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

Thank you, and good morning, everyone joining on the call. I'm Jason Weate, Fund Manager of DXC. Having recently joined the Dexus management platform, today, I am pleased to be delivering the 2022 full year results. Following the presentation, I will be joined by Joseph De Rango, Head of Finance for Real Estate Funds for the Q&A part of the session. I'd like to start proceedings by acknowledging the traditional custodians across the many lands on which we operate across Australia. We pay our respects to their elders, past, present and emerging and remain committed to supporting reconciliation across our business. Under the FY '22 key highlights, the fund has delivered on another strong set of results for the year. During a period of increasing uncertainty and changing market conditions, we have delivered on financial guidance with FFO per security up 5.5% on FY '21, effectively managed and enhance the quality of the property portfolio and demonstrated our active approach to capital management. On portfolio performance, we completed 15 high-quality acquisitions for $168 million on a yield of 5.5%, which have enhanced the portfolio by monetizing the asset base, increasing exposure to nonfuel tenants in addition to expanding the fund's longer-term development optionality. NTA grew strongly by $0.36 to $4.03 per security. Valuations were the primary driver of that growth, with close to half being driven by contracted rent growth, which will help support valuations through the cycle. From a capital management perspective, it has been an active period. We responded to the shift in market conditions by launching an on-market buyback program to capitalize on the volatility in our security price. We provided greater certainty by lengthening debt maturities, increased our hedging profile and maintained gearing within our target range. Finally, since the start of this calendar year, we have divested 4 assets, including one that exchange contracts last week, delivering an overall premium to book of 4%, reinforcing the high quality nature of the portfolio, which is being recognized in the direct market. Slide 6 summarizes DXC's key portfolio metrics, which stand out in the current environment, including one of the most defensive growing income streams in the sector, backed by some of the highest quality tenant covenants, a large-scale, well-located portfolio, which is 83% weighted to metro and highway locations, with weighted average rent reviews of over 3% with 77% of income generating fixed growth of around 3% and the remainder benefiting from CPI-linked exposure and close to 100% occupancy with a long vail of over 10 years. Combined, these characteristics have delivered and will continue to deliver secure and predictable growth in net operating income, providing investors with a high degree of certainty. The resilient property portfolio characteristics I just described are ultimately enhanced by our role as a manager. And over the year, we have demonstrated that we are a reliable custodian of capital. During the first half, we delivered growth. During supportive market conditions, we raised $55.5 million of new equity on attractive terms at $3.58 per security for deployment into portfolio-enhancing acquisitions. We further broadened our capital base by increasing debt facilities by $70 million, and we allocated capital towards development and CapEx initiatives that delivered value-accretive outcomes such as new long-term deals with 7-Eleven at Redbank Plains and Viva Energy at Lawnton. Over the second half, DXC entered this period of market volatility in a strong starting position, and we have continued to evolve our capital management approach accordingly. We bought back over $4.5 million of securities on issue at an average discount to NTA of 15%. We divested properties to capitalize on the disconnect between pricing in the direct and listed market. We chose not to pursue previously planned acquisitions, and we increased debt duration on favorable pricing terms and increased our hedging profile. Turning to ESG, where we have made good progress in our first year under Dexus to leverage its platform to advance our ESG priorities. We have made solid progress towards carbon neutrality for our managed operations with official certification expected within the coming weeks, and we continue to work with Chevron and a third-party solar installation company to assist Chevron in the rollout of on-site solar across 29 sites within our portfolio with work expected to commence in FY '23. Going forward, we will continue to align with Dexus' approach to sustainability and work closely with tenants to support long-term value creation. On the financial result, FFO and distributions of $0.231 per security was in line with our upgraded guidance and up 5.5% on last year. This is a strong result in a challenging environment. Compositionally, property FFO grew by $10 million to $43.8 million, primarily driven by recent acquisitions with like-for-like property income growth of 2.3%, which was impacted by larger-than-usual nonrecoverable costs associated with land tax. Finance costs increased by $2.5 million to $6.4 million due to a higher average debt balance while the increase in management fees reflected the increase in the overall size of the portfolio. NTA per security increased by $0.36 or 9.6%, the majority of which was attributable to $30.8 million in valuation gains with an additional $0.10 attributable to fair value gains on derivatives. Since IPO, DXC has excluded amortization of borrowing costs from FFO to align with PCA FFO guidelines. From FY '23, these expenses will no longer be added back from statutory NPAT to FFO. For FY '22, the impact would have translated into FFO of $0.228 per security, approximately 1% lower than the reported FFO of $0.231. Our FY '23 guidance, which I will provide later, has been set with reference to this newly adopted approach. On capital management, pro forma balance sheet gearing of 34.7% sits within our target range of 25% to 40%, and we continue to target further asset sales to further strengthen our balance sheet providing redeployment optionality, including the potential for further buyback of our securities. The fund's weighted average cost of debt was 2.6% for the year, which going forward will be impacted by shifts in the yield curve. And as mentioned earlier, we've meaningfully extended our average debt maturity at 4.2 years, and we also extended our hedging in the second half to reduce interest cost uncertainty over the medium term. During the year, independent valuations were undertaken across 81 of the 112 assets in the portfolio, resulting in an increase of 3.8% or $30.8 million. Close to half of this increase was driven by contracted rent growth, and this will be a key differentiating factor for DXC going forward, whereby certainty of cash flow is expected to provide valuation support in an environment where the outlook for cap rates is less certain. In the direct market, fuel and convenience transaction sales volumes are on balance, 30% down versus first half FY '22, with the emergence of price softening relative to vendor expectations. Notwithstanding this, we think the defensive attributes for fuel and retail assets, which include strong tenant covenants exposed to essential infrastructure, predictable and growing cash flows, will result in relative strength in liquidity compared to other asset classes. As I touched on earlier, it's been an active period for transactions and fund-through development over the year. Our purpose in undertaking such activity is to continually optimize the portfolio. And in this regard, I'm pleased that over FY '22, we have increased our exposure to nonfuel tenants from 6% to 11%, in line with our mandate to invest in high-quality convenience retail and nondiscretionary retail properties. We've rebalanced the composition of our rent reviews with CPI-linked increases now representing 23% of the rent roll, and we've lowered the average age of the portfolio through acquiring modern assets at an average age of 3.8 years. And we've increased the scope of development optionality following the acquisition of Glass House Mountains in March earlier this year. So in summary, the fund is well positioned to generate strong performance in an uncertain environment. We have high income security with contracted annual rent increases and long-term leases to high-quality well-capitalized tenants underpinning top line growth. Through our disciplined approach to capital allocation, we will continue to actively manage the portfolio to further improve quality and resilience with a focus on further asset sales to increase balance sheet capacity for redeployment opportunities, and this includes the potential for further repurchasing of our securities. For FY '23 guidance, we expect to deliver FFO in line with our restated methodology within a range of $0.212 to $0.220 per security. In setting our guidance, we're coming from a strong vision with contracted rental growth at the top line, and we include our expectations for floating interest rates of 2.75% to 3.75% with no assumed further transactional activity. Distributions will continue to be paid out in line with FFO, which is appropriate given the low ongoing CapEx requirements of the portfolio. Thank you for joining the presentation today. And with that, I'll hand back over to the moderator for Q&A.

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

Just a couple of questions in regards to guidance. So I was just wondering what you are forecasting a that you refinanced a bit of debt. I was just wondering if there was any improved margins there?

Yes. Thanks, Leanne. I think the way to think about weighted average cost of debt and just sort of going through the various compositional items. Obviously, we have around about 40% of our debt balance exposed to floating interest rates, so you'll need to make your own assumption as to what average 90-day BBSW will look like for that component. And we've provided what our hedge rate over FY '23 will be. And as it relates to margins, I think we extended our weighted average debt maturity profile on attractive pricing terms. And the way to think about the pricing on that component is something in the order of 180 to 200 basis points, in line with what is market for a vehicle of this size and nature.

Can you just remind me, is that an improvement from previously? Or is that in line with what you had in the margins?

That's in line with what we previously had, Leanne.

And just the second question, I noted that the guidance didn't assume further divestments, but you did mention that you weren't focusing on further asset sales. So I'm just wondering why you haven't included that in guidance? Are you, I guess, confident that you'll be able to sell these more vertical assets? And would you be looking to sell them at book value? I mean I noticed that you did put 3 assets up for auction last week, and we're only able to sell one. So I guess just thoughts on that.

Yes. Thanks, Leanne. Look, I guess the way to think about our intention is to further expand our asset divestment program is that -- the way to think about the quantum, I should say, Leanne, is that we do have an intention in the first instance to further strengthen our balance sheet towards the midpoint of our target gearing range. So that should give you an idea for quantum. But in terms of why we haven't looked to include that within guidance, is that there's obviously a lot of variability outside of just quantum. It's obviously the average cap rate we ultimately model to divest on, the timing associated with those divestments, but also the redeployment opportunities available to us at that time and the time in which we might realistically redeploy as well. So we appreciate, there's a lot of variables within that. And so I wouldn't necessarily directly associate asset sales with potential further dilution to the guidance range that we've put out today. Certainly as it relates to the auction process, yes, we did go to auction with 3 assets last week. We did sell Peregian, one of the assets at a 1% premium to book value of $4.2 million. We did have 2 other properties. They did not achieve the reserve pricing that we had set, although we are still in dialogue with prospective buyers at this time, and we continue to actively explore other divestment opportunities, and we're doing that through a strategic lens, and we'll be disciplined on the terms of which we look to sell.

And sorry, just 1 final question. So you have do $75 million in available liquidity. What are you looking to do with that? Are you more likely on-market buyback, acquisitions, just thought on that?

Yes. I mean, again, I think the way to think about the sequencing of the capital management initiatives that we're looking to undertake is to first execute on further asset divestments. And again, I just mentioned earlier that we are looking to, in the first instance, take gearing back towards the midpoint of our target gearing range, at which point we will then look to see what potential redeployment opportunities are available to us. Certainly, with our share price currently with where it's at, the potential for further repurchasing of our securities would screen as a strong investment opportunity, but that's not the only opportunity that we may look to execute on.

Your next question comes from Murray Connellan from Moelis Australia.

Just to, I guess, expand on the feedback that you were just giving around the strategy to potentially dispose of assets or continue with that program. Can you maybe just give us a bit of feedback or color on what the depth of the direct market is looking like at the moment on the buy side? And I guess how that compared to the sort of peaks that we were seeing towards the tail end of last year?

Yes. Thanks, Murray. Look, certainly, as I mentioned earlier, like transaction volumes are down more broadly. I think it's fair to say that acquirers of assets have been more selective about some of the attributes they're looking to undertake and execute on. There has -- we have seen the emergence of probably more opportunistic buyers coming to the fold as well, Murray. And so that's where we need to be able to strike a balance between dealing with prospective purchasers that have clear acquisition filters and clarity around the nature of the assets that they want and clear about the attributes associated with that because ultimately, we will measure ourselves on the strength of terms on which we can execute asset sales on. It needs to be done with reference to what we think makes sense for unitholders at the same time, Murray. So that's a bit of color, I guess, around in terms of what's been emerging within the direct transaction market. Further to that is the asset sales within the smaller average asset size segment of the transaction market more broadly still continues. There's still a fair bit of liquidity out there. Again, it just -- it will take a little bit more time for us to ensure that we're negotiating with the right parties and frankly, serious parties that aren't necessarily out there looking to execute on buying assets on an opportunistic basis.