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

Thank you for standing by, and welcome to the Dexus Convenience Retail REIT FY '23 Results Briefing. [Operator Instructions] I would now like to hand the conference over 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 full year result. 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 the elders, past and present, and remain committed to supporting reconciliation across our business. Today, I will touch on DXC's investment proposition, FY '23 key highlights and financial outcomes as well as providing some color on portfolio activity over the period. Moving to Slide 5. The macroeconomic environment over the year is one that's mostly been characterized by uncertainty. In that context, DXC's investment proposition is an attractive one to provide investors with defensive income with embedded growth through the cycle. We delivered this, firstly, by maintaining a high-quality portfolio underpinned by some of the strongest tenant covenants in the market, close to full occupancy a long WALE and a blend of contracted fixed and CPI-linked rental escalators. Secondly, we ensure we manage capital appropriately, having regard to the valuation cycle with our operating target gearing range of 25% to 40%. And thirdly, we take an active approach to portfolio optimization via the combination of acquisitions, divestments and development opportunities that continue to evolve the portfolio and ensure its resilience over the long term. Supporting these pillars is an aligned manager with market-leading capabilities across transactions, development and asset management. In FY '23, the Dexus platform has played an important role in executing capital recycling activity, resulting in the divestment of circa 7% of our portfolio despite challenging market conditions. As I will highlight today, these divestments support the fund's outlook by strengthening our balance sheet and enhancing portfolio quality, which positions us well to deliver a secure and attractive distribution yield for investors of over 8%. Turning to the highlights for the period. It has been an active year to position the fund for long-term outperformance. And in what has been a challenging environment, we have been focused on key priorities across areas that we can control. In terms of financial performance, we delivered FFO and distributions of $0.216 per security, reflecting the midpoint of our guidance range. We also achieved average rent reviews of 3.7%, supported by CPI-linked increases, which will support top line growth and drive improvement in like-for-like income growth. We have continued to focus on pursuing asset sales to further strengthen our balance sheet. Pro forma gearing has lowered by 3.2% to 31.8% despite asset devaluations across the portfolio in a rising interest rate environment. Our active approach to portfolio optimization resulted in the delivery of $52.3 million of divestments for the year, reflecting an average discount to prior book values of 2.5%, which compares to implied asset devaluations of 22% at DXC's current security price. Of the total divestments, $12 million of sales were secured post 30 June at attractive price points for our investors. The DXC portfolio comprises 105 assets across 676,000 square meters, primarily along the Eastern seaboard of Australia. As a result of transactional activity in the year, our exposure to metro and highway assets has increased by 2% to 85%, which benefit from high traffic flows. These assets are also 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. Given our low average site coverage of 35% across our sites, we are well placed to support our tenants on this journey. We derive 88% of our income from 10 major tenants, all of which operate on a national scale and some internationally. The remainder is sourced from a range of convenience retail tenancies that are diverse, with 68 specialty retailers across the network. Our portfolio offers embedded property income growth, with the majority benefiting from contracted fixed rental increases each year and the balance reflecting CPI-linked increases. These rent reviews, combined with our WALE of 10 years, makes our property income stream one of the most defensive in the sector. Turning to sustainability. We seek to drive outcomes across our network. We will maintain operational control, which represents approximately 15% of the portfolio. Across these assets, we received our inaugural carbon-neutral certification for our under the government's Climate Active program for our prior year emissions and will again be seeking certification this year as part of the Dexus Group submission. Outside of our managed assets, we work closely with tenants to improve outcomes at their sites. And in line with this, we have continued to progress solar rollout across part of the Chevron network within our portfolio. The uncommitted redevelopment of Glass House Mountains presents an opportunity for us to enhance sustainability of the site, and we have worked alongside our development partner to incorporate environmentally friendly features such as energy-efficient lighting and water fixtures, rooftop solar and EV charging stations into the project design. Going forward, we will align with Dexus' renewed sustainability strategy to support long-term value creation. Turning to the financials. As mentioned earlier, our FY '23 FFO and distributions per share of $0.216 came in at the midpoint of our guidance range, which is in line with floating interest rates averaging around 3.2% for the period. FFO per security was down by 5.3% on FY '22, with a like-for-like growth of 2.7% being more than offset by higher interest costs and marginal dilution from asset sales. NTA per security decreased 6.9% to $3.75, the majority of which was attributable to $41.3 million in asset valuation declines in an environment of rising interest rates. On capital management, divestment proceeds have strengthened the balance sheet. And as I touched on earlier, the macroeconomic environment remains uncertain, and we consider it prudent to manage gearing at around the midpoint of our 25% to 40% target range at this point in the cycle. We recorded pro forma gearing of 31.8%, and we expect over 70% of debt to be hedged over FY '24 compared to 64% for FY '23, providing additional protection from rising interest rates. We also refinanced a portion of our debt during the period, which has extended our nearest debt maturity out to FY '26, while retaining a long weighted average debt maturity of 4.2 years. Independent valuations were undertaken across 82 assets in the portfolio, resulting in a decrease of 5% on prior book values. Overall, valuations remain supported by predictable cash flows and strong tenant covenants, with contracted rent growth partly offsetting the impact of cap rate expansion. Our average cap rate expanded to 6.1%, which remains above the marginal cost of debt. And in the direct property market, we are seeing us appeal to a broad range of investors seeking high-yielding opportunities. Over the period, we divested 11 assets, representing 7% of the portfolio at an average discount to prior book value of 2.5%, and we are pleased with this outcome given subdued market conditions. As I mentioned earlier, these divestments have strengthened our capital position to reducing gearing to around the midpoint of our target range and enhancing our natural hedging position. In addition, the divestments have enhanced overall portfolio quality and operating performance metrics. And in particular, they have reduced our exposure to regional assets with 42% of total divestments being regionally located; reduced our exposure to older tank infrastructure by roughly 1/5; and enhanced the relevance of our asset base, with average asset sizes increasing by 3.7%. In summary, we are well placed to continue generating defensive income with embedded growth for our investors through preserving portfolio attributes that deliver certainty of income, continuing to actively manage the portfolio and balance sheet to position the vehicle for long-term growth opportunities and leveraging Dexus' market-leading capabilities. In relation to FY '24 guidance, we expect to deliver FFO and distributions per security of $0.207 to $0.211, which is based on an average 90-day BBSW range of 4.25% to 4.75% and reflects an attractive distribution yield of greater than 8% for investors backed by strong income visibility. 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.

My first question, looks like we've sold additional 2 assets for about a 6.5% discount to book value. So just on that, firstly, are you looking to sell more assets? And if so, I guess, what discount would you be willing to sell assets at?

Yes. Thanks, Leanne. So maybe, I just might touch on the -- your first part of your question there. I mean, yes, we did sell additional 2 assets. I think the relativity you're pointing to refers to deck 22 valuations. We did revalue both of those assets as at 30 June basis, having taken those to market post balance date. And I guess, relative to that valuation round, it actually reflect around about -- sort of well within 5% discount to book for those 2 assets. So very much in line with 30 June book values. I think it's an important point to note, especially as it relates to the rigor of our valuation process. But I guess our focus does continue to remain on further strengthening our balance sheet, obviously, to create redeployment options that add value for our investors while still managing gearing at around the midpoint of the range. And I think that's prudent at this stage of the cycle, whilst interest rates are still moving. But there is no hard target per se. It really does depend on the strength of terms that we can achieve, the timing and order of magnitude with which we can release capital. And we'll continue to be opportunistic in our approach and that will ultimately inform, I think, the relative attractiveness of redeployment options available to us at that time.

And just a second question. Obviously, pro forma gearing now at 32%. I guess what -- if you can't get asset sales, would you be looking to redeploy potentially buy back all Glass House Mountains at that level of gearing? Or would you need further asset sales to redeploy those funds?

Yes. Thanks again, Leanne. I mean, obviously, we want to be managing gearing at around the midpoint of the target range, so long as there is -- this uncertainty remains as it relates to interest rates and inflationary pressures more broadly. So that probably doesn't lead us with a whole lot of headroom with us coming from a starting point at 31.8%. So I think prior to those redeployment options that you spoke about, yes, there would be an imperative for us to recycle out of a few more assets, I think, at least to position us well to provide redeployment options and deploying a way that still sees us managing at around the midpoint of the target range.

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

Jason, I was hoping you could just give us a bit of an update on Glass House Mountains, please? And I mean update from this morning seems to suggest a 5% to 6% potential yield on cost for that one. I mean, at this stage, would you be expecting to go ahead? Or is there a bit more work to be done and a bit more, I guess, macro uncertainty to wash under the bridge before you make a decision?

Thanks, Murray. Good question. I mean, I'll start by saying, obviously, Glass House Mountains remains an incredibly high-quality property regardless of what happens there. We do maintain that there's considerable upside through development potential, and that has regard to the yield on cost range that you just highlighted. At the end of the day, as and when relevant DA approvals and agreement for leases are in place, we have the option to commit for Stage 1 in particular. I think the timing of that would be sometime during the second quarter. So we have a little bit of runway between now and then to finalize those elements before in a position to commit capital. But perhaps the way to think about what those capital commitment look like at the moment for Stage 1, I think Stage 1 would represent probably less than half of the total project amount that we've highlighted in the materials today. And so from a gearing perspective, that would be probably less than 2%. But regardless of whether we progress or not, Murray, we think it's a very high-quality asset with very strong appeal to a wide range of potential owners irrespective of what we do there.

Sure. I mean, I guess, you have flexibility in terms of when a kickoff for that project would be. But I mean, I guess, just at this stage, and again, I appreciate that you probably are still in the process of coming to a decision around the feasibility of Glass House Mountains. I mean at this stage, would you feel that a better use of capital would be deployment into Glass House Mountains or deployment to a share buyback?

Yes. So just on the first part of that, certainly where we think the market cap rate of that asset stands in the market on a completed basis, we think that, that project is in the money. Does that mean it makes it the best deployment of capital option for us? I think ideally, we want to be in a position, Murray, where we have sold a number of assets to provide us with multiple deployment options, with Glass House Mountains being one of those options. So by virtue of that, I think as I mentioned to Leanne just earlier, we'll continue to do what we have been doing, but we've selectively looking at incremental asset sales, but doing that in a disciplined way that creates balance sheet headroom for us to look at various deployment options, including Glass House Mountains.

There are no further questions at this time. That does conclude our conference for today. Thank you for participating. You may now disconnect.