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

Thank you for standing by, and welcome to the Dexus Convenience Retail REIT 2024 Annual Results Briefing. [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 2024 full year results. 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 and present, and remain committed to supporting reconciliation across our business. Today, I will touch on DXC's investment proposition, key highlights for the period, the financial outcomes as well as trends we're seeing in the broader market. DXC's investment proposition is to provide investors with defensive income with embedded growth through the cycle. We deliver this firstly by enhancing portfolio metrics that deliver high income certainty and growth. Secondly, we maintain a prudent capital structure, having regard to the broader macroeconomic environment and property valuation cycle. And thirdly, we take an active but disciplined approach to portfolio management, including the assessment of strategic growth opportunities beyond fuel and convenience. Supporting us in executing these pillars is an aligned manager with Dexus, committed to delivering long-term performance for our investors across its entire fund management platform. Turning to the highlights for the period. We delivered FFO and distributions at the upper end of our guidance range of $20.8 to $21.1 cents per security as our portfolio continues to deliver a resilient income backed by high-quality tenant covenants. We executed $23 million of divestments to support the fund's capital position with gearing maintained at around the midpoint of our target range of 25% to 40%. Post-balance date, we also exchanged contracts to sell two assets for $5.9 million at an average premium of 2.4% to June book values, which will reduce pro forma gearing by an additional 50 basis points. We continue to explore additional asset sales to support capital redeployment into higher-returning opportunities, with the sale of up to an additional $40 million of assets under negotiation subject to successful equity raised by the purchaser. The DXC portfolio reflects a high-yielding valuable land bank with a majority weighting to metro and highway locations. These sites will play a critical role affording long-haul travel and transport over the long term and to capitalize on 1.2 million new fuel reliant car sales over FY '24, reflecting year-on-year growth of 11%. We are also well placed to support tenants in evolving their strategies in light of the continued shift in the energy mix. As mentioned within our highlights, 89% of DXC's portfolio is zoned to high-value uses of commercial, industrial, residential and mixed-use providing flexibility in our on-site offering over time. We continue to explore broader alternate use and redevelopment opportunities with approximately 20 value-add opportunities identified to date. Our income is backed by some of the high-quality tenant covenants in the market with 95% of income derived from experienced national and international operators. Our top tenants continue to publicly commit and invest in the long-term performance of their sites with 3 of our major tenants investing in convenience retail capability via acquisitions. BP's acquisition of X Convenience is the most recent example of this. Turning to sustainability. Our approach aligns to the Dexus sustainability strategy which includes three priority areas, being customer prosperity, climate action and enhancing communities. We continue to source 100% renewable electricity and maintain a carbon-neutral position across our controlled assets. We also actively engaged with the tenants to support their varied ESG initiatives. And currently, we are in discussions with 5 major tenants on solar initiatives and we have electric vehicle charging rollout across 22 sites within our network. Turning to the financials. We achieved FFO at the top end of our guidance range as solid property operating performance was somewhat impacted by continued increases in interest expense. NTA per security decreased 5.1% to $3.56, the majority of which was attributed to asset valuation declines. As I touched on earlier, gearing remained around the midpoint of our target range despite further asset devaluations including two post-balance date sales, gearing would decline by 50 basis points and were we to include additional asset sales currently under negotiation it would decline towards the bottom end of our 25% to 40% target range. This positions us well to consider various strategic capital deployment options. We also enhanced our debt book during the year having extended $130 million of facilities at sharper pricing, which will deliver incremental savings in the future. The Glass House Mountains project presents an opportunity to significantly enhance the convenience retail offering. The Northbound project is expected to commence 6 months later than planned as we worked with Viva Energy over the second half to finalize the design of a new, expanded, On The Run format, which will be focused on food-on-the-go, grocery convenience and will include an internal QSR. Construction is expected to begin this quarter for a period of 12 months. As the project is a fund-through, the later than planned commencement has no financial impact for DXC, and we continue to expect strong development returns. Independent valuations were undertaken across 96 assets in portfolio. In total, property valuations decreased 3.1% over the 12-month period. Valuations continue to be supported by predictable cash flows with contracted rental growth, partly offsetting the impact of cap rate expansion. Our average cap rate expanded to 6.4% which remains above the marginal cost of debt with broad-based appeal to direct property market investors. Despite a challenging interest rate environment, fuel and convenience transaction volumes have remained relatively robust, allowing for material price discovery to inform asset valuations and NTA. We have seen this in our portfolio with 20 basis points of cap rate expansion experienced in the first half, reducing to 10 basis points over the second half. We're seeing investors continue to take a long-term view on underlying land value growth and tenant lease renewal potential, supporting interest in the sector. Additionally, we are seeing increasingly strong pricing for assets with QSR retail and attached, providing indicative valuation support for the Glass House Mountains development on completion. In summary, we are well placed to deliver defensive and growing property income and will retain our focus on enhancing portfolio attributes that deliver certainty and growth of income, preserving balance sheet strength, executing portfolio optimization initiatives, including the Glass House Mountains redevelopment and leveraging Dexus' market-leading capabilities. In relation to FY '25 guidance, we expect to deliver FFO and distributions per security of $20.6 cents, impacted by dilution associated with $40 million of asset sales currently under negotiation. Our FY '25 guidance reflects an attractive distribution yield of over 7% for investors backed by strong income visibility. And in the current macroeconomic environment, whereby there is an increasing bias towards rate cuts over the near term, DXC represents an attractive investment opportunity, coupled with strong underlying exposure to nondiscretionary income and an NTA base that is well validated by recent transaction activity. 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 Andy MacFarlane with Bell Potter.

First question, just wondering if you could walk us through how you're thinking about guidance for the year ahead and the components of it?

Yes, sure. So if we think about a bridge from FY '24 to FY '25, you should probably think about like-for-like income growth being offset by the increase in interest expense, so flat after those two things and I guess the way to think about the vast majority of the decline from there is the full period impact of asset sales undertaken in FY '24 and also the additional $40 million of sales currently under negotiation.

Just in terms of the cost of debt, just wondering what you're assuming in terms of the variable component of it for FY '25?

So the floating rate that we've assumed was -- had regard to the market curve, obviously, at the time of setting guidance rather last week, appreciate there's been a bit of volatility in the market, but the floating rate that's implicitly assumed is in the mid-4s.

In terms of the asset sales that you've announced today underway the $40-odd million, can you just give us a little bit more color on what they are in the pricing for those assets?

Yes. So firstly, the portfolio is skewed to regional and regional city locations in Queensland. As far as pricing is concerned, the overall discount to December '23 book values is at about 2.8%. And I guess, were we to apply broader external valuation inputs as at June at discount would look more like being under 2% to June -- an assessment of June valuations. From our perspective, that does reflect the cost of liquidity, I guess, across the larger scale portfolio in the current environment. And we've had regard to capital redeployment returns on offer in accepting that discount.

I guess as a follow-on, is there any other asset sales that you're thinking about kind of looking forward?

Well, I guess gearing operating range is 25% to 40%, and that's to facilitate flexibility during various stages of the valuation cycle. And so with the extent of interest rate volatility that's still in the market, my preference is to continue managing gearing at around that midpoint. And so if you think about balance sheet -- or sorry, pro forma gearing including asset sales underway, but also full redeployment into Glass House Mountains developments Stage 1 and 2 then gearing would be sort of back at the midpoint of the target gearing range. So I think that these asset sales place us in a position where we're well funded with near-term capital deployment opportunities. And I guess any asset sales above and beyond that would be to fund additional opportunities.

Final one, if I may, just on the Glass House Mountains. Just wondering what the reason is for the delay. Just wondering if you could give us a little bit more color around it and the impact to the financials.

I mean the reason for the delay really is just to accommodate a redesign. The Viva OTR box in the layout and parking layout. And there's also some provision of extra EV charging. There will be 10 EV charges on that site. So -- and this council approval is required for those changes, which takes time. You asked about financials. I mean, most importantly, there is no FFO or development profit impact resulting from the delay and what we get as a landlord is increased prospects for tenant longevity via the creation of the most up-to-date and highest quality offering OTR has in the market.

Your next question comes from Murray Connellan with Moelis Australia.

I was wondering whether you could just give us a little bit more color on how you're seeing the broader direct market at the moment. I appreciate that there's a bit of disclosure in the presentation. But if we just sort of zoom in to the last sort of 6 to 12 months in particular. And I guess, how you're seeing transaction yields tracking on a like-for-like basis. And how that informs how you're thinking about the valuations in your own portfolio over the next sort of 6 to 12 months? And I guess, how that informs your thinking about the balance sheet as well?

Well, look, firstly, just on the transaction market itself. I mean, I think calendar year '24 year-to-date, I think we're very much on track to exceed very reasonable levels of transaction volumes in calendar year '23. And over the last month, there's been another 7 transactions above and beyond what we've disclosed in the presentation materials. And I think the overall drivers for buyers in the market really are positive cap rate spreads to the marginal cost of debt generally improving outlook for interest rates and positive themes from fuel and convenience tenants, including meaningful reinvestment into their operations and sites. And so in that context, I feel really comfortable with our positioning in the market with a portfolio average cap rate of 6.4%. I think that's an undemanding cap rate in the context of a number of the yields that we've seen transact in the direct property market over the last 6 months or so. And from a valuation perspective going forward, I guess if -- well, if you have regard to the current interest rate curve, which does have a rate-cutting bias, I'd say we're pretty much there based on what we're seeing in the transaction market. Murray, there's a healthy spread, as I mentioned, to the cost of debt. And there's material price discovery in that transaction market that's ultimately underpinning NTA for the book.

And then maybe just touching on commentary around diversifying income sources away from fuel. Is the way to think about that still around the sort of broadening convenience offering that's attached to the existing portfolio? Or do you think there's a strategic slant towards non-service station type assets as we look forward into the sort of medium to longer term?

So look, I mean, I guess, our investment proposition is income-based. So where there are opportunities that have attributes such as income resilience and growth of income, strong tenant credit quality and industry relevance on land that has strong barriers to entry and long-term prospects for growth, we will look at. And I guess, by asset class, what that means is we'll continue to look at fuel and convenience with QSR attached like Glass House Mountains, that's a really core part of how we think about growing the fuel and convenience portfolio. But also other essential services-based retailers, the grocery anchored retail, needs-based LFR and possibly, the provision of co-located services in and around our convenience retail centers and potentially that could extend into the health and medical sectors as well.

[Operator Instructions] Your next question comes from Adam Calvetti with CLSA.

Congrats on the result. Just continuing on Glass House Mountains, so $20 million and $25 million in Stage 2 for the -- it's valued at -- both sites are valued at $20 million at the moment. What is the $20 million in Stage 1 cover from construction cost front? And I guess where is the bulk of that money being spent?

So I mean, if you think about the scope of works for Glass House Mountains Stage 1, it's a complete leveling of the site so if we think about the incremental cost attached to that is essentially the vast majority of that is in construction costs, but they're also -- it is being developed by a third-party developer and there is a development management fee that's attached to that as well. So they have two key components, but the vast majority is construction costs were basically a brand-new offering, service center offering, but also including 3 additional QSR pad sites.

That makes sense. And you mentioned here that based on the independent valuation on completion, so you managed to just knock down a cap rate on completion. Are you going to disclose that?

Look, we're not currently in a position to disclose specific cap rates at this juncture, but I guess any development commencement will be premised on an expectation for a comfortable cap rate spread below the incremental yield on costs.

And did Viva Energy when they triggered -- when they elected to redevelop the site, does it trigger the major capital works clause in the Viva Energy leases?

Sorry. Can you just repeat that?

So when Viva approached you to redevelop the site, did it trigger the major capital works clause in the Viva Energy lease for works above $250,000?

So I mean, the way in which the development was brought about was us approaching the major tenant in Viva. So the site was auctioned up and secured by a third-party developer. We came alongside that third-party developer and commenced a negotiation process to essentially not terminate, but sort of Viva reaching a point where it would surrender the balance of its lease tail in place of commencing a brand-new lease on that site as part of the commercial tools that ultimately drive the decision-making to proceed. So that's the context around how that development opportunity came to lot.

And one more, if I may. I understand it's time for redevelopment, why is there a spread on the yield on cost, I am sure it should be an agreed coupon?

So it's really to reflect finalization of commercial terms with the external developer. So that continues to move around a little bit until we have all the agreement for leases secured and to which point that yield on cost will be locked in, but I think it's fair to assume that it would be towards the upper end of that range that we've disclosed.

Your next question comes from Fiona Buchanan with Morgans.

Jason, actually, my question got answered because it was around all the transactional. So I'll jump off the queue. Thank you.

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

Well, thanks, everyone, for taking the time to join the call this morning, and I look forward to catching up with a lot of you over the coming days and weeks. Thank you.

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