Cromwell Property Group (CMW) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the Cromwell Property Group FY '23 Results. [Operator Instructions] I would now like to turn the conference over to Dr. Gary Weiss, Chairman. Please go ahead.

Thank you to everyone who has called in today. Welcome. I acknowledge the traditional custodians of the land on which we meet and pay my respect to their elders past, present and emerging. Today, I speak from the Gadigal land of the Eora nation. We opened our annual results for the period ended 30 June, 2023, looking at the company's performance for the year behind us. While it has been a challenging 12 months, we have made progress on a number of our key strategic initiatives. During the financial year, Cromwell has continued to simplify the business, going back to key core funds and property management. We have continued our program to sell noncore assets on and offshore, as well as growing our fund management platform in a measured way, which Jonathan will speak to more in a minute. While the company's gearing at balance date was 42.6%, outside of our target range, it is to be noted that Cromwell has sold more than $240 million of noncore assets and reduced borrowings by $319 million over the financial year. Unfortunately, valuation declines have hindered more positive gearing ratios being achieved. [indiscernible] navigating the current environment is balance sheet strength through prudent capital management, including good leader relationships and hedging, which Michael will set through in more detail. As we move into FY '24, Cromwell is positioning itself to move into the next phase of growth. We have continued to simplify our business and to focus on key skills of funds management and asset repositioning strategies, further debt reduction and completion of our asset sale program. I'll now hand over to Jonathan to speak more about the operations of the group over the last 12 months.

Thank you, Gary. I'd like to start by reviewing some of the key strategic achievements outlined on Slide 7. Since 2021, Cromwell has been focused on the simplification of its business strategy, aiming to focus on its fund management business and reducing its gearing by selling noncore assets and businesses. To date, we have completed noncore asset sales of more than $460 million locally. We have completed a 50% exit of Italian logistics, selling down to a new joint venture partner, Value Partners in Italy. Earlier in the year, we made a full exit of LDK returning some $160 million of invested capital. Cromwell's fund management platform is performing well, notwithstanding the obvious headwinds faced by the sector. We're reducing nondiscretionary mandates, approximately 1/4 deployed in Europe and the proposed transaction between Cromwell's Diversified Property Fund and Australian Unity Diversified Property Fund, which is implemented, will increase the size of this fund significantly. With our continued focus on ESG, we're proud that the Cromwell Direct Property Fund, we've now ranked equal third in NABERS Sustainable Portfolios Index 2023 for energy performance, up from equal fifth and ranked equal seventh for water performance. Also pleasing is that our latest GRESB scores are all above average for management performance, environmental, social and governance, with Cromwell Direct Property Funds growing 87 out of 100. And our Australian investment portfolio, we've now rated equal fourth for by NABERS Sustainability Portfolio Index for energy performance, up from 14th in 2022 and equal eighth in water performance. Our GRESB score has improved here as well, scoring overall 82 out of the 100. Most recently, we announced the development of our sustainability finance framework, writing our first green line in Australia for $130 million for the Cromwell River Park Trust. Through active asset management, our assets -- through active asset management of our assets in Australia, we not only continue to meet the changing requirements of tenants, but also seek to address a shortcoming in the real estate industry of recognizing the value of the embedded carbon contained in our buildings. These and other ESG initiatives will continue to be a point of pride for our group locally, more of which Michelle Dance will step through later in his presentation. I will now hand over to Michelle (sic) [ Michael ] to review our financial performance.

Thanks Jonathan. Turning to Slide 12. We announced a statutory loss of $443.8 million for the financial year, but with underlying operating profit of $158.6 million, representing $0.066 per security. As many of our peers have covered off over the last month, we faced rising interest costs, which were up $23.8 million, equating to a 43.8% increase on the prior financial year. We're pleased with progress made on our debt repayment goal through asset sales, with a repayment of $319 million of debt through the 2023 financial year. Operating profit was $158.6 million, down 21.1% on last year, and distributions were $0.055 per security, representing a payout ratio of 19.8%. Turning to Slide 13. Fund and Asset Management in Australia achieved earnings of $28.8 million, down 23.8% on the prior financial year due to no transaction fees being earned in 2023. Earnings from our European business were up 5% to $12.5 million, due to higher performance fees. The Cromwell Poland Retail Fund received higher rents over the period, although this was more than offset by the increasing service charge costs in a high inflationary environment. In Australia, our investment portfolio headline performance was down 6.7%. However, excluding asset sales, the portfolio delivered like-for-like NOI growth of 3.9%. Corporate costs were down 10%, mainly due to lower insurance costs over the year. Turning to Slide 14, where we recognize the impact recent property revaluations have had on our NTA, which fell from $1.04 to $0.84. The total value of the Australian office portfolio fell by 9.1%, driven by cap rate expansion. This decrease was consistent with other falls seen in the market. The total value of the Polish retail portfolio fell by 21%. This portfolio consists of 6 wholly owned retail assets and a 50% joint venture of a further asset. The portfolio of 6 wholly owned assets is for sale and currently in exclusive due diligence. While external valuations had these 6 assets valued at a higher number, the Cromwell Board has adopted a carrying amount, which is reflective of the indicative offer from the party in exclusive due diligence. The offer was for the entire 6 assets, came with a strong commitment from the purchaser for the bid price, and there are substantial strategic benefits to exiting the portfolio. While completion of this transaction is not certain, adopting the offer price as the carrying amount, best reflects the application of the relevant accounting standards. Capital management outlined on Slide 15 remains a priority. Asset sales and retirement of debt will ensure we can bring our gearing in range and shore up the balance sheet for an uncertain operating environment over the next year. While our gearing of 42.6% is outside our target range of 30% to 40%, significant progress has been made on debt repayment, decreasing our net debt from $1.88 billion at June 2022 to $1.74 billion at June 2023. Our efforts to bring gearing back into range have been hindered by $491.6 million of asset revaluations. Further asset sales are slated for the 2024 financial year, with assets in due diligence of more than $560 million. Proceeds will be applied to debt repayment in the first instance. Including the sale of 2 Station Street Penrith, and the 50% sale of the Italian portfolio, both occurring after 30 June, 2023, we estimate gearing to be 40.9%. And upon the exit of the Cromwell Poland retail fund at the current carrying amount, further debt reductions, we've been gearing to well within our target range. I'll now turn to debt covenants and hedging on Slide 16. Simplification continued through 2023, with the closing out of the euro-denominated convertible bonds. We have a diversified lender profile, with a good split of exposure to Australian, Asian and European lenders. Near term expiry in 2024 is attributed to the Cromwell Poland retail fund asset level debt, and we are in advanced stages of renegotiation with 3 European lenders. We maintained comfortable buffers to covenants, noting that we negotiated the relaxation of the Euro revolver ICR covenant down to 2x to reflect the higher level of the EURIBOR 3-month rate. Cromwell is hedged to 70% with new collars commencing in July 2023. This level is appropriate given the potential future asset sales. Our current average cost of debt is 3.9%, including derivatives, up from June 2022 and in line with current markets globally. I will now hand back to Jonathan to talk about our fund and asset management and co-investment segments.

Thanks, Michael. Touching upon the co-investment performance on Slide 23 now. Our strategic investment in Cromwell Direct Property Fund remains valued at $16.5 million with a distribution of $1 million, representing a yield of 6.05% over the financial year. We hold a 28% share in Cromwell European REIT, listed on the Singaporean Stock Exchange, which is valued at $589.7 million. We received distributions through the financial year of $41.1 million and remain a committed long-term investor in this fund. CREIT has performed well over the year and continues to reweigh the portfolio towards logistics in Europe, having sold office assets of EUR 131 million and buying logistics assets of EUR 15.8 million. CREIT's performance remains robust, with net property income of EUR 68.5 million, up 3.9% for the half year to 30 June, 2023 on a like-for-like basis compared with the prior corresponding period. The fund's gearing remains well within covenant limits and out of the monetary authority of Singapore's mandated covenant limits. The Cromwell Italy Europe Urban Logistics Fund performed well over the financial year, 100% leased to DHL in Northern Italy. Cromwell's operating profit for the financial year was $3.5 million. The new joint venture with Value Partners commenced in June 2023, we took a 50% stake in the portfolio, based on a portfolio asset value of EUR 55.8 million. I will now hand over to Michelle, who will review the activities of the Australian investment portfolio.

Thank you, Jonathan. We have continued the simplification of the Australian investment portfolio, with $246.5 million of noncore asset sales throughout the 2023 financial year, the proceeds of which have been used to repay debt. A further $91.1 million of sales are under contracts and to complete in the coming [ weeks ]. Since the program commenced in December 2021, we've sold just over $300 million of Australian noncore assets, as or above book value in aggregate. Valuations in the portfolio were down 9.9% to $2.6 billion. For these declines are being mitigated by the sale of lower-quality assets such as Mary Street, TGA and The Cinemas' last financial year and assets in noncore markets such as Wollongong and Newcastle this financial year. The weighted average capitalization rate of the portfolio has increased over the year from 5.2% to 5.7%, which has been mitigated by leasing, which I'll discuss further shortly. While valuation movements have been largely driven by increases in global interest rates and capitalization rates, valuations have also been supported by pent-up demand in the sector of the office market in which we are invested. Premium investment and sustainability initiatives and asset repositioning has supported a strong leasing outcome, with approximately 18,500 square meters of space leased over the financial year, and 8.4% rental reversion on new leases signed during the year. Like-for-like net operating income, capping account of assets that have been sold, is also up respectable [ 9.39% ]. Active leasing in same portfolio occupancy remained stable at 94.6% by income on a like-for-like basis, and the portfolio WALE is 5.3 years at financial year-end. The portfolio maintains a strong rating of 46% by income to government tenants and further 19% [indiscernible]. This provides Cromwell with a high income security over time at foreign market valuation. Vacancy and near-term expiry is weighted towards markets demonstrating rental growth, and is concentrated in single floors and suites, where tenant demand has been stronger. A consistent theme this reporting season has been the relative strength in the A-grade office market, particularly in Sydney. While larger occupiers have been contracting in response to the normalization of hybrid working, smaller employees have been maintaining or increasing their footprint, and upgrading the sustainability and quality of their premises, as an employee attraction and retention tool. The chart in the bottom left corner of Slide 27 expresses this well. Supply of A grade space has also been more moderate than in premium grade. Sydney CBD A grade stock only increased by 0.3% over the year to June, whereas premium stock increased by 4.7%. The combination of muted supply and supported pent-up demand has seen the national A-grade vacancy rate actually fall over the year, from 15.6% to 14.1%. In Sydney, we have some vacancy at 207 Kent Street and at 475 Victoria Avenue, Chatswood. 207 Kent Street has had strong demand and continues to see good inquiries with tenants relocating to the building from elsewhere in the CBD, but also for markets such as Rhodes in North Sydney. Kent Street is a great example of the A-grade market strength I've been speaking of. It's affordable for a wide range of tenants, [indiscernible] work, and it has excellent in-house and nearby [indiscernible]. Our Chatswood asset is about to complete a significant repositioning, which includes [Audio Gap] facade, ground plan and a lobby refresh and we're already seeing this translate into leasing outcomes. We have small amounts of leasing to do in Brisbane, both at 400 George Street and HQ North. And at both assets recently, it has been pleasing, it's [ very ] encouraging. Looking forward, capital expenditure will continue to be prudently applied, with a focus on ESG initiatives, such as the full electrification of the McKell building, decommissioning with the cogen plant at HQ North, and installation of solar plants, [indiscernible]. Our commitment to improving the sustainable portfolio, includes the cognizance of the embedded carbon in our assets, and the emissions involved in dealing with [ wet streams ], and we are advancing practical decarbonization plans for all of our assets. This will also have the benefit of bringing us closer to our tenants, as we work towards [indiscernible] emissions. Jonathan, I'll hand back to you for the group outlook.

Thank you, Michelle. Before we do that, I have just realized that I've skipped a section. So if you can bear with me, I'm just going to run through the fund and asset management performance of the growth. We have worked very hard across the financial year to bring new opportunities to light and I am pleased with the results, so I'm now on Slide 18. Our assets under management of $8 billion, is comprised of $2.5 billion in Australia and $5.5 billion in Europe. In Europe, we continue to deploy capital from nondiscretionary mandates, having invested EUR 560 million, I should say, of just over EUR 2 billion committed. These mandates vary across sectors and domiciles, with a key focus on Nordics, Germany, Netherlands and Italy. We have also commenced bringing on Value Partners as a new joint venture partner, having -- after they have invested 50% into the Cromwell Italian Urban Logistics fund, based on a portfolio asset value of EUR 55.8 million, which is an approximate 9.4% increase on Cromwell's initial purchase price. Turning to Slide 20. In Australia, the unlisted funds management platform continues to receive inflows, and our flagship fund, the Cromwell Direct Property Fund, has announced the proposed transaction with Australian Unity Property Fund, to bring the 2 funds together under Cromwell management. This will make a lot of sense for investments with the 2 funds having an aligned investment mandate. This transaction will create a $1.1 billion fund, which will benefit with more diverse geographic and sector exposure, as well as operational economies of scale. A vote will go to the Australian Unity Property Fund unitholders in October 2023, and if approved, implementation will occur towards the end of the 2023 calendar year. Leasing remained active in the Cromwell Direct Property Fund, although no fees from transactions were booked during the financial year, and we are managing increased redemptions carefully and in line with the fund's policy. We announced our first green loan certified by the Climate Bonds Initiative in Australia, transitioning an existing $130 million bilateral loan from Cromwell Riverpark Trust during the financial year. Under the newly developed group, sustainability financing framework, we will further optimize the group's borrowing practices and move closer to decarbonization goals. I will now skip to the outlook, our long-term strategic objectives remain unchanged. Debt reduction remains key as we continue our goal to bring gearing within our target range, which we believe is achievable on the exit of the remaining assets being completed during FY '24. We will position our fund management platform for growth, with well considered deployment of capital through partnerships and acquisitions, where this makes sense, using prudent capital recycling opportunities as they become available. Our commitment to becoming a capital-light fund manager remains, although the pace of this transition will be hampered by market conditions. Lastly and very importantly, we remain committed to group ESG improvements, with our commitment to a decarbonization strategy released during the financial year. Specifically, we plan to implement Scope 1 to 3 emissions inventory and modeling reduction pathways, with our goal for Scope 1, 2 and 3, including tenant emissions and [ in body ] carbon by 2045. Moving into the 2024 financial year. We will focus on execution of proposed of the proposed transaction with Australian Unity Property Fund, and continue to develop products for our investors in Europe and Australia. Our investment portfolio assets continue to perform well, with active leasing and driving value through upgrades and repositioning. This will remain a key focus for the Australian team, during a more difficult operating climate. Ongoing reduction in gearing to within our target range remains a high priority. This is to be achieved or hope to be achieved through the completion of these sales currently in due diligence. Cromwell will continue its current practice of not providing annual guidance. Given the uncertainty around the progress of asset sales and the need to protect the balance sheet liquidity, the Board will adopt a conservative distribution policy throughout the year, unless circumstances change. A distribution of $0.0083 per security is expected to be paid to the September 2023 quarter. I will now hand back to the call operator to open the line to questions.

[Operator Instructions] Our first question is from Solomon Zhang with JPMorgan.

First question from me was just of the valuation of the Polish retail portfolio. Given your passing of 5.9% based on the FY '23 MPI carrying value, on slide 19. It just seems a little bit modest versus the 10-year lease performance. I guess that [Technical Difficulty] independent valuation. Just any comments on where the value is [Technical Difficulty].

I'm sorry, Solomon. I'm finding it very hard to hear you. Could you just repeat that question?

Maybe I will come back.

The next question is from Fiona Buchanan with Morgans.

Just wondering on the asset sales that EUR 560 million. If you could just give some -- I guess just a view on timing. Obviously, some are contracted, but the Polish in particular, just expectations around timing? And I know Michael mentioned, I think, the 6 assets, does that include that asset that you've got a 50% holding in? Just if you could guide on that?

Yes, sure. So the EUR 560 million assets, so we're expecting basically in exchange of contracts or the plan is for an exchange of contracts on the Polish portfolio in about October-November, that sort of time frame. We're sort of hoping to sort of deal with any issues that might have risen in diligence in September. So that's the timing on that. The other 2 assets in diligence had similar timeframes. So that -- and our Australian assets. And that comprises of EUR 560 million. The fixed portfolio -- the 6 asset portfolio of assets in Poland does not include the 50% joint venture we have with Unibail for the [ Krokus ] shopping center. So it's -- yes, so that doesn't include that asset.

We have Solomon Zhang back on the line.

Hopefully, you can hear me a bit better, Jonathan.

Much better.

Okay. That's good to hear. Just on the val of the Polish retail portfolio. I'm just getting a passing of 5.9% based on the NPI booked in FY '23 and the carrying amount, which has been revised down by the indicative bid. I guess the trend is a little bit modest versus where the 10-year polish yield is. I guess if we use the independent valuation of 7.33%, that would be even lower. Is the NPI sort of depressed in the short term, and where does that sit versus the value of distressed NPI for those assets? Any color there?

Yes. So Solomon again, you have to remember that Poland has been quite challenged, particularly on the cost side for the NPI. So while we've seen rent growth in line with improvements in trading in a post COVID world, they've definitely been suffering from obviously a high inflationary environment in Poland, which is driving up service charges or outgoings, as they have over there. It's driving up energy costs, as well as their own interest costs as well, which is all flowing through to suppressing that general NPI.

So to be clear, Solomon, the outgoing -- the cap on the outgoing that you can cover from the tenants, and we've exceeded that cap.

Yes. Got you. So I guess it's probably normalization assumed in the value assumptions going forward?

I think it's a bit of that. But I think over time, you can see those outgoings normalize a little bit. They did jump up the way in which they're set, there was a massive jump in outflows -- in that immediate aftermath, with the Russian invasion of the Ukraine and the gas shortage that we sort of experienced this time last year. So there is every chance I think that you'll see a bit more of a normalization to the outgoing as well as, yes, there would be some resetting being done.

And I think you called out -- [indiscernible] the rent is linked to the EU CPI, not Poland, which is obviously higher.

That is correct.

That's correct? That's cool. And just appreciate discussions are ongoing, which you don't want to compromise, but can you provide any high-level comments on the types of purchases, do you have logged binding offers? Are they sort of opportunistic for your players or...?

Look, they vary a little bit. I mean, the one thing I would say is that they're typically local. And when I say local, I mean Central European investors. But that sort of range from family offices. There are some German people in there as well. But the one sort of obvious thing for me is that, they're mainly sort of that Central European local investors.

Got you. Second question was just on the AFFO conversion in second half '23. Just seems kind of weak at $45 million versus $70 million in the first half. Is there anything that is driving that lower?

It would just be the timing of the CapEx spend.

Yes. okay. And just a final quick one, just the debt margins across the platform. Any update on whether [Audio Gap]

Any update on what, sorry?

Where your debt margins are?

In terms of the bank margins or our underlying? Not really changing.

Just any numbers you can provide around that?

Well, I mean, for Australia, we're seeing them sort of stay at that 4 mark. [indiscernible]. So no, I think [indiscernible] we've been doing -- or the reintegration that we've been doing, there hasn't been that much of a shift to honest. So they're sticking around at 200 basis points.

[Operator Instructions] Your next question is from Alex Prineas with Morningstar.

Just a question on the funds management business. There's been a number of headlines down here about how the funds seeing outflows. Just wondering if you can comment on which specific funds are in a state of inflow or outflow at present?

So we really have the one unlisted open fund, which is the Cromwell Diversified Property Fund. That -- and we are still seeing the inflows into that fund.

What about some of the other structures like Oyster and that type of thing.

Yes. Yes. So the products are a little bit different in [ outset ], but to the extent they do have an open-ended fund, they're seeing sort of a similar dynamic, which is there are inflows, but they're absolutely slowing, slowing down. The other funds, there are outflows, particularly the more liquid funds. And so yes, but so whilst there are inflows, the trend is definitely a declining number of inflows.

Okay. And just another one on gearing. So gearing has stayed fairly flat so far, despite the asset sales, but you've sort of outlined it on a pro forma basis, as these deals go through. It would be back in your range. I guess I'm wondering, if we see further asset devaluations, can you provide any comment there on expectations around cap rates and asset devaluations? And I guess whether there's a prospect of, if further devaluations come through and push the gearing back up again, is there sort of a plan B or can you just comment on how you're sort of thinking about that sort of more medium-term outlook for gearing?

Yes. The short answer is, we are focused on the asset sales. We have reasonably generous covenant limits in all of our facility documents. This is [indiscernible] basis, probably a little bit higher. So our gearing covenants are around the 60% mark. So we do have -- even though our gearing is currently at 42%, a little bit of headroom between where our gearing sits at the moment in the covenants. So if there's no real, I guess, sense of panic at all. What we're really focused on, is just getting within the target range, and we're going to do that in a controlled audit manner, and that's what we're committed to do.

There are no further questions at this time. I'll hand the call back over to Dr. Weiss for closing remarks.

Thank you, everybody, for your time on the call today, and we look forward to continued progress at Cromwell. Thank you.

That does conclude your conference today. Thank you for participating. You may now disconnect.