Dexus Convenience Retail REIT (DXC) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the Dexus Convenience Retail REIT 2022 Half Year Results Briefing. [Operator Instructions] I would now like to hand the conference over to Mr. Chris Brockett, Fund Manager, please go ahead.

Thank you, and good morning, everyone. Welcome to Dexus Convenience Retail REIT's 2022 Half Year Results Presentation. Look, before I start today, I'd really like to say a quick thank you to the team for all of their efforts during this busy period. It's certainly been greatly appreciated. We would like to start by acknowledging the traditional custodians on the land on which we operate as an owner, manager and developer of assets across Australia. We pay our respects to their elders' past, present and emerging and remain committed to supporting a reconciliation across our business. So moving to the key highlights. I'm pleased to report the fund has delivered another strong set of results in what was a period of uncertainty in the broader market, demonstrating the resilience of our portfolio. Distributions of $0.115 per security for the half were up 4.6%. We also remain on track to deliver our FY '22 FFO and distribution guidance, which was upgraded in December to $0.231 per security and represents a 5.5% increase on FY '21. It has been another active period, having contracted the acquisition of 6 assets, valued at $73.7 million. These acquisitions represent good value, compared to other transactions we've seen in the market, with an average yield of 5.6% and an average WALE of 10.5 years. We've raised $66.3 million of new equity during the half to fund the acquisitions and provide balance sheet capacity to pursue further growth opportunities, as and when they arise. We maintained our disciplined approach to capital allocation and retained flexibility to deploy capital towards value-accretive opportunities. We continue to deliver on our strategy of providing investors with an attractive, defensive and growing income strength. We have achieved consistent income and value growth, over time, for investors, demonstrated by our distribution per security growth each financial period as well as growth in NTA per security of 8% per annum over the past 4 years. We've also actively diversified and enhanced the overall quality of the portfolio. Since inception, we have acquired [ 53 ] assets, valued at $397 million at an average acquisition yield of 6.1% and a long WALE of 12.5 years, which reflects our disciplined approach to acquisitions, ensuring that the opportunities we pursue are attractively priced and meet our strict investment criteria. These acquisitions have considerably enhanced the portfolio of tenant diversification and quality through the introduction of 6 new major [ fuel ] tenants since the IPO. Our established partnerships with major tenants and developers also ensures that the fund is well positioned to take advantage of future growth opportunities. We're also taking active approach to managing the portfolio. It was pleasing to complete several initiatives during the half, including the repositioning of the [ Muruwari ] and [ Cannondale ] sites through expanded retail offerings, including a new Pizza Hut restaurant, as well as commencing the development of the Redbank Plains site to include car loss facilities. Turning to strategy. Dexus Convenience Retail REIT is focused on providing investors with an attractive, defensive and growing income stream, which is underpinned by resilient cash flows and long-term leases to quality national and international operators. Our strategic objectives is to prudently manage capital to deliver long-term value to all security holders and to engage with and support our tenants to ensure that they are well positioned for the long term, including the sustainability of their operations. Our mandate, which has not changed since inception, is to invest in high-quality convenience retail and nondiscretionary retail properties. While our current portfolio is focused on service stations, our mandate includes the entire convenience retail landscape, which we are attracted to for its defensive qualities and secure underlying cash flows. We maintained a disciplined approach to acquisitions, ensuring that the opportunities meet our strict investment criteria, including location, strength of lease covenants and various site-specific factors such as land side and zoning. While the market dynamics and industry trends will continue to evolve and change, the portfolio is well positioned to remain resilient, with long-dated leases providing income certainty in the medium to longer term, with 93% of leases by income expiring in FY '30 and beyond. During the half, we executed new long-term lease deals with 7-Eleven at Redbank Plains and Viva Energy at Lawnton, pushing these lease expiries to FY '37. These leases, which included major capital investments from the tenants to upgrade the site, highlight the continued commitment from our major tenants to remain at these sites for the long term and adapt to the evolving market trends, and it ensures the long-term income sustainability of the fund. We also have an optimal portfolio mix, with 66% of the portfolio being represented by metro sites that are well located and strategic advantages for convenience retail alternatives, well into the future, while 17% of the portfolio are highway sites that will remain essential for long journeys and long-haul trucks, no matter what energy is fueling our vehicles. The remainder of the portfolio are regional sites, which have high exposure to diesel sales and are located in areas where EV adoption is expected to be significantly slower. So the portfolio is well placed to remain resilient in the long term, with strong future income security. Dexus' globally-leading ESG credentials will support the advancement of our ESG approach. Unlike other asset classes, our major fuel tenants have full operational control over the site because they have whole of land leases. The majority of these tenants have already announced net zero targets, and the fund is here to support them as they continue to provide essential goods and services to their customers, while enhancing the sustainability of their operations on our sites. For example, for Chevron, we facilitated the rollout of on-site solar at 330 sites across their entire network, 40 of which are within our portfolio. These solar works are expected to commence later this year. Moving to our financial results. FFO was up $3.2 million, to $15.4 million, compared to the 2021 half year. Now, this was primarily driven by a $5.1 million or 32.5% increase in net property income due to like-for-like income growth of 2.3%. The balance came from the contribution of acquisitions. Incorporating the new securities issued during the period, FFO per security was up 6.6%. Distributions per security grew by 4.6%, with our payout ratio just under 100% of FFO and in line with cash flow. for the security was up 4.4% on 30 June, to $3.83, and that was primarily driven by the $21.1 million property revaluation gain. So moving to capital management now. The balance sheet is in a strong position with gearing of 32%, which is around the midpoint of our target gearing range of 25% to 40% and provides sufficient capacity to pursue accretive opportunities, as and when they arise. At the same time, we are actively considering asset sales to recycle capital into opportunities that will continue to enhance the overall quality of the portfolio. The fund's weighted average cost of debt remains competitive at 2.7%, and the weighted average debt maturity is 2.5 years with a relatively even maturity profile. So turning to portfolio valuations. Independent valuations were undertaken on a total of 42 assets. Together with the recently-acquired properties, 47 of the portfolio's 112 properties were independently revalued. Overall, 94 properties have been independently valued within the last 12 months. The weighted average cap rate across the portfolio tightened 20 basis points from 6.02% to 5.82%. The total revaluation increase, excluding fair value alignment, was $21.1 million. Cap rate compression was responsible for 54% of the total increase, while rental growth attributed to 46%. Appetite for service stations and convenience retail assets has remained strong over the last 12 to [ 18 ] months, fueled by existing market participants,along with investors seeking alternate asset classes that are defensive in nature and supported by secure and predictable cash flows. Transaction volumes remained stable in calendar year 2021, compared to 2020, with average market transaction yields tightening 31 basis points, to 5.38%, over the year. Turning now to portfolio performance. The portfolio remains resilient and is underpinned by strong lease covenants and reliable tenants, with 90% of the income drive directly from the major fuel tenants. The portfolio continued to record occupancy at close to 100% and is supported by a long weighted average lease expiry of 11.5 years. During the half, we successfully secured new, long-term lease deals with major fuel tenants at 2 properties, enhancing the fund's lease expiry profile and providing security holders with a stronger level of income security, with 93% of rental income expiring in FY '30 and beyond. The portfolio provides a sustainable and growing income stream, with 78% of rental income subject to fixed annual increases of 3% or more, while 19% is linked to CPI rental escalations, and this results in an average portfolio of rental growth of 3% per annum. The chart at the bottom left illustrates the growth we have achieved, increasing the portfolio by approximately $515 million since the IPO in July 2017, with $130 million of this attributable to revaluation gains. This highlights that we have acquired well in line with our disciplined approach to acquisitions, which has created value for investors. In the process, we've continued to derisk the portfolio through enhancing tenant diversification and quality. Moving to acquisitions. During the period, we successfully contracted 6 acquisitions at an average yield of 5.6% and WALE of 10.5 years. Service Center was acquired on a -- on a fund-through basis and is expected to complete by April 2022. All of the other transactions had settled prior to 31 December, with the exception of BP Brendale, which settled last week. Turning to the development projects. During the period, we completed the fund-through development at Hillcrest in South Australia, which comprises a mobile service station and a stand-alone Hungry Jack's. Total spend for the project was $8.5 million, representing a yield on cost of 5.5%. This site was revalued at $9.1 million on a 5.2% cap rate at 31 December. The fund has one further fund-through project currently in progress, and that's the Service Center, which comprises a mobile service station and a stand-alone Carl's Jr. The fund is also investigating a potential second stage to this development, which will involve another stand-alone quick-service restaurant and 3 large-format retail tenancies, all of which will be leased to quality tenants. So in summary, the fund remains well placed to continue to deliver on its strategy of providing investors with an attractive, defensive and growing income stream. We have high income security with contracted annual rent increases and long-term leases to high-quality, well-capitalized tenants. We have a disciplined approach to managing our capital, with the willingness to divest assets or acquire assets that meet our strict investment criteria and stack up financially. We continue to actively execute on our strategic objectives. And finally, we reiterate our FY '22 [indiscernible] distribution guidance that was upgraded in December of $0.231 per security, subject to a continuation of current market conditions and no unforeseen events. So on that note, thank you for your time this morning. I'll now hand it back to the operator for any questions.

[Operator Instructions] Your first question comes from Leanne Truong from Ord Minnett.

My first question, you've got some available liquidity, and you've also announced the buyback. So I guess, going forward, are you even more likely to be acquiring assets or buying back shares?

Yes. Well, I mean, I think, there's no doubt that DXC has experienced a weaker share trading performance recently, then, when we've activated the buyback program to provide us the flexibility to be opportunistic and enhance security holder returns by taking advantage of -- that continued and persistent share price weaknesses. But equally, we also remain opportunistic, in terms of our acquisitions as well. So we'll continue to opportunistically look to acquire assets, where it makes sense to do so, in particular, considering the cost of capital. And of course, the transaction needs to stack up financially and track -- that it needs to create value for investors as well. So look, we remain opportunistic on both sides. We'll continue to actually manage our capital appropriately. And it will all, sort of, depend on where we think the best value is and presents itself for investors.

And in terms of acquisitions, are you seeing the market getting more competitive, less competitive or the same?

Well, I mean, there's no doubt that the last two years have had significantly increased transaction volumes. And that's evident in the fact that the weighted average transaction yield had dropped 31 basis points, to 5.38%. I mean, I still think we're still acquiring well. Our average acquisition yield was 5.6% in the half. So look, I think it's going to be interesting to see whether that transcends into this year. But we're still very opportunistic about what we are seeing out there, and we'll continue to be disciplined in our approach to acquisitions.

And just a question on your rent reviews, I noticed that you're assuming CPI of 2.25%. So is there -- do you think there's some upside there for the rest of the financial year 2022?

Yes, I will -- If inflation gets to go up beyond that, there certainly is upside. That's the -- I mean, that's the view -- that's the [ house ] view as to where inflation will land. I think, we've got a good mix of fixed rental increases and CPI-linked increases, I mean, as you say, 19% of our income is linked to CPI rental increases. So yes, I mean, I think that, that potentially is some upside, but I mean, I can't speculate on where inflation is going to head, unfortunately.

And just one final question for me. And that is, you've got some developments going on there Redbank Plains and the and the rollout of the solar. Are you rentalizing that? Or is that being paid by the tenants?

You're talking about the solar installation?

Yes, the solar installation, and also, you've got just done some development at Redbank Plains in ?

Yes. So the development at Redbank Plains is that we're using some excess land that we had. So we've essentially taken that excess land that essentially 7-Eleven weren't using. So we've done a new lease deal with 7-Eleven for a portion of that land, and we're developing a new 6-bay carwash with a Queensland-based carwash operator that will go in there. So that it's like a brand-new lease to a new operator. The [ Muruwari ] and sites were us just working with our part of the new lease arrangements with EG Group, which kicked in during the half. And so we worked with them. We didn't need to make a capital contribution towards that. That was something that EG ended up funding, but it was factored into the rents, if you like, that we achieved, the new [ committed ] rent that we achieved with those brand new 10-year leases. In terms of the solar -- online solar rollout, no, those are costs that will be borne between the solar energy provider and/or Chevron. So they have an arrangement between themselves. All that we did was facilitate the engagement between the solar energy provider and Chevron. So we brought the parties together, as we saw there's an opportunity for Chevron too to roll out or have a rollout of solar in the network. And as I say, I mean, 330 sites of the 380-odd sites, nationally. It's a pretty good -- it's pretty good to ship on to be the -- have such a significant solar rollout.

[Operator Instructions] Your next question comes from Murray Connellan from Moelis Australia.

Chris, could you just give us a little bit of color around -- I appreciate you've made mention of the direct market and the strong valuation uplift that seems to have come through from a yield perspective. But just in terms of transaction volumes in the last, call it, 6 months, can you maybe just unpack what those have looked like? Have they been impacted by lockdowns? And then maybe just a comparison between what things looked like, from an auction perspective versus the off-market component?

Yes. Yes. Thanks, Murray. I mean, the -- is we've guided is, sort of, also over the whole of the calendar year 2021, which, as I said, transaction yields have tightened 31 basis points. The transaction volumes were in line with what they were in 2020, which in 2020 was nearly their all-time highs as well. So there's no doubt, in 2021, transaction volumes remained high, and the results were obviously sharper than what they had been previously. I mean, we have seen the service station sector tighten almost the most of all asset classes, probably along with child care. I haven't seen much in the way of transactional evidence so far this year, albeit we're, sort of, really only, probably, 2 or 3 weeks in. So we'll see whether that continues. As I said to Leanne, we'll be interested -- myself to see how that transcends this year. The auction process is tend to -- I haven't -- I can only speak to anecdotal evidence, but the assets that are normally put into an auction process, are the ones that [ sit in ] that $4 million to $6 million price point. And they are the ones that are obviously the most attractive to the high net wealth individuals, who tend to participate in auction processes rather than the institutional-grade properties like ourselves. So I would have to guess that the results at an auction process are significantly tighter or sharper than what they would be through, say, an EOI process. And we tend to participate in the EOI processes or, more commonly for us is, in off-market opportunities. So yes. I mean, the auction process, towards the end of last year, did ease off a little bit in December, but I think it is fair to say there was a fair degree of lethargy in the market by then, probably coming off the back of what was a very busy transactional year in the sector.

And then just noting that, I think, the [ last ] developments that is currently underway in your portfolio, is the one that you're doing in ] and [ last Oracle ], I think it should probably be finishing, more or less, now. If that's right, I don't know whether there's been a few delays through COVID. But just wondering, whether the strategy is going to remain to keep that development pipeline refreshed or whether the deployment of capital now make more sense going into the direct market rather than its [ developments ] ?

Yes. So on the asset, we do expect that to complete in April 2022, we originally thought it was going to be February, March. has been impacted by some weather, particularly throughout December. So that has had a little bit of impact on the delays on that one. But we do expect that, that site will be completed in April. We also -- as I said during the presentation, we do see, there's an opportunity to do a second stage, which is actually larger than the Stage 1, the one that we're building now. So that would include, again, another stand-alone quick-service restaurant as well as 3 large-format retail tenancies. So we're investigating that, we're sort of doing our due diligence on that with the developer at the moment. So that might be an extension of the development pipeline. I mean, I still see the development pipe -- developed projects and certainly, the fund-through projects has been an important avenue of growth opportunity for us. It does come with some advantages, in terms of savings, and it allows us, through our relationships with the developers, to get access to some good opportunities before they would ordinarily, probably, go to the market, must be complete. So it does give us the opportunity to buy well. And I think, certainly, with the developments that we've done, we bought those well and created value for investors. They've all gone up in value since we've built them. So I still think it's an important part of our growth. But equally, I think, having acquiring near-new or existing assets in the market is just as important, and we'll continue to take an opportunistic view to all of our acquisitions, going forward.

And then just lastly, you've mentioned that the potential to be selling a few assets, although I don't know whether that's necessarily set in stone yet, but I was wondering whether -- I was wondering what the thoughts are around the sorts of things that may go, in the event that, that would start happening?

Yes. I mean, absolutely, we remain opportunistic and open-minded, in regards to property sales and recycling the capital into opportunities that will enhance the overall quality of the portfolio. That's the most important thing. So we are assessing the portfolio to identify properties that we believe do not meet our strict investment criteria. And I'm talking about, for an example, assets that require significant CapEx investments, such as the older sites with the older infrastructure. But I'm not going to be calling out any specific assets at this stage, of course.

There are no further questions at this time. I'll now hand back to Mr. Brockett for closing remarks.

Yes. Thank you. Look, I just want to thank you for -- it's a busy time for you guys. I really appreciate your time this morning, and I look forward to catching up with you guys over the next few days. So thank you, and enjoy the rest of your day.

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