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

Thank you for standing by, and welcome to the Dexus Convenience Retail REIT H1 '23 Results Conference Call. [Operator Instructions] I would now like to hand the conference over to Mr. Jason Weate, Fund Manager. Please go ahead.

Thank you, and good morning, everyone, joining on the call. I'm Jason Weate, Fund Manager of Dexus Convenience Retail REIT, and I'm pleased to be delivering the 2023 half 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. Moving to Slide 5. Our results for the half reflect the resilient nature of the portfolio, which offers secure portfolio income underpinned by long WALE, attractive average rent reviews and high-quality tenant covenants. In terms of financial performance, we delivered like-for-like income growth of 2.4% and narrowed FY '23 guidance range to FFO and distributions of $0.214 to $0.218 per security. We've been focused on pursuing asset sales and have announced 6 divestments totaling $25.4 million in the financial year-to-date, reflecting an average discount to book of 1.3%. The sales have also strengthened our balance sheet with pro forma gearing of 33.5%, broadly in line with the midpoint of our 25% to 40% target range. The DXC portfolio is characterized by high income certainty backed by some of the highest-quality tenant covenants amongst A REITs. Our income resilience is reflected in occupancy remaining above 99%, and we remain predominantly exposed to metro and highway assets, which are expected to perform better in the long term as tenants seek to evolve their product offering in line with alternative energy vehicle technology and the associated convenience retail offering. We derive 89% of our income from 10 major tenants, all of which operate on a national scale and some internationally. We continue to work closely with each tenant to enhance the performance and sustainability of their sites. Most of our portfolio benefits from contracted fixed rental increases each year, with the balance reflecting a combination of CPI-linked increases. These rent reviews, combined with our WALE of more than 10 years, makes our property income stream one of the most defensive in the sector with strong growth prospects. Turning to the financials. This half, FFO increased 2.0% to $15.6 million. Compositionally, property FFO increased 12.1% to $23.9 million, reflecting full period contributions from acquisitions undertaken in first half '22 and like-for-like income growth of 2.4%. Finance costs did increase significantly due to higher floating interest rates and a high average debt balance. Overall, on a per-security basis, FFO was down 0.8% to $0.113 per share largely due to higher average securities on issue. As flagged at our last results, our 2022 half year FFO metrics have been restated to include amortized borrowing costs in FFO to align with PCA guidelines. For this half, distributions were $0.106 per security, reflecting the payout of 93.9% of FFO. For the full year, our FY '23 distribution payout ratio is expected to fall within our 95% to 100% policy range, while the first half distributions were conservatively set with reference to the low end of our prior guidance range. NTA per security decreased 2.1% to $3.94, the majority of which was attributable to $14.9 million in asset valuation declines. Moving on to capital management. Reported gearing was 34.1% or 33.5% on a pro forma basis, which broadly sits at the midpoint of our target gearing range of 25% to 40%, and we continue to target further asset sales to enhance our balance sheet strength. Our cost of debt increased to 3.4%, in line with increasing floating rates, which averaged 2.8% for the period. 63% of debt was hedged during the half and our average maturity of hedges sits at 3.7 years. Independent valuations were undertaken across 25 assets in the portfolio over the period, resulting in a decrease of 1.8% or $14.9 million on prior book values, although contracted rental growth partially offset the impact of cap rate expansion of 16 basis points. In the direct market, fuel and convenience transaction sales volumes are on balance, down by around 50% due to cautious buyer sentiment in response to changes in the market cost of capital. Notwithstanding this, we expect relative valuation resilience for fuel and convenience retail assets based on the nondiscretionary nature of retail and fuel spending, predictable cash flows underpinned by long leases to well-capitalized tenants and average asset sizes appealing to a broad range of investors. As I mentioned earlier, we have divested 6 assets in the financial year-to-date at an average discount to book of 1.3%. This includes $10.1 million of proceeds, which are expected to be received in the coming months, which will further enhance balance sheet strength through reducing gearing and increasing hedging levels. The divestments have also enhanced the quality of our portfolio by meaningfully reducing our exposure to older tank infrastructure as well as our exposure to regionally located assets, which is expected to reduce to 15%, while our income derived from nonfuel tenants now stands at 13%. In summary, DXC offers strong portfolio income visibility amidst an uncertain economic backdrop. This makes us well placed to deliver consistent property income growth over the long term, underpinned by high-quality international and national tenants, generating over 3% average rent growth per annum. We remain focused on strengthening our balance sheet, including through exploring additional asset sales to increase redeployment optionality. In relation to FY '23 guidance, we have narrowed our FFO and distribution range to $0.214 to $0.218 per security, assuming average floating interest rates of circa 3.25% for the year. 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 Murray Connellan from Moelis Australia.

I was wondering whether you could unpack the sales process in a bit more detail for us and maybe just give a bit of commentary on what the direct market looks like right now versus 6 months ago. And then maybe just also any scope for further asset sales in the coming months. And I guess what sort of bidders remain in the market at the moment?

Thanks, Murray. I'm not sure if all those questions exceeds the 2 limit or whether -- but in any case, I'll try and get through all of those, but I might start just on sort of transaction markets more broadly. I think the full effect of the interest rate and inflationary environment are yet to play through, and I guess, depending on where the short and long end of the yield curve ultimately lands. I wouldn't be surprised to see cap rates continue to expand from here. But as it relates to the revenue side of DXC's assets, I mean they will continue to drive locked-in rent growth of over 3% per annum, and that does provide a positive offset equivalent to around about 25 -- sorry, 20 basis points of cap rate expansion. So I think that sort of talks to where the transaction markets are and how DXC assets are positioned. As it relates to the EOI campaign itself, I mean, we have announced a few additional sales as part of today's release. As it relates to pricing, I mean, that was struck at pricing well within 5% of June '22 book values. Negotiations do remain ongoing on a number of other assets, but there is a lot of buy caution out there in the market, and transactions are taking longer to finalize, but we will continue to assess the merit in offers that we continue to look at on a case-by-case basis. In terms of further asset sales, if you're looking for a quantification at this stage, that's probably a difficult thing to provide, Murray. I guess it really does depend on how the market continues to evolve. But we do remain very mindful of NTA, and we do have an overarched balanced view on proceeding with transactions that we believe will add value for all security holders.

Your next question comes from Leanne Truong from Ord Minnett.

Just a follow-up on the asset sales. So you took 14 assets to market. How many are you expecting to sell? And I guess, are you still looking at that like 5% discount, I guess, range? What -- I guess, where would you sell the assets at?

Yes. So we did take 14 assets to market, Leanne, and that was to entice, obviously, the broadest mix of investors as possible to participate in the process. By no means was that a sale target. As far as how we're thinking about discounts on offers potentially coming in, we're not ruling anything in or out. It ultimately depends on how the market continues to evolve. And again, I think as I alluded to in my comments to Murray, we will transact on terms that we believe will add value for security holders. So we don't have a prescriptive discount number in mind that will place a limit on what we're willing to accept. But depending on where the market is at, it has to make sense in the eyes of all security holders.

And you've -- I mean you just mentioned before that you're looking beyond the original 14 that you put to market. So I guess, how many do you consider non-core? Or are you going into your core assets and looking at selling them?

So the 14 assets that form the part of the EOI campaign reflected a mix of what we viewed as being lower-tiered assets and some of which were noncore, but it also did include a mix of assets that probably rank more mid pack in terms of the quality mix of the portfolio. So we are looking broader -- a broad-based mix assets again to really entice as much investor interest to participate as we can.