Cromwell Property Group (CMW) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the Cromwell Property Group's Half Year '24 Results Conference Call. [Operator Instructions] I would now like to turn the conference over to Dr. Gary Weiss, Chairman. Please go ahead.

Thank you very much, and welcome to those of you who have joined our call this morning. Firstly, I would like to acknowledge the traditional custodians of the lands on which we meet and pay my regards to their elders, past, present and emerging. Today I open this call from the Gadigal Lands, the Eora Nation. We provide an update on the performance of Cromwell Property Group with insight into activities and operations for the 6 months ended 31 December 2023. The ongoing higher interest rate environment impacted our operations and valuations across the group globally. We maintain our focus on the ongoing simplification of the business, continuing to target noncore asset sales to reduce net debt. Notwithstanding the $584 million of noncore asset sales completed or contracted since the commencement of our asset sale program in December 2021, gearing remains above our target range. This is as a result of the significant decline in value of our investment portfolio. We anticipate that on completion of the transactions currently underway, that gearing will return to within our target range. We recognize that uncertainty in the current operating climate, coupled with expansion of cap rates, has impacted security holder value, with Cromwell securities trading at a significant discount to net tangible asset value. We are endeavoring to address this discount by simplifying our business and bringing the group's focus back to core real estate skills, together with exploring value-accretive growth opportunities to provide long-term security holder value. Today, you will hear from Jonathan, Cromwell's CEO, who will provide an overview and strategic update. We also welcome Michelle Dance, appointed to the position of Chief Financial Officer this year, who will review the group's financial performance. And then Rob Percy, Cromwell's Chief Investment Officer, will provide an overview of the performance of Cromwell's underlying investments. I now hand over to Jonathan.

Thank you, Gary. As we are all aware, the real estate sector globally has experienced significant pressure on valuations. Globally, our assets under management are down $98.1 million from FY '23 to $11.4 billion in total. We maintain operations and offices in Australia, New Zealand, Singapore and Europe, as outlined on Slide 4. Our asset management platform oversees 217 properties, housing more than 2,100 tenant customers globally. Turning to Slide 7. Cromwell reports a statutory loss of $271.4 million for the half year, attributed largely to the unrealized fair value adjustments of the Australian investment portfolio and an adjustment to the sale price of the CPRF Sale portfolio. The underlying operating profit of the group was $83.7 million for the half, equivalent to $0.032 per security. Cromwell distributed $0.0158 per security during the half year, which represents a payout ratio of 62.6% of adjusted funds from operations. Importantly, Cromwell's net debt position was down $90 million over the 6 months to 31 December 2023, which reduced our overall debt position to $1.6 billion. This reduction in debt levels, however, was offset by negative valuation impacts, pushing Cromwell's gearing ratio up in the 6 months from 42.6% to 44.7%. Michelle will talk more on capital management in a few minutes. Across our platform, our Australian investment portfolio remains strong, valued at $2.4 billion with an occupancy of 93.4% and like-for-like net operating income being up 1%. We had growth in mandates committed and deployed in Europe, increasing AUM, assets under management, from $5.5 billion to $5.9 billion. Valuation declines in our Australian retail funds partially offset that growth, ending 31 December 2023 $100 million lower at $2.4 billion in third-party AUM assets under management. An important and ongoing focus for Cromwell is our environmental, social and governance commitments, which underpin our day-to-day activities as outlined on Slide 9. We have internal goals to ensure an equal and diverse workforce with ambitious though achievable targets. We believe that our ESG considerations filter down through our business to future-proof our assets, relationships and support our long-term security holder value. Some key points I'd like to note. The Australian investment portfolio, tenant customer engagement score of 87%, 7% above our peer benchmark and is supporting ongoing leasing success. Solar panels are installed on 4 out of our 18 Australian properties, with a further 6 planned for the remainder of FY '24, assisting us to manage ongoing costs associated with building operations. We announced global scope 1 and 2 emissions as well as a full scope 3 emissions inventory for financial year FY '23, leading the sector, and are happy to report a 12% reduction was achieved in Australia and a 22% reduction in Europe compared to financial year 2022. Over the past 2 years, Cromwell has taken significant steps to reduce our gender pay gap, now 11%, which is below WGEA's industry benchmark of [ 16 ].7%. [ Of ] all key strategic achievements are outlined on Slide 9 for the half year results presentation. And our full 2023 ESG report is available on our website. Turning to financial performance. I echo Gary's sentiment in welcoming Michelle at Cromwell's CFO since 1 January 2024. Michelle is highly respected across the sector, and I'm sure known to most of you, with an impressive 30-year career in both real estate and finance. I hand to her to review the financial performance and capital management for the half year.

Thank you, Jonathan. Starting on Slide 11, Cromwell reported statutory loss of $271.4 million for the half year. This is attributed to unrealized fair value adjustments to the Australian investment portfolio, with fair value reductions of $195.7 million or $185.5 million on a like-for-like basis, and downward adjustment to the sale price of CPRF Sale portfolio of $44.5 million. In the current interest -- high interest rate environment, net financing costs were up $6 million compared to HY 2023. We report operating profit of $83.7 million, $0.032 per security, which is 3.9% down on the prior corresponding period. This has been driven by nonrecurring profit on asset sales during the last half year reporting period. Distributions paid of $0.0158 per security reflects a payout ratio of just under 63%, which is lower than our desired payout ratio that was prudent in the current uncertain environment and considering Cromwell's ongoing sale program. Turning to the earnings overview now on Slide 12. Australian funds and asset management earnings were lower at $3.9 million, with the large [ variance ] to the prior corresponding period due to the profit received from the LDK sale in October of 2022. Earnings in Europe were up 36%, which includes performance fees. Cromwell's Polish Retail Fund positively benefited from both increased rental income and positive foreign exchange moves during the 6 months, driving a 31.3% increase in EBIT from the prior corresponding period. CIULF income remains steady and unchanged, with the portfolio 100% leased to sole tenant DHL on a 7.3 year WALE. The 37.5% decline in earnings for the period reflects the 50% sale executed to Value Partners in July last year, but now only includes our 50% share of income. Cromwell's stake in CEREIT remains unchanged, with share of income up 1%. During the period, Cromwell sold Campbell Park, which resulted in operating income of $12.3 million. In Australia, the investment portfolio had like-for-like net operating income growth of 1%, and income overall was $78 million for the 6-month period. Headline portfolio EBIT down 3.1% compared to [Technical Difficulty] [ HY22 ], which reflects the sale of an asset in [ pen ] during the period. Corporate costs were down compared to the HY '23 period. We continue to make considered effort keeping these lower, especially in current environment where debt costs remain high. Net financing costs were up 17.8% on HY '23 with higher floating interest rates offset somewhat by derivatives and lower drawn debt. Lowering net debt continues to be a significant focus for the group. On Slide 13, we show how the activities over the period have impacted the net tangible assets of the group, now $0.72 per security, down from $0.84 per security at 30 June 2023. The largest contributor to the decline was a $0.09 per security negative move in asset revaluations, with Australia and Poland down 7.5% and 8.1%, respectively. 2-6 Station Street Penrith and a 50% share of Cromwell Italy Urban Logistics Fund were sold during the period for a total of $94 million. We've mentioned the asset sale program a few times, and I want to reiterate how important this step is in resetting Cromwell's strategy. On Slide 14, you can see that since the end of 2021, Cromwell has made significant process (sic) [ progress ] on the simplification of its business, aiming to concentrate on our core businesses of funds and asset management. Since the end of 2021, we've undertaken $584 million of sales, which includes $73 million of assets sold or contracted for sale after 31 December 2023. Our sale program began prior to the increase in market capitalization rates and has mitigated the impact of adverse market movements on our balance sheet. On the completion of the sale of the Cromwell Polish Retail Fund, asset sales since the end of 2021 will total more than $1.1 billion. I'd like to take this opportunity to provide a very brief update on the valuation of the CPRF portfolio, being the [ 6 ] assets of sales currently bound by a letter of intent and excluding Ursynow, which we hold as a joint venture partner, Unibail Rodamco. Ursynow is currently in the process of settling, and we anticipate receiving sale proceeds shortly. The CPRF Sale portfolio is in the final stages of negotiations with the purchaser, who has signed a detailed letter of intent to purchase the assets, and this is backed by a significant nonrefundable deposit. This represents a positive step for a very complex transaction, which has been undertaken in a highly volatile macro environment. We will make a market announcement when this portfolio is formerly contracted for sale, which we anticipate will be soon. On Slide 15, we show that following the completion of the Polish and Australian asset sales that are currently underway, pro forma headline gearing is anticipated to fall to 34.1%, with liquidity refreshed at $489 million. It will return leverage to well within our targeted range. On Slide 16, you will note that currently, Cromwell has a weighted average cost of debt of 4.7%, up from 3.9% at 30 June 2023. The weighted average debt maturity is 2.4 years, with the near-term European debt facilities to be retired from the proceeds of asset sales and the Australian facilities are under negotiation for extension. Lastly, I'd like to turn to Slide 17 to address covenants on hedging. Following the completion of the asset sales program, we will have the ability to simplify our balance sheet further by closing out 3 debt facilities associated with the Cromwell Polish Retail portfolio. Following this, we will have one main senior secured facility and ample liquidity in which to manage any further valuation falls in the investment portfolio, should the Australian office market deteriorate further. Cost of debt remains reasonably flat over the medium term, again, allowing us to focus on income security and strengthening the balance sheet. I'll pass now to Rob, Cromwell's Chief Investment Officer, to review funds management, co-investment and Australian investment portfolio [ over porshe ].

Thanks, Michelle. Starting on Slide 19. We maintain a good allocation of third-party assets under management across Australia, New Zealand and Europe, totaling $8.3 billion, up on 30 June 2023. Europe is facing similar valuation pressures as we are in Australia, also with slower capital market volumes impacting the pace at which mandate deployment [ is possible ]. Logistics continue to be favored in Europe, as indicated by CEREIT's continued pivot to logistics, a new mandate from a U.S.-based partner to develop and manage logistics assets as well as an agreement to asset manage a Finnish portfolio of EUR 142 million of logistics. In Australia, Cromwell's retail funds management platform remains robust at $2.4 billion in assets under management across a number of products. Cromwell's flagship direct property fund has reported asset revaluations down 8.9% over the 6 months from 30 June 2023. This fund has limited monthly withdrawal facility, [Technical Difficulty][ as tempered frequencies ] to be offered as it mitigates the downturn in the commercial property cycle. The fund remains focused on protecting capital and will continue prudent management of debt and capital for the long-term benefit of investors. Cromwell Funds Management won the 2023 Zenith Fund Award in the Australian Real Estate Investment Trust category for Cromwell Phoenix Property Securities Fund following wins in 2022 and 2021. I will now briefly review the co-investment performance on Slide 23. Due to valuation impacts in Cromwell Direct Property Fund, our 4.2% co-investment in the fund is down from $16.5 million to $13.6 million in the 6-month period, with the unit price down 18% to $0.9165 per unit. Cromwell maintains 27.8% share of Cromwell European REIT listed on the Singapore Exchange, valued at $535.2 million. CEREIT was impacted by net property valuation declines in office markets, largely offset by the significant weighting to logistics, which had valuation increases over the period. Cromwell's share of operating profit is $20.3 million, relatively even with the prior corresponding period. Cromwell Italy Urban Logistics Fund, which consists of 7 assets tenanted by DHL in Italy, is now valued at $23.7 million. This represents Cromwell's 50% ownership following the sale of half of the portfolio to partner Value Partners in July 2023. Operating profit remained stable, with Cromwell's share reflected at $1 million for the 6-month period. Lastly, Cromwell Polish Retail Fund, we hold for CPRF at 53 -- $531.8 million. The CPRF sale portfolio price is down 8.1% as a result of negotiations with the purchaser. Rental income improved over the period, resulting in Cromwell's share of operating profit before finance costs of $19.3 million. The portfolio remains anchored by [ Osha ], who represent approximately 30% of the portfolio income. In Australia, our investment portfolio occupancy remains strong and reported like-for-like net operating income growth of 1%, although ultimately this was impacted by valuation pressures, resulting in a 7.5% decline in portfolio valuation to $2.4 billion. In line with our valuation policy and best practice, we rotated our valuers for the period ended 31 December 2023, which ensures a robust and independent valuation outcome. All assets, excluding those held for sale, were externally valued at the half year. Portfolio occupancy by NLA decreased slightly during the period from 94.6% to 93.4%. This was driven by the sale of a 100% leased asset at 2 to 6 Station Street Penrith and increased vacancy at 207 Kent Street, Sydney and 400 George Street, Brisbane. Operational efficiencies through ESG upgrades continue to be a focus for Cromwell, to reduce operational costs in the longer term as well as ensuring tenants are in assets that meet their employees' needs, companies' environmental goals and price point. During the last 6 months, we have undertaken 2 key projects, being building electrification at McKell in Sydney and removal of the Cogen plant at HQ North Tower in Fortitude Valley. We are partway through a major solar installation project at Collins Street, Melbourne, but we are very cognizant of prudent and measured capital expenditure in the current operating environment. More than 80% of the investment portfolio income comes from government and top ASX-listed tenants or subsidiaries, showing good quality tenants and income security. Leasing markets remain active with approximately 12,000 square meters leased in the 6-month period. Positive rent reversion was noted in a number of leases, although overall was down 4.7% due to a material lease renewal which removed some significant lease expiry risk in 2026. Whilst we still have some occupancy to work on in our portfolio, we're happily well below average national vacancy rates and see ongoing positive activity in the markets in which we are leasing. Jonathan, I'll hand back to you.

Thanks, Rob. Our long-term strategic objectives remain focused on debt reduction through the completion of noncore asset sales and balance sheet security. We continue to bring gearing within our target range, which we anticipate will be 34.1% after the sale of the CPRF Sale portfolio, which we anticipate completing before 30 June 2024. We will then be ready to take advantage of strategic growth opportunities in our fund management business, with well-considered and value-accretive redeployment of capital through partnerships and acquisitions where this makes sense over the medium term. We remain committed to ESG and ongoing emissions reductions and are on track to meet a net zero target across Cromwell's entire portfolio, of scope 1, 2 and 3 emissions by 2045. Our investment portfolio assets continue to perform well, with active leasing and driving value through upgrades and repositioning, to ensure those assets remain desirable and suited to our tenants and their employees. We will continue to provide distribution advice quarterly as we move through the final stages of the asset sale program. The Board will continue to adopt a conservative distribution policy to protect balance sheet liquidity in the near term. A distribution of $0.0075 per security is expected to be paid for the March 2024 quarter. I will now hand back to the call operator to open the line to questions.

[Operator Instructions] The first question comes from Solomon Zhang of JPMorgan.

Jonathan. Just wanted to just clarify with the CPRF sale process because it's just a letter of intent. There's nothing stopping the buyer from walking away except for losing that deposit. Is that correct? And also, what's the rough percentage of the sale price? What does that deposit constitute?

Thanks, Solomon. Thanks for the question. Yes, the -- if the seller were to walk away, what they would lose would be the deposit that they've paid. The deposit that they've put down is a couple of percentage points of the sale price.

Got you. And in terms of the material adverse change clause, is that related to their ability to get back their deposit? And what would sort of trigger that? Is it -- there's obviously a bit of sheer political uncertainty in the area, would it require a big escalation in that? Or just perhaps just talk to some of that risk there.

I won't go into all the MACs, but what I would say is that they are along the lines of substantial drops in income, substantial drops in occupancy and the like. So they have more to do with the underlying performance of the real estate than anything else.

Yes. Great. And just on Slide 16, you sort of talk about your early extension discussions with lenders. Maybe a question for Michelle. But could you just talk about where your incremental debt margins are expected to hedge? I think the group margins are around 200 basis points as of the last update 6 months ago.

Look, we're not seeing any material change at this point. So yes, there's been some shifts here and there between margins and utilization fees. But all up, we're not seeing any material change.