Dexus Industria REIT (DXI) Earnings Call Transcript & Summary

Thank you, and good morning, everyone. I'm Alex Abell, Fund Manager of Dexus Industria REIT, and thank you for joining us for the 2023 half year results presentation. At the conclusion of the presentation, I will be joined by Joseph De Rango, Head of Finance for (sic) [ and ] Real Estate Funds, for the Q&A part of the session. Dexus Industria REIT has interests in 93 properties across Australia, and we acknowledge that each of these are on the lands of the Traditional Custodians. I would like to start proceedings by acknowledging the Custodians across those many lands and pay respects to their Elders past and present and reaffirm Dexus' commitment to supporting reconciliation. In terms of today's agenda, I will speak for approximately 15 minutes and touch on DXI's strategy and key highlights for the period, the financial outcomes and positioning of the REIT as well as providing some color on portfolio performance and the dynamics across the markets in which we operate. DXI's vision is to be the first choice for investors seeking listed industrial real estate exposure by delivering superior risk-adjusted returns. The core strategic pillar that DXI is the beneficiary of is the broad capabilities and the expertise of the Dexus Group, which unlocks the key value drivers, with examples including the transformational acquisition of a stake in Jandakot Airport, allowing DXI to gain access to a development pipeline that will enhance the quality of the portfolio over time; secondly, securing opportunities for DXI to establish ownerships in key locations across Sydney, including Kemps Creek and Moorebank, which have subsequently benefited from record-high year-on-year rental growth of 39% in 2022; and thirdly, the divestment of DXI's Rhodes Corporate Park assets in a challenging market, which has reduced income risk and strengthened the balance sheet. This active management approach and focus on returns has been recognized through the share price, which has outperformed the ASX 300 Property Index on a 1-, 3- and 5-year basis as well as since the IPO of the REIT in 2013. Now let's turn to the highlights for the period. In a challenging environment, we are pleased to confirm we are on track to deliver on financial year 2023 guidance after delivering FFO of $0.085 and distributions of $0.082 per security for the period to December 2022. The resilience of the income continues to be demonstrated with 2.7% like-for-like NOI growth. And the quality of DXI's assets combined with the leasing capability across Dexus has resulted in 67,700 square meters of leasing being completed, which is another record for the fund. The balance sheet is strong with look-through gearing of 29.5%, below the target range of 35% to 40%; after $160.5 million of divestments, reduced gearing by approximately 7%. And following the repayment of debt with the divestment proceeds, our liquidity position is particularly robust with no refinancing event until FY '25 and $139 million of undrawn debt facilities. As we move forward, the quality of the portfolio and organic growth is particularly important, and I will draw your attention to 2 key points on the following slide. Across the 93 interests carried out an average cap rate of 5.13% and totaling $1.6 billion, we have a balanced lease expiry profile, as you can see in the chart shown in the top right. This expiry profile is the outcome of curating a portfolio over many years that delivers a resilient income stream whilst also providing the ability to access market rent uplifts from time to time. And in the next 2 years, we have approximately 20% of income expiring as well as our development projects, which would equate to at least another 5% of the portfolio that we can reset to higher market rents. The pie chart displayed at the bottom right also demonstrates that 45% of the portfolio is linked to CPI reviews, and the average uplift from the CPI reviews during the period was 5.7%, an uplift that will materially benefit future periods. The financial overview I will now take you through confirms that DXI is well placed as we move into the second half of FY '23. At the top line, property FFO increased by 27.6% driven by a full period contribution from Jandakot, which was partially offset by vacancy at Rhodes and its divestment in November. On a like-for-like basis, the net operating income rose by 2.7%. Net finance costs were $4.7 million higher than the prior period driven by the cost of debt increasing 110 basis points to 3.4% and a higher debt balance primarily associated with the Jandakot acquisition and development land. The funds from operations outcome of $27.1 million was an uplift of 9.2%. However, given there were a higher number of securities on issue following the equity raise in the prior period, funds from operations per security fell by 9.7% to $0.085. With regards to the balance sheet, net tangible assets per security reduced 2.2% to $3.52, with $4.5 million of like-for-like valuation gains offset by the loss associated with the divestment of Rhodes. Let's now move to the balance sheet and capital management slide for more detail. The DXI balance sheet is well positioned, with gearing reducing by 4.7% from June 2022 to 29.5% on a look-through basis. This is below our target range of 30% to 40%, a position that provides balance sheet flexibility. From a security and certainty of funding point of view, we took out $75 million of new 5-year debt facilities and canceled $125 million of near-term maturities. And as shown in the chart at the bottom of the page, we do not have any debt maturities until financial year 2025 and retain undrawn debt facilities totaling $139 million. Hedging at period end was approximately 75%, which is 14% higher than the average of 61% during the period following the sale of Rhodes and the subsequent paydown of debt. Dexus revalued 100% of the portfolio as at December 2022. There continues to be positive sentiment for industrial real estate, which is supported by record levels of rental growth that flowed through to the DXI portfolio and drove a like-for-like valuation increase of $4.5 million. Capitalization rates expanded by 20 basis points largely as the value has recognized weaker transactional markets that have been influenced by the higher cost of ownership, including higher interest rates. After taking into consideration the divestment of Rhodes, the portfolio is now valued at $1.564 billion, which reflects a valuation decline of $26.7 million. Now let's take a moment to walk through the performance of the portfolio and the market dynamics at play. The industrial assets within our portfolio now make up 89% of total assets. The 2.4% like-for-like NOI growth was held back by incentive amortization expenses on assets for the first time. And once we take this into consideration, the FFO equivalent was 3.2% growth. We anticipate this to improve over the full year as the second half benefits from the average 5.7% in CPI reviews and the 11.1% re-leasing spreads reported for this period. Key leasing deals during the period included 25,200 square meters at 34 Australis Drive and 10,100 square meters at 1 West Park Drive, both in Derrimut, Victoria. And at Jandakot, we recorded double-digit re-leasing spreads across 9,000 square meters. It is worth noting that there was no downtime associated with any expiries during the period. The total leasing during the period is shown in the chart on the right. And as you can see, the Dexus team completed leasing outcomes almost as high as the previous 12-month period although this was, of course, only for the 6 months to December. Developments now account for approximately 7% of the portfolio by value, with the pipeline anticipated to total $369 million. The pipeline encompasses interests in 411,000 square meters of future warehousing in Sydney, which last year recorded rental growth of 39%; and Jandakot in Perth South, which recorded 27% year-on-year growth. The strength of these markets underpins Dexus' ability to continue to generate healthy returns. DXI has $94 million of committed spending remaining and another $250 million that we expect that will be activated over the coming 3 to 4 years. The $139 million of debt headroom as well as targeted divestments over the coming periods will be utilized to fund the commitments, and we are confident that delivering the development pipeline will improve the overall portfolio quality and generate higher risk-adjusted returns. It is worth noting that we have experienced delays across several committed projects largely associated with planning, weather and supply chain events that has resulted in completions pushing out 6 to 9 months. Industrial fundamentals remain attractive, with demand running well above the 10-year average and with manufacturing continuing to be strong. We observe this not only in research reports but through our own portfolio, where tenants have limited capacity for growth. The vacancy statistics, which are below 1% across the capital cities, and we have included these in the appendix for your reference, as well as the observations that we make against -- make across not only the DXI portfolio but throughout the DEXUS portfolio, is evidence that the market remains buoyant and retailers still appear to be securing stock where they can, with inventories continuing to build back towards pre-COVID levels. These dynamics bode well for the DXI portfolio generally and, in particular, to our development pipeline, which will benefit from materially higher rents that should flow through to income growth and value creation in due course. Brisbane Technology Park is located adjacent to the Gateway and Pacific Motorways in Brisbane and appeals to many life science occupiers and supported the leasing outcomes that drove the 4% like-for-like NOI growth during the period. Approximately 6,000 square meters of leasing was completed, materially de-risking the short-term outlook and supporting the 6% cash flow yield whilst also providing upside potential from lease-up of the remaining vacancy. Small occupiers also continue to be attracted to the precinct with 81% of tenants under 250 square meters either being retained or seeing space backfilled within 3 months, which is a testament to both our leasing team on the ground and the location and quality of the offering. As we move to the summary slide, I wanted to leave you with 3 key points on the DXI portfolio and what it means for the outlook. Firstly, our actions throughout this period have ensured that the fund is well positioned in an uncertain environment. We have offset inflation impacts by capturing CPI reviews averaging 5.7% across the portfolio and increased our hedging position through a combination of asset sales and ongoing risk management initiatives that provide a degree of resilience against rising interest rates. Secondly, the portfolio quality and the quality of the tenants that pay the rent, that ultimately funds the distribution, provides income resilience, which also enables us the ability to capture rental upside through market rental growth. And thirdly, we have continued to be disciplined in how we allocate capital and carry substantial liquidity, a prudent strategy that promotes the balance sheet strength that underpins the long-term success of the fund. As a result, I am pleased to reaffirm the FY '23 guidance statement of $0.167 to $0.175 per security of FFO and $0.164 for the distribution, which represents an FFO yield range of 5.5% to 5.7% and a distribution yield of 5.4% based off yesterday's close. Thank you for joining the call, and I will now hand back to the operator for any questions.

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

Alex, I was wondering whether you wouldn't mind just unpacking the 2.7% like-for-like NOI growth in a bit more detail, please. Was -- would there be much in the way of one-offs there or is it, I guess, the underperformance relative to CPI to a certain extent to do with cost inflation?

It's a function of a few things, and part of this is related to the last 12-month period. So CPI in the prior period was relatively low to where it is now, so the CPI reviews that flowed through for the like-for-like weren't as strong as what they will be this period, 5.7%. And then the other part was the fact that in the prior period, you may recall that our leasing deals were down 15% ahead of the prior valuer assumptions, which was a key driver of NTA growth, but the spread to passing was flat. So that did hold back that NOI growth on a like-for-like basis. And that's why with the 5.7% during this period and across the whole portfolio the average rent review was 4.5% during the 6-month period. So that's what I anticipate what drives that number higher moving forward.

And then just for the industrial portfolio more broadly, would you mind commenting on where your rents are on average or, I guess, where you believe you're in to be on average in terms of passing versus market? And then also where the value is, how do you have your assets assumed in terms of those ranges?

Yes. So I mean, historically, we have almost, without exception, outperformed our valuation rents. We outperformed our valuation rents by 7% during this period with those 11% spreads to passing. And as I said in the prior period, we're 15% ahead of our valuation rents. So broadly speaking, the portfolio remains -- according to the value, is around market rented, and there are different sort of components of that throughout the portfolio. But probably from my perspective, I'm looking particularly for FY '24 and FY '25 and the growth that may come through those periods from leases expiring. And to provide some color from that, we have some expiries within Melbourne and also in Adelaide in next financial year, where I would expect some quite healthy rental spreads of at least 15%. And that sort of makes up about 2/3 of the industrial expiries next year, for some color. And so I would expect that we can continue to outperform those valuation rents, which will continue to enhance our NTA throughout an uncertain period.

Your next question comes from James Druce from CLSA.

Alex, just to clarify that last question, so the rents versus the rents in the vals, what's the gap?

So I mean the gap is broadly flat, James, is the short answer.

Okay. And then going back on the first question is there anything else there? Because you getting 11% spreads, you have occupancies up, and you've leased a lot of sort of space over that first half. I'm just surprised NOI growth isn't a little higher on that like-for-like number.

Yes. So it is a function of what I mentioned to Murray. The other part of our NOI that's worth keeping in mind is that, that NOI number that we print is a -- includes amortization, and so some of the deals that we had completed about 18, 24 months ago did include high levels of incentives which hadn't previously been carried through the amortization line. And I've spoken to investors about this over many years that when you -- typically, when you buy an asset, it doesn't carry any amortization. When you release an asset, you will start carrying amortization, and that creates effectively an NOI headwind that at the face level doesn't exist, but on an effective basis, it does. So that has also played a little bit of role in holding back that NOI growth. And that's why when you back that out for industrial, you get to a 3.2% like-for-like NOI growth number.

Okay. Then just on guidance, the sale of Rhodes, that would have been accretive to earnings, I imagine, given the low yields it had and the high cost of debt. Is that correct?

It would have, correct. And I suppose the degree of accretion depends on your lease-up assumptions that you may have made in your model. And that's probably -- I mean, it's probably worth just taking moment to reflect on how we actually come up with guidance in the first place. And it's obviously predicated on a variety of outcomes across the portfolio. And what we presented today is what we see halfway through the year, and as I said, we're on track. So I mean, the key factors that really sit behind that guidance statement at a property level, renewal outcomes and particularly downtime, which can impact like-on-like numbers and, obviously, the income nature of the portfolio; secondly is some development and operational items at Jandakot, and they have caused a bit of a drag of approximately $800,000 between those 2 during the period. And we've also got -- we're also paying tax through Jandakot as well. So that was about $200,000 for the period as well. So there's numerous moving parts within our guidance statement, and those have formed part of it. And obviously, there was the lease-up of vacancy and other transactions, including Rhodes, which we apply probability weighting, too. So those moving factors have allowed us to restate our guidance for the period and hopefully give you some color on the moving parts.

Okay. And do you assume any more devaluations in guidance given you're externally managed or revalue assets, rather?

No, we haven't. And if we did, it would flow to '24 anyway.

Yes. One more, if I may. So I noticed the development yields are going up. Some of those projects you're close to completing, can you be a little bit more specific on where you think they'll land?

Yes. So the committed developments that we already have underway, the majority of those, particularly Jandakot, are pre-committed, so they'll be delivering yield in the 5.5% range. Where the upside is coming is the rental growth that you've seen throughout 2022. And we're -- at the moment, we're building a spec facility at Jandakot, which we expect will be able to capture higher market rental growth from that, for example, which will pop us close to 6% or even indeed above it. And in -- at Moorebank, where we're going through planning at the moment, clearly, there's been some really strong rental growth in Sydney at 39% throughout last year. So we expect that to outperform, and hence, we've upgraded the yield range in that to 5% to 6%. And at Kemps Creek as well, where the fund through the development is conceding, it is held up with planning. So that's delayed by 6 to 9 months as well. But frankly, it's probably played into our favor in terms of market rents have moved so rapidly in that market, that we should be able to crystallize a materially higher yield on cost.

Your next question comes from Stuart McLean from Macquarie.