that's down 10.7%, reflecting the impact of the April 2020 equity raise. Distributions for the year were $0.234 per unit and were more than 100% covered by operational cash flows. Now turning to Slide 6 and the REIT strategy. Our strategy is to be the leading owner of property for convenience retailers, and this is achieved through active asset management, enhancing the asset quality and maintaining a prudent capital position. The result of our strategy is that we deliver a resilient and growing income stream for our investors. Now looking at the strategies in more detail on Slide 7. At its core, the CQR portfolio of convenience assets are dominant in their respective catchments and provide essential everyday goods and services to the communities in which we operate. We proactively enable our major convenience retailers with the facilitation of omnichannel servicing through last-mile, home delivery, Click & Collect and, more recently, contactless pickup and direct to boot. Through the bp partnership, we've added another market-leading convenience retailer to the portfolio and expanded our reach to include a strong network of 295 fuel and convenience locations across Australia and New Zealand. Convenience comes in many forms, and this segment of the market continues to evolve and grow as a channel for essential goods and services. Now moving to Slide 8. In late June, we were pleased to announce the acquisition of Butler Central Shopping Centre in Western Australia for $51.2 million on a 6% cap rate. Butler Central is a convenience center located 40 kilometers north of the Perth CBD and was developed by Woolworths in 2018. The 9,000-square-meter center is anchored by a Woolworths supermarket with BWS, The Reject Shop and Best & Less mini-majors, 30 specialty shops and over 450 at-grade parking spaces. The center benefits from being located adjacent to the Butler Transport interchange with direct rail links through to Perth. The acquisition was negotiated off-market with Woolworths and is due to settle in September. As the dominant convenience retail center in a large and growing catchment, Butler Central is an excellent addition to the CQR portfolio. I'll now hand over to Christine to run through the financial results for the period, and then I'll return to discuss the operational performance in some more detail. Thank you, Christine.

Thanks, Greg. Now turning to Slide 10 and the financial impact from COVID-19 over FY '21. As you can see from the chart at the bottom of the slide, the financial impacts of the COVID-19 pandemic on CQR's financial performance continue to diminish over FY '21, with the level of tenant support progressively reducing as government-mandated restrictions eased and specialty sales and traffic rebounded strongly and quickly. Over the period, CQR provided $6.7 million of COVID-19-related tenant support, which was down significantly from the $10.7 million in tenant support we provided in the last quarter of FY '20. Additionally, rent collection over the period has been strong. As at June 30, rent outstanding was only $1.8 million or 0.6% of portfolio billings. Additionally, as at 31 July, FY '21 rent outstanding has reduced further to 0.5% of portfolio billings. Notably, $2.7 million or 60% of total COVID-19 rent deferrals over FY '20 and FY '21 has been repaid as of 30 June. Our expected credit loss provision reflects our strong rental collection over the period and also accounts for the continued uncertainty of the current trading environment. As a result, the $1.4 million of provisioning in our operating earnings remains largely unchanged from 30 June 2020 and is a reduction from the $1.7 million in December 2020. Our operating earnings and distributions can be found on Slide 11. We delivered operating earnings of $156.2 million or $0.273 per unit and distributions of $134 million or $0.234 per unit for the 12 months to 30 June '21. And this is in line with guidance provided in February this year. Our operating earnings payout ratio of 85.7% for the full year is up from 80.2% in FY '20, reflecting a reduction in COVID-19 tenant support. Total net income has risen $12.8 million or 7.1% to $194.1 million. This income growth has been driven by same-property NPI growth of 1.9%, our recent investments in long WALE convenience retail properties and offset by the divestment of 10 convenience retail properties in the prior period. Annexure 4 provides further details on the impacts of these movements on the total portfolio composition. Finance costs have reduced as a result of the timing of transactions, deleveraging from the April 2020 equity raise and continuation of the lower interest rate environment. Other expenses have increased, reflecting the net portfolio growth through both acquisitions and valuation growth and a corresponding increase in management fees. Consistent with the June '20 reporting period, our operating earnings includes recognition of income from those tenants that were provided COVID-19 tenant support. The $5.4 million of rent-free incentives agreed are included in operating earnings as they have been capitalized. The $1.3 million of rent deferrals have been included in operating earnings and recognized in property income. The strong operational performance has led to the positive timing of cash movements over the period. As a result, operating earnings and operational cash flow are largely aligned for the period, and the $134 million distribution is more than 100% covered by our operational cash flows. For the period, the primary impact of change in statutory profit is due to the positive valuation movements. A reconciliation of statutory profit to operating earnings and distributions can be found in annexure 2 of the presentation. Turning now to Slide 12 and the balance sheet. Our total property portfolio increased by $395 million over the 12-month period with positive valuation movement of $188 million and acquisitions exceeding divestments by $207 million. Our investment into long WALE convenience assets has increased following the bp New Zealand portfolio acquisition in December 2020 and the Coles Adelaide Distribution Centre in July. Borrowings have increased $115 million, primarily due to the investment into the bp New Zealand portfolio and capital investment. This is offset by capital returns received from RP1 following the divestment of Pemulwuy and West Ryde Marketplace. The primary impact on other assets and other liabilities is the movement in derivatives. The 7% growth in NTA from $3.75 to $4.01 predominantly reflects the strong valuation gains over the period. Our key valuation metrics are shown on Slide 13. 100% of the portfolio was revalued externally over FY '21 with 64% revalued externally as at 30 June 2021. Over the 12 months, the portfolio valuation increased to $3.6 billion with a portfolio cap rate of 5.81%, compressing 22 basis points. Our shopping center portfolio valuation increased 3.3% or $92 million, with $57 million of capital investment, with cap rate compressing 7 basis points. The long WALE convenience retail investments increased 14.2% or $96 million. The cap rate compressed 30 basis points to 4.7%, reflecting the increasing demand for this asset class over the last 12 months. The valuation uplift of these movements was an increase of $130 million or 3.7%. Notably, the valuation uplift for those assets acquired in the last 12 months was 28%. The revaluation movement over the period reflects the quality and resilience of the portfolio and our continued commitment to active asset management. Slide 14 shows key highlights of our capital management. Our liquidity sits at $308 million, placing the REIT in a strong position to manage any future uncertainties plus execute on strategic opportunities should they arise. The weighted average debt cost over FY '21 was 2.7%, which we expect to continue into FY '22 whilst the current interest rate environment endures. Over the past 12 months, we have refinanced $525 million of debt maturing over FY '22 and FY '23, with no debt maturing until 2024. This results in the weighted average maturity extending to 4.1 years. Our balance sheet gearing remains low at 25.7%, and look-through gearing is in the middle of the 30% to 40% range at 33.1%. The gearing levels will increase approximately 1% following the acquisition of Butler Central expected in September. We're comfortably within our gearing and ICR covenants. And during the period, Moody's reaffirmed our Baa1 issuer rating with a stable outlook. Now back to Greg to present the operational performance of the fund and our outlook.

Thanks, Christine, and we'll turn to Slide 16 for the portfolio summary. And even with the disruptive effects of the COVID-19 pandemic across the country, the resilience of CQR's assets has been evident, as has the success of our strategy of aligning with major convenience retailers. Our centers have seen occupancy improved from 97.3% to 98.3% over the year. Portfolio MAT growth improved from 3.9% to 5.4%, and portfolio WALE increased from 7.2 years to 7.5 years following acquisitions and major lease extensions. Our growing partnerships with bp and Coles increases our exposure to long WALE assets within the REIT and has contributed to strong valuation gains and delivered certainty of income. Collectively, these changes to the portfolio has seen a weighted average portfolio cap rate compress from 6.03% to 5.81%. Now let's talk about our tenant customer profile in some more detail on Slide 17. In FY '21, we've increased the proportion of portfolio rental income from our major tenants from 51% to 53.5%. Our portfolio remains well balanced between Coles and Woolworths, both the equal largest contributors to portfolio income. The expansion of the bp partnership now sees it as our third largest tenant customer at 12.1% of rental income. Importantly, we continue to grow our partnership with ALDI, and they are now the fifth largest tenant customer with 12 stores across the portfolio. When we look to our exposure to any one specialty retailer, it remains limited. And we retain a clear bias towards everyday needs and convenience-based retail, food and services. Now turning to Slide 18. Supermarkets continue to demonstrate their resilience, delivering MAT growth of 4.3% over 12 months or 10.3% over 2 years to June 2021. Demonstrating the quality of our portfolio, the number of supermarkets in turnover increased to a record 66%, with a further 17% of supermarkets within 10% of their respective turnover thresholds. We completed 10 supermarket new leases and term extensions, while 14 supermarkets or 20% of the supermarkets within the portfolio were refurbished by the operators over the period. Partnering with our supermarket tenants, we've expedited the rollout of Click & Collect and direct-to-boot facilities across our centers. This enables our major retail partners to adapt to the evolving customer needs in a pandemic environment. With 49 Click & Collect facilities in place and a further 5 planned, coverage with Coles and Woolworths will sit at 95% of their stores within the CQR portfolio. This is a significant differentiator and a desirable consumer amenity. Now turning to Slide 19. Our specialty tenants continue to be impacted due to COVID-19-related lockdowns, mandated store closures and trading restrictions. However, a considerable portion of our portfolio specialty tenants have been permitted to remain open and trading during lockdowns and restrictions given their role in providing food, essential goods and services. Additionally, customer traffic and sales have rebounded quickly and strongly once restrictions are lifted. Specialty tenants delivered 7.1% MAT growth for the year, and sales productivity lifted to a record $10,213 per square meter. This saw occupancy cost decrease to a very sustainable 11.2%. As mentioned during our portfolio highlights, it was a record year of leasing activity with 457 transactions delivering positive leasing spreads of 1.6%. 215 of these were new leases, and they were completed during the period with a positive leasing spread of 3.8%. Incentives for new leases remained stable at 13 months. Additionally, 242 renewals were completed with positive leasing spreads of 0.2%. Our retention rate lifted to 80%, and that's up from 72% as at June 2020. Whilst ongoing mandated closures and trading restrictions may temporarily impact future sales productivity and MAT growth, the CQR portfolio has demonstrated its resilience through prior COVID-19 lockdowns and restrictions. Our specialty tenant sales and customer traffic continues to rebound strongly and quickly when restrictions are eased. The portfolio's strong sales productivity, sustainable occupancy costs, positive leasing spreads and high tenant retention demonstrates the ongoing defensive and resilient nature of CQR's income. Now moving to Slide 20. We continue to proactively invest in our centers to ensure they maintain their position as the dominant convenience centers within their respective catchments. Over the year, we invested $58 million of capital across the portfolio that was recognized in portfolio valuation gains. We continue to align our capital works program alongside our major tenants as they invest in their existing store networks. Our capital investment alongside the investment by our major tenant customers has delivered lease extensions, expanded stores and enhanced convenience. We completed the Bass Hill redevelopment in Sydney, including the refurbishment of Woolworths and the expansion and refurbishment of ALDI. We also completed the upgrade of food forecourt area at Pacific Square in Sydney. Notably, Pacific Square is now the highest-performing MAT per square meter for centers in Australia with a GLA of less than 20,000 square meters as rated by Shopping Centre News. We continue to unlock value through pad site developments and introduce new users into the portfolio. As part of this program, we completed 2 childcare facilities in Western Australia and have commenced works on 2 drive-through food offerings in Victoria. Looking forward, we've identified a pipeline of potential pad site developments, and subject to development approvals and leasing demand, we believe there are between 10 to 20 future development opportunities. In addition, we've also continued to apply capital towards sustainability initiatives. Our sustainability investments have been directed towards reducing our carbon emissions and initiatives that reduce operating costs and outgoings. Importantly, these asset enhancement projects are low risk and deliver a positive total return on investments and incremental earnings while ensuring our centers remain the dominant convenience retail centers within their respective catchments. Now turning to Slide 21. We've previously made a commitment to net 0 emissions by 2030 across our portfolio. I'm pleased to announce today that we have brought forward this target for the CQR portfolio to 2025. We have a clear pathway to 100% net 0 carbon emissions and 100% renewable energy for CQR by 2025. We now have 16.7 megawatts of solar installations commissioned across 23 centers with a further 3 megawatts across 4 assets to be completed and commissioned early in FY '22. In addition, we continue to partner with our major tenants, all of whom have set net 0 or renewable energy targets. As part of this, we've seen Coles and Woolworths install a further 2.9 megawatts of solar at our centers to meet their own targets. We have improved our NABERS energy and water ratings across the portfolio and expanded our NABERS footprint. Our successes here have been recognized with improved GRESB ratings. Our ESG commitments also extends to recognizing the important role our centers play within their respective communities, and we continue to undertake a range of community initiatives, supporting 16 local community programs and donating over $500,000 to local fundraising activities. Now moving to Slide 22. Annually, we continue to engage Monash University to survey our tenant customers regarding the satisfaction in dealings with us. Pleasingly, our overall tenant customer satisfaction increased significantly year-on-year. Our tenant customers told us that our people continue to be our greatest strength, coupled with our approach and response to the COVID-19 pandemic and associated operational challenges. Notably, the likely to recommend score increased for Charter Hall to a 5-year high. During the COVID-19 pandemic, it's the Charter Hall team and their commitment to maintaining strong tenant customer partnerships that has been critical in the ongoing delivery of CQR's strategy. I would like to acknowledge and thank our teams for their continued efforts. Now turning to Slide 24, and we'll take a closer look at the current operational impacts from COVID post balance date. Our priority during the pandemic has always been safeguarding the health and well-being of our team, our shoppers and our tenant customers whilst ensuring our communities continue to have access to food and essential goods and services, which are at the core to our convenience-based assets. Since late June, we've seen various snap lockdowns across multiple jurisdictions that has highlighted the continued uncertainty of day-to-day trading conditions whilst COVID-19 persists within Australia. Today, we have 428 specialty stores temporarily nontrading. This represents 10.8% or approximately $2.6 million of the portfolio's monthly total income. Of the 428 specialty stores that are temporarily not trading, 274 of these specialty stores are SMEs. These SMEs represent 5.5% or approximately $1.3 million of the portfolio's monthly income. CQR's model is one of partnership with our tenant customers. And as we continue to navigate the ongoing challenges of the COVID-19 pandemic, we will look to prioritize support negotiations with genuinely impacted SMEs in accordance with the recently announced Commercial Codes in New South Wales and Victoria. Portfolio rent collections for the month of July 2021 were 93%, with New South Wales and Victoria at 89% and 90%, respectively. Importantly, our strategy is to be the leading owner of property for convenience retailers, and our 53.5% weighting towards major retailers and long WALE retail underpins the majority of CQR's earnings. As I've mentioned several times already, CQR investors benefit from the quality of our portfolio and our centers being the dominant convenience-based retail centers in their respective catchments as customers continue to shop closer to home for their everyday needs. Now finally, turning to Slide 25 for our summary and outlook. CQR's portfolio is expected to continue to demonstrate its resilience and defensive qualities in financial year '22. We will continue to focus our portfolio curation activities on providing income resilience, and our strategy remains focused on partnering with the leading nondiscretionary convenience retailers. Our expectation is that supermarket and convenience retail sales will continue to be strong, driven by customers' preferences to shop closer to home and focus on everyday needs, subject to COVID-19 lockdowns. For our specialty tenants, we have seen their sales and traffic rebound strongly and quickly after temporary COVID-19 lockdowns and restrictions. We expect this pattern to continue. In light of the current COVID-19 lockdowns across multiple jurisdictions and uncertainty as to when these restrictions will be lifted and the ongoing risk of additional measures, CQR will not be providing FY '22 earnings guidance at the current time. Distributions will continue to be paid with reference to operating cash flows. Now that ends the formal remarks, and I'll now hand back to the operator to seek any questions. Thank you.

[Operator Instructions] Your first question comes from Lou Pirenc with Jarden.

Two questions, one long term, one short term. In the short term, can you just talk a little bit about -- I mean it's very useful, the color you've provided in terms of the impact on your rents. Just interested to see if the lockdowns continue, whether you expect more of your tenants to close down. Have you seen that kind of over time?

No, Lou. The tenants that remain open -- and you'll note that most of the impact for us is in the state of New South Wales. So we've got in excess of 1,000 stores in New South Wales, and just under 400 of those are currently closed. So over 60% of our stores -- specialty stores remain open, and we would anticipate that they will remain open. So I don't see that changing.

Yes. And linked to that, have you taken a view about -- clearly, there's a code of conduct for your SME specialty stores, what approach you're going to take with the others? In terms of providing rent...

We'll deal with it on a case by case -- it will be on a case-by-case situation, Lou, as we did the same this time last year, so very much tailored support on a case-by-case situation.

Great. And then more in the longer term, what is your acquisition pipeline? And what does the market look like? You've been successful with Butler, but it's -- do you feel that there's a good pipeline of acquisitions coming through?

It's very competitive at the moment. There's been significant transactions occurred post balance date, and we've seen activity in excess of $200 million for convenience-based assets at pretty tight pricing. So we've always got one foot in the market. We're always assessing opportunities. And where we see value and opportunities to continue to drive the portfolio performance, we'll acquire. But there has been significant activity and it's very, very competitive in our universe.

Your next question comes from Adrian Dark with Citi.

First question might be one for Christine. Could you clarify for me, please, the treatment of COVID impacts in [indiscernible]?

So look, how we -- COVID impacts [ consistent ] with 30 June. So we've not changed our accounting treatment since then. So our operating earnings include a recognition of income from those tenants that were provided the tenant support as all incentives have been capitalized. And on the deferrals, obviously, that's treated in our receivables, and there's an ECL against that. So this is consistent with how we've treated it in previous periods and also accounting for rent-free incentives in our normal course of business.

Okay. So I think I think you mentioned somewhere in the order of $67 million of COVID impact in FY '21. Is it correct to think that most of that is not reducing operating earnings?

So of that, so we have the $5.4 million, which is rent-free incentives. So that's not reducing our operating earnings. And then we also have the deferrals. And against the deferrals, we have that ECL provision.

Okay. And then more of an operational question. Obviously, you've pointed to lockdown across a range of geographies and it's a fairly fluid environment. I was looking at specialty sales result of Victoria, which was reasonably soft in FY '21, as you'd probably expect given protracted lockdowns in Melbourne over the course of the year. It looks like there hasn't really been a material narrowing of the gap between Victoria and the rest of the portfolio in the second half of the year post lockdown. So I was interested in whether you're seeing a difference in leasing appetite or outcomes in Victoria versus the rest of the portfolio. And any thoughts you have on that in relation to New South Wales given what's happened there, please.

Yes, sure. So no, we haven't seen any material difference in leasing demand in Victoria. So we've got 4 strong assets in Victoria. But for Victoria to go through what it went through last year and for our specialty MAT to be only negative 2.5% is still a very good outcome to my mind. And then with New South Wales, obviously, that's our largest geography. And surprisingly, still our leasing team is transacting. So I don't think I can add any more color than that at this point in time, Adrian.

[Operator Instructions] Your next question comes from Stuart McLean with Macquarie.

Sorry if these questions have already been asked. But I was just looking at -- first question, just looking at Slide 35 in the specialty and mini-major tenant expiry profile, it looks it's almost 21% of expiries coming up in FY '22. Can you just talk to how you're seeing rental spreads, how you're thinking about tenant retention over that large proportion of your profile, please?

Yes. So the standard specialty lease to be circa 5 years, just simple math is around 20%. Obviously, we had a pretty strong year of renewal activity in '21 with a retention rate in the 80% range and positive spreads. So at this point in time, we don't see why that would change. And that 20% expiry profile in F '22 doesn't cause us any concern whatsoever.

Okay. Sorry, just to confirm you're still expecting positive leasing spreads across the portfolio in FY '22.

That's what we'll be aiming for. So with -- all we can look at is the lead indicators for us, which is our sales densities at now over $10,000 per square meter and our occupancy cost at 11.2%. And ultimately, leasing is a supply and demand game as well, and we've got limited supply and pretty strong demand ongoing. So we'll be working with our leasing team. We've got 25 strong leasing team. They'll be doing everything they can to come up with the right outcomes. And it's not all about financial outcomes either. It's about making sure we're bringing forward the best possible mix to make sure that the centers remain their dominant positions at all time.

And then second question just related to Slide 24. Again, apologies if this has been asked. But would there be -- sort of SMEs at 5.5% of total monthly income, which were the ones that will be receiving the rental relief as per the code. Is there a number of tenants that -- and not SMEs that you're likely to provide or need to provide rent relief to as well?