Cromwell Property Group (CMW) Earnings Call Transcript & Summary

Good day, and welcome to the Cromwell Property Group Half Year '23 Results Conference Call. [Operator Instructions] Finally, I would like to advise occupants this call is being recorded. Thank you. I'd now like to welcome Dr. Gary Weiss, Chair of the Board to begin the conference. Dr. Weiss, over to you.

Thank you, and welcome to everyone on today's call. I would like to open today's meeting by acknowledging the traditional custodians of the lands on which we meet today and pay my respects to their elders past, present and emerging. I speak from the Caddiegal lands of the Eora Nation. Welcome to Cromwell Property Group's financial results update for the half year period ended 31 December 2022. We acknowledge the tough environment that Cromwell is currently operating in. Today, I would like to focus on how the Cromwell team, led by Jonathan Callaghan, has navigated through this environment and put in place a stable and committed team with clear goals and objectives and an operating platform designed to achieve success. I'm pleased to report that Cromwell's assets under management remained at $12 billion with ongoing positive activity. We have seen good progress towards the simplification of Cromwell's operating structure, improved staff retention and engagement scores and continuing focus on balance sheet management by the execution of noncore asset sales. This is reflective of Cromwell's long-standing ability to adapt and continue to drive success through complex market conditions. The Board remains focused on the next stages of growth for Cromwell. We do this mindful of the headwinds the group faces across the regions in which we operate as high interest rates impact valuations and confident stores and investment markets. We move forward cautiously, focused on reinforcing our balance sheet while rigorously assessing potential growth opportunities. I now hand over to Jonathan to review the activities for the first half of the financial year ended 31 December, 2022.

Thank you, Gary. Cromwell has achieved some important milestones in not only the 6 months since our last update, but also in the last 1.5 years since we went through a period of company-wide change, defining a new strategy and having to adjust and pivot to suit changing economic conditions. Looking at Slide 7, which is an overview of our strategic summary. We remain focused on continuing to strengthen our business and transition to a capital-light fund manager. We will apply our long-standing skills of managing well-located assets and continuing to improve them through leasing efforts and repositioning. We continue to focus on noncore asset sales, which are well progressed. We particularly note the exit of our position in LDK, which has substantially simplified our balance sheet back to our core business of real estate. At the people-driven business, we continue our focus on being an employer of choice, placing huge emphasis on diversity, quality and inclusion. We've redefined our values and reset our corporate strategy. Importantly, as part of these reflective processes, we've also refreshed and redefined Cromwell's environmental, social and governance or our ESG ambitions, setting targets, which we believe are impactful and achievable, outlined at headline level on Slide 10 and more information is available in our 2022 ESG report available to view on our website. We turn to our financial summary on Slide 8. Our global AUM remains at $12 billion, split equally across our platforms. There remains a high weight into global office markets, but we expect an increased exposure to industrial and logistics sectors as investor demand for these asset classes far outstrips that for office. During the last 6 months period, there have been substantial challenges posed by changes in the macroeconomic environments in which we operate. For the half year ended 31 December, 2022, Cromwell reports statutory loss of $129.5 million due largely to revaluations and an operating profit of $87.1 million, which benefited from the performance of our funds management platform. Michael will talk shortly about our financial performance in more detail, although I will note that we have a keen focus on the liability side of our balance sheet, and we are managing our debt and hedging positions very closely. We are comfortable with the current positions, although we are aware during global economic challenges, this is a time to be prudent. We can quickly adapt and adjust when needed. I will now hand over to Michael to talk more about the group's overall financial performance and capital management.

Thank you, Jonathan. I'll start on Slide 12. Cromwell reports a statutory loss of $129.5 million for the 6 months to 31 December, 2022. This was the result of $113.3 million in unrealized fair value losses on investment properties in Australia, where market-wide valuation impacts are being felt. Our Polish retail portfolio has also experienced both surging energy costs and valuation impacts felt across the wider European retail sector, both amplified in this case by the neighboring war in Ukraine. The Polish retail portfolio recorded $68.1 million in unrealized fair value losses. We reported an operating profit of $87.1 million for the period of 6 months to 31 December, 2022, which was 10% down on the prior corresponding period of $96.4 million. The half year operating profit is equivalent to $0.033 per security, down 10% on the prior corresponding period. On a like-for-like basis, excluding asset sales, net operating income from the Australian property portfolio was up 2.7%. Performance of the funds management platform improved on prior reporting period with an operating profit of $27.2 million, up from $22.7 million for December, 2021. This was offset by lower total net operating income in the Australian investment portfolio following the sale of noncore assets during the second half of FY'22, lower operating profit from the Cromwell Polish Retail portfolio and increased finance costs. Turning to segmented results on Slide 13. I'll start with growth in our fund and asset management business, reporting $27.2 million in segment profit. The European business generated an operating profit of $4.6 million as a result of higher recurring fee income and performance fee income. In addition, fund and asset management revenue includes the $7.7 million profit made from the sale of our interest in LDK, which included a payment of $20 million for our equity interest. The Australian Funds Management business saw no transaction or performance fees during the period. Returns from our co-investment positions were down by 6% compared with the prior corresponding period. Our long-term position in the Cromwell European REIT, listed on the Singapore Exchange, showed resilience with our share of operating profit being $20.1 million versus the $21.6 million for the prior corresponding period. We received distributions of $19.8 million during the half year. The Cromwell Urban Italian Logistics Fund performed well through the half year, with sole tenant DHL, continuing to report robust transport demand. Valuations were slightly up, and operating profit was $1.1 million. This portfolio is now being actively marketed for either sale or co-investment. Cromwell Polish Retail Fund suffered valuation impacts during the half year period. As is well known across Europe, retail assets have been impacted by rising inflation and rising energy costs. These cost increases are compounded by the war in neighbor, Ukraine. All asset values fell during the period, down 9.8% compared with the June 2022 valuations. This portfolio continues to be marketed for sale. I'll now turn to capital management outlined on Slide 14. Owing to the combination of valuations and timing of LDK loan repayments, our gearing is at 41.8%, marginally outside our gearing range. We anticipate this to be restored once the LDK loans are repaid and from the use of the proceeds from the sale of our asset at 84 Crown Street, [ Wollongong ]. As we continue through the process of selling noncore assets, we will be focused on applying new sale proceeds in the first instance to debt repayment to ensure we maintain a strong balance sheet. We have a manageable debt expiry profile, with only a small amount of offshore debt expiring next financial year. Cromwell will continue to enjoy solid banking from domestic and global banks. This was validated by the extensions late in this period of EUR 215 million of the euro-denominated revolver and a 3-year extension on $200 million of Cromwell's Australian facilities. Liquidity remains high with $294 million available on demand. 58% of our current book is hedged against future interest rates at an average 2.2-year term, providing ongoing security in the current environment. Hedging is up from 2.1 years at 30 June, 2022, through an additional three new forward starting interest rate caps, one of which commenced in December '22 and the remaining two commenced in July 2023, maturing in July '24 and July '25, respectively. We continue to monitor our position closely and we'll increase our hedging when the current global market dislocations create the best opportunity to do so. This will be managed in line with noncore asset sales. Jonathan, I'll now hand back to you to review the segment updates in more detail.

Thanks, Michael. Starting on Slide 17, outlining our fund and asset management activities. We report that our European platform has closed three new nonprogretionary mandates. Two mandates are focused on Germany and Nordics Logistics and one is a pan-European mandate. Deployment has started with several assets contracted to settle in the first quarter of 2023, totaling approximately EUR 300 million. All revenue trends reported growth in Europe, generating an operating profit of $4.6 million, up from December 2021 loss of $800,000, included in this profit figure our performance fees of $3.8 million. In Australia, our retail funds management platform generated $3.3 million of operating profit down from $9.9 million in the prior corresponding period, driven largely by the absence of transactional and performance fees. Within the Cromwell Diversified Fund, all assets were externally valued during the reporting period, resulting in revaluations down of 2.8% to $633 million on a like-for-like basis, rating Canberra, which was sold for $18.2 million at a 3.9% premium to book value. The DPS suffered a decline of inflows from the prior corresponding period, down to $16 million of net inflows. This was driven by market sentiment around inflation, which led to reduced new investments. We remain focused on careful asset selection in key locations for this portfolio and continue to assess various [indiscernible]. Outlined on Slide 22, co-investment income over the period was down slightly. In DPF, our position was valued at $18.9 million, down approximately $1 million. This position remains a long-term strategic commitment for Cromwell. Cromwell's 28% stake in CEREIT has carried at book value of $573.6 million and received operating profit of just over $20 million for the 6 months to December -- to 31 December, 2022. We consider this position important to Cromwell's ongoing strategy and continue to support CREIT's pivot to logistics in Europe, currently, almost 50% of its portfolio, but Cromwell's active asset management experience can add and enhance value. We continue to refine the compositions of the Australian investment portfolio outlined in Slides 25 to 27, selling noncore assets, the process of which are prioritized to repay debt. Portfolio occupancy remains strong at 95.6% by income, a WALE of 5.6 years and weighted average cap rate of 5.4%. The portfolio remains maintained a strong weighting of more than 50% to government tenants, providing high income security in volatile markets with very low and manageable levels of lease expiries in the next few years. Leasing activity remained solid during the half year with 18,500 square meters of renegotiated or new leases struck and weighted average rent increases as a result of annual rent increases or rent reviews of 4.5%. This reflects positivity on our strategy of having well-managed, well-located assets in this portfolio and the strength of our in-house [indiscernible] key focus on our portfolio is active asset management, which has been Cromwell's strong suit for many, many years. The incremental upgrades, refurbishments and additions we identify through strong tenant engagement and market intel is what sets us aside and is reflected in our strong portfolio metrics. On Slide 26, we have outlined a few of these initiatives and the subsequent successes we have found in a market full of commentary around the retreat from CBD offers and large-scale downsizing. The relationships the team has directly with our tenants and the capability to position our assets to meet tenant needs [ season ] outperform. Looking forward, we continue to move forward with our strategy of becoming a capital-light fund manager. We will continue to focus on simplification of the business, particularly the sale of assets in Cromwell Polish Retail Fund and the Cromwell Italy Urban Logistics Fund with the process to be applied to reduce gearing to acceptable levels before disciplined strategic redeployments into growth activities. In the immediate coming months, we will continue to ensure the stability of our balance sheet closely monitoring and managing debt and hedging. As always, our active asset management and leasing will continue to bolster asset management activities globally with an invigorated focus on ESG considerations. We expect to pay a distribution of [ $0.1375 ] per security for the March 2023 quarter, while we prudently manage distribution to account for current market conditions, overlaid with any timing lags between asset sales and redeployment. Thank you for dialing in to today's update. I will now hand back to the conference operator to open to questions.

[Operator Instructions] And your first question comes from the line of Solomon Zhang from JPMorgan.

Two questions from me. Firstly, just on the Polish retail assets as you called out a pretty challenging environment with inflation in the teams and discretionary sales down quite a bit. Can you perhaps just discuss the operating performance of those assets? And also the lease structures. Are any CPI linked or are they mostly fixed?

Yes, happy to talk about that. The portfolio -- the Polish portfolio is performing satisfactorily. The biggest headwinds it faces are the outgoing increases as a result of the energy situation in Poland, particularly the gas pricing. There are caps on the out guides that we can receive from tenants and many of those caps are being hit. So that's providing a bit of headwind. The other big headwind is the debt associated with those assets. The Euribor, in particular, has sort of gone from 0 to about 2.6 in the space of 6 months, and that's provided a little bit of headwind. But generally speaking, the performance of the assets, the footfall, the turnover is all returning back to pre-COVID levels. It's not quite there on footfall yet, but it's approaching it. So generally speaking, the assets are performing quite well. In relation to increases in the leases, are they CPI? They're generally CPI linked.

Great. And just on occupancy...

Just to be clear, the CPI linked to the European CPI, not the Polish CPI and they have caps.

Yes. What was the cap [indiscernible]?

The caps on the CPI increases?

Yes. So they use this cost of living calculation in Poland. It's all to do with equity to the retail tenants and how much we can pass on. So it varies depending on the size of the tenant.

Great. Second question, just on the AUM outlook for the EU fund business. Could you just give us a feel for how quickly you expect to deploy that $1.9 billion in mandate capacity in this current environment? And also, could you discuss the upcoming expiries of any mandates that might be rolling off over the next couple of years?

Sure. The biggest expiry we pay to CPRF to the Polish retail assets that we're selling, that will be pretty much the only material expiry in the next few years. And in terms of deployment, of the dry powder, I'd be hesitant to really say how quickly we can deploy that. It depends upon a number of factors. First is that these are nondiscretionary mandates. So the grants the mandate has final say on whether or not to invest it. And whilst activity is returning to the European market, it is still fair to say that it is a little bit new to the demand.

[Operator Instructions] And your next question comes from the line of Alex Prineas from Morningstar.

First of all, just wondering with the neighbors energy and water ratings, clearly, there's quite a few 5.5 and 6 star ratings in there, which is good to see. But what would it take to get the remainder of the lower rated buildings up to 5.5 or 6 stars. Is that incremental spend? Or are some of those buildings never sort of likely to be able to achieve those types of ratings?

Yes. I mean I don't think I can give you a specific answer, but I can give you a general answer. I mean, generally speaking, most of the things that you spend money on to bring up the neighbor's rating is effectively your lighting, the sort of lighting you put in. It's your lifting and at your HVAC that is sort of the three big ones in terms of operational efficiencies. All of those things have to be replaced over time. So a lot of the efficiencies that you'll get from upgrading the assets, those expenses are already cash or basically already typically picked up in the valuation depending upon when it's being spent. So naturally, over a period of time, we do expect an improvement in the neighbor's ratings for all of the assets, particularly the lower and these are general comment. It becomes more difficult when you need to start doing things for the facade, and that usually is the facade or the glass in the facade. But generally speaking, we do expect the lower-rated assets to improve over time naturally.

Can you maybe just elaborate on how many of the buildings need those more significant facade works?

I would have to take that question offline. Alex.

No worries. That's okay. And then just on the -- a significant portion of the portfolio that is occupied by government tenants, can you comment on what the sort of employee presentee rate is or the utilization rate? I guess I'm just trying to get a feel for when those leases are great to have and rock solid. But when the lease expires, I'm sort of looking at what indicators I can look at to see whether that lease is likely to be renewed?

Yes. And I understand. The short answer is particularly -- I mean I think we don't have a great indication of the presentism in those particular buildings. But what I would say is that I haven't seen government tenants shrinking yet. Because they may be adapting to different ways of working. The one on the density, I guess, of the requirements that we have set in the market have increased rather than decrease.

Okay. And just a follow-up on the new mandates as well. Are you able to comment on -- so they're nondiscretionary mandates. Can you elaborate on what that means versus your sort of [indiscernible] in terms of -- compared to your existing book of [indiscernible], what sort of proportion of [indiscernible] or profitability level, these new mandates are likely to be once deployed?

The current [indiscernible] in Europe, in euro, is EUR 3 billion?

It is EUR 3.5 billion.

EUR 3.5 billion. About EUR 500 million of that is in the European -- in the Polish assets that are on the market, EUR 500 million roughly. So you're looking at sort of -- if you take that into account, it shrinks to EUR 3 billion. And so that gives you an idea of scale of these mandates. And what does it mean?

Yes. I'm just looking for potential fee levels on the new mandates versus existing?

They vary, but they're certainly not as high as the CEREIT [ fee loads ]. These would be typical [ nondiscretionary ] mandate staff fees, which sort of range between 20 to 35 basis points.

Your next question comes from the line of Fiona Buchanan from Morgans.

Just on the retail on the, I guess, more domestic retail. Obviously, there was a comment, not unexpected that inflows were a bit softer. Just any comment around what you're seeing, I guess, in the last few months around more the retail distribution side?

Sorry, [ Fiona ] the very last few months?

Just what you've seen, if there have been any changes in the last couple of months on what you're seeing on the domestic retail inflows with those funds you've got?

Yes. They definitely have been slowing down the inflows, but they're still present. So I mean really, if I could give a sort of a rough number, I mean, because it all depends upon a number of different ways, but I would say that the gross inflows are down about 40%. And -- yes.

[Operator Instructions] As there are no further questions, I would like to thank our speakers for today's presentation, and thank you all for joining us. This now concludes today's conference. You may now disconnect.