Dexus Industria REIT (DXI) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the Dexus Industria REIT 2024 half year results. [Operator Instructions] I would now like to hand the conference over to Mr. Gordon Korkie, Fund Manager. Please go ahead.

Good morning, everyone. I'm Gordon Korkie, the new Fund Manager of Dexus Industria REIT. Thank you for joining us for the 2024 half-year results presentation. I'd like to start proceedings by acknowledging the traditional custodians across the many lands on which we operate throughout Australia. We pay our respects to their elders, past and present and remain committed to supporting reconciliation across our business. Today, I'll cover off on DXI's investment proposition and key highlights for the period, the financial outcomes as well as providing some color on portfolio performance and the dynamics across the markets in which we operate. We'll then hand over to Q&A, where I'll be joined by Chris MacKenzie, Head of Industrial Transactions and Development; and Chris Glasson, Head of Real Estate Funds Finance. The purpose of DXI is to generate superior risk-adjusted returns for investors seeking listed industrial real estate exposure. We deliver this by generating organic income growth from high-quality assets with our strategically located portfolio capable of reaching 80% of the population in each capital within 60 minutes. Second, we conservatively manage the balance sheet to provide resilience and the flexibility to invest opportunistically. We manage gearing with regard to where we are in the valuation cycle and have operating target gearing range of 30% to 40%. Third, we take an active approach to managing the portfolio through improving the efficiency of our assets in partnership with our tenants and pursuing additional value-creating opportunities such as our development pipeline. Supporting these pillars is Dexus and a line manager with over $12 billion of industrial assets under management. Dexus' deep real asset capability and expertise provides us with the ability to leverage not only insights, but tenant and supplier relationships. In doing so, it allows us to extract maximum value from our assets and ultimately positions DXI to deliver strong real estate performance over the long term. Turning to the highlights for the period. Today's result demonstrates the benefit of our proven and long-standing active management approach. Over the past 18 months, we've delivered more than 160,000 square meters of leasing, achieving double-digit re-leasing spreads. This has underpinned strong property income growth with like-for-like growth of 7.3% across the portfolio this half. We also significantly increased occupancy at BTP to 95.7%, which is a fantastic achievement by the Dexus leasing team. Over that period, we also dealt with forthcoming expiries, bringing forward re-leasing where we thought it's favorable to capture localized supply-demand dynamics. Importantly, we have executed almost $300 million of divestments since July 2022. This has provided us with one of the lowest gearing levels in the sector at 26.2%, which is below our target range and positions the fund for strong relative performance should economic settings remained challenging. Equally, it also provides us the capacity to be opportunistic should conditions improve. This has been achieved while remaining on track to deliver our FY '24 guidance, notwithstanding the impact of higher interest rates. Turning to the fundamentals of our quality portfolio. The diversified portfolio comprised interest in 91 assets valued at $1.4 billion, which generated secured income with strong defensive characteristics. Property income growth is embedded within the portfolio, underpinned by close to full occupancy across the portfolio and record occupancy of BTP, which is at its highest since IPO. Our portfolio offers an attractive blend of fixed and CPI-linked reviews, which delivered an average rental increase of 4.8% for the half. While leasing volumes in the period were low, this largely reflects the record leasing we achieved in FY '23, which delivered double-digit re-leasing spreads, as I touched on earlier. We have minimal lease expiries for the second half, providing strong income visibility. Our income is resilient with the WALE of 6.1 years, backed by high-quality tenant covenants with no evidence of distress across our portfolio. We maintained a disciplined approach to pursuing growth opportunities through our development pipeline. Over time, we have the opportunity to introduce an additional $16 million of additional income to the portfolio at attractive incremental returns of approximately 8% and above. Turning to sustainability. Our approach aligns to the Dexus sustainability strategy, which includes 3 priority areas: being customer prosperity, climate action and enhancing communities. The DXI portfolio continues to maintain its carbon neutral status. And across our business park assets, we have maintained close to 5-star NABERS ratings. We continue to explore further opportunities to rollout solar across the portfolio with a 1.6-megawatt project at Westrac which was recently received design approval. Rooftop solar delivers positive environmental outcomes for our portfolio and for our customers. At BTP, our waste diversion program has reduced the amount of waste being sent to landfill by over 20%, a great outcome, demonstrating our constant endeavor to drive meaningful improvements in sustainability across our portfolio. Turning to the financials. FFO for the half was $27.3 million or $0.086 per security. Property FFO was down 2.6%, primarily due to the impact of divestments. Significantly, the stabilized portfolio continues to drive strong top-line performance with like-for-like growth of 7.3%. Reflective of a lower average debt balance from asset sale proceeds, net finance costs were down 8.2%. The full impact of higher debt cost was mitigated by our strong hedge cover. With regards to the balance sheet, net tangible assets per security reduced $0.12 to $3.32. The NTA movements were largely driven by $36.1 million like-for-like property devaluation and a $7.8 million fair value loss on derivatives. We are well placed from a capital perspective with pro forma look-through gearing of 26.2%, which is below our 30% to 40% target range. We've been deliberate and decisive in positioning the fund to deliver strong relative performance regardless of the economic climate. This position of strength allows us the flexibility to pursue development pipeline as well as other opportunities that may arise in the future. Asset sales, support of natural hedging, which averaged 77% over the half. Hedging of over 80% is expected in the second half, which provides material insurance against increases in interest rates. During the half, we independently revalued 100% of the portfolio. On a like-for-like basis, property valuations declined $36.1 million or 2.5% on prior book values. Our weighted average cap rate expanded to 5.77% with industrial cap rates expanding 40 basis points. Rental growth outcomes across the portfolio continue to support valuations. Industrial assets within the portfolio now make up 89% of total assets. Like-for-like growth was 6%, supported by a 4.9% average rent reviews and double-digit re-leasing spreads achieved in FY '23. We expect strong like-for-like growth to be maintained over the second half. 23,600 square meters of leasing was achieved across a small sample size of deals. This followed the record volumes achieved in FY '23 and are also a function of high occupancy with limited expiries. Pleasingly, we continue to consistently achieve rental outcomes above valuation assumptions, having outperformed by 10% on deals executed this half. As we look to progress the development pipeline, the quality of the underlying portfolio will continue to improve. Upon completion, we anticipate more than $16 million, representing 15% of additional income to be delivered from the completed developments. Jandakot continues to perform well with 5.2% like-for-like income growth underpinned by 59% of income linked to CPI. There are now 55 industrial assets totaling 430,000 square meters across Perth's leading master-planned industrial estate. We remain well placed to continue to roll out further developments that will enhance the quality of the portfolio at attractive risk-adjusted returns in line with our strategy. The total cost of development pipeline is $269 million across more than 330,000 square meters with projects in Sydney and Perth. Across our committed projects, we have $42 million of remaining spend. Included in this amount is our project in Moorebank, where we've recently received development approval to deliver a multiunit estate across 17,900 square meters. This project is located in one of my Sydney's strongest submarkets and is to be delivered at an attractive yield on cost of 6% to 6.5%. Over the medium term, we estimate a further $125 million of capital will be required to build out the landholdings at Jandakot; where we are targeting yields on cost of 6% plus and generating an incremental yield of 8% and above. DXI is well positioned to fund these developments within the constraints of our target gearing range. A notable emission from our pipeline is a fund-through development at Kemps Creek. Following continuous delays through the planning process and with no clarity on likely delivery time lines, we decided to exit the project. In doing so, we were able to provide additional balance sheet flexibility by releasing $67 million of future funding commitments, which equates to a 3% gearing benefit. We've included additional detail on the development pipeline in the appendix for your reference. Long-term thematics for the industrial sector remains supportive, driven by population growth. Australia's population is expected to grow by more than 50% over the next 40 years or over 1% per annum, which is one of the highest rates amongst advanced nations. The continued structural shift towards e-commerce is also expected to continue with online penetration rates expected to increase to 16% by 2030, an increase of approximately 25% from current levels or 3.5% per annum. Together, population growth and e-commerce are expected to generate incremental demand for approximately 2.8 million to 3 million square meters of space annually. Over time, this demand is expected to run ahead of the supply of immediately available serviced land. Australian vacancy rates remained low in the global context with the rents also being more affordable. And we are not expecting the domestic market to experience a sharp reversion in rental growth as we witnessed in offshore markets, although domestic rental growth has begun to moderate as market conditions normalize. At BTP, we delivered exceptionally strong performance with strong like-for-like growth of 15.4% for the half. This was achieved with 4,400 square meters leased with continued interest from technology and life science tenants. Occupancy increased 10 percentage points to 95.7% during the half, but was also supported by average rent reviews of 4%. As in past periods, we have continued to achieve strong retention levels with 84% of space retained or backfilled within 3 months. These factors continue to support a very attractive income yield of more than 7%. Pleasingly, leasing was executed at positive re-leasing spreads while incentives remained circa 15 percentage points lower than the broader Brisbane office market. In summary, I am pleased to reaffirm our FFO guidance of $0.171 per security as well as distributions of $0.164 which reflects an attractive distribution of approximately 6% for our investors. We are well placed to continue delivering investors with long-term value. Our focus remains on enhancing portfolio attributes that deliver organic income growth, pursuing value-enhancing investment opportunities, maintaining a strong capital position and leveraging Dexus' capabilities. Our earnings profile is resilient, underpinned by embedded fixed and CPI rental escalations, minimal near-term lease expiries and prudent hedging levels. Significantly, our balance sheet provides us great flexibility to perform well, regardless of the economic environment. Thank you for joining the call. I will now hand back to the moderator for questions.

[Operator Instructions] Your first question comes from David Pobucky with Macquarie Group.

Gordon, congratulations on your appointment and on the result as well. Look, FFO beat consensus expectations and you achieved good leasing outcomes at BTP, which increased occupancy there substantially. Guidance was only reiterated. So just wanted to ask how we should think about that? From your perspective, what's different now to the upside or the downside versus what was embedded in guidance when you said it, please?

Look, we remain comfortable with guidance. We believe we're in a strong position to deliver guidance for the period. As you rightly pointed out, there were areas of outperformance within the portfolio. But there were also mitigating factors, which meant that we held guidance. Some of these included an early surrender at Jandakot. We were aware that that would create an income hole in our FFO, but it was ultimately the right real estate decision. And on that basis, we proceeded with the surrender. We also saw an unexpected delay within the Kilsyth settlement, which pushed out by about 4 months and created a bit of an earnings drag for us. And then finally, we also saw minor delays at our Jandakot developments which pushed back the leasing program. So hopefully, those factors give you a bit of color as to what ultimately led us to holding our FFO guidance for the period.

You also mentioned double-digit re-leasing spreads. But just wondering if you could quantify what they were in industrial and maybe just expand on leasing conditions and are you seeing leasing tension continue to soften?

So I guess, just by way of reminder, we brought forward a lot of FY '24 re-leasing into the FY '23 financial year. And in that period, we delivered re-leasing spreads of around 17%. Going into this period, we had very minimal lease expiries. And in terms of our industrial leasing undertaking, there were only really 5 deals. Three of those were at Adelaide. If you recall, we had bought those assets at in an over-rented position with an initial yield of around 8%. So we managed to hold those rents, but still outperformed [ value ] rents by around 10%. So that was a really good outcome. The other two leasing deals were at Jandakot where we achieved re-leasing spreads in the low teens. In terms of the broader market, I mean, we've been cautious for some time now. Rents have been normalizing. There's still demand, but where we find ourselves now is a situation where tenants have choice. And with that choice, comes softer rents going forward. A lot of that will be a function of localized demand and supply dynamics. And obviously, where -- which markets you're operating on. The industrial market remains strong but we just don't really expect to see the same extent of rental growth as witnessed in past periods.

And just one last one for me, if I may, before I turn it over. With you stepping into the role, are you thinking about the strategy for the vehicle any differently? And maybe if you could just touch on BTP there as well, please?

No, I mean, the strategy is set for purpose, both Alex and I worked on the fund for 7 years and we're pretty aligned in our views. So the order of the day is really executing on what we need to do, which is to maximize the portfolio that we do manage. Obviously, within that, there's, certain plans in place. And you've mentioned one of them, which is BTP. I would characterize us as being patient in terms of achieving an outcome there. The portfolio is now generating a 7.5% income yield, which is quite attractive. But probably the transaction market needs to improve a little bit for us to have a transaction pathway sentiment around interest rates definitely gives us a pathway to making that happen. But a lot of it really depends on having a motivated purchaser for that asset. While we wait patiently, we will continue to drive performance out of that asset.

Your next question comes from James Druce with CLSA.

Just to follow up on David's question, can you quantify how much that surrender income hole actually is?

The hole at an income line was around $800,000 for the period. We've subsequently re-leased 40% of that space. Majority of that is back-ended in this half. So you don't see that coming through 800-square meters of the size was from the surrender date of November, I believe. So there's only a small amount of income coming through into the first half. Obviously, we've taken the benefit of that surrender and applied it against interest. And so on a net basis, the hole was around $600,000, give or take.

Okay. That makes sense. And then, in the accounts, this can we just run through sort of the big picture. You talked about $11.5 million worth of surrender income and as well as I think there's a divestment on street as well. But it looks like you've taken some of that income above the lines and maybe $1 million worth. Can you just maybe just explain what's going on there?

Good observation, James. I'm not surprised you picked that up. So the long and the short of it is we've taken none of that through FFO, which is probably one of the reasons why we've held guidance. All of that's been booked through our statutory profit. So does that hopefully a bit of color as to how it was treated within our accounts.

Okay. Maybe we'll take it offline. And then, just on BTP. It's record occupancy. You've just moved occupancy up 10% in 6 months of these markets generally is still pretty weak. I appreciate this is a single asset. But this has been an asset that's been difficult to lease out over a long period of time. Just curious what actually changed over the 6 months? I mean what's really gone on with that asset?

Well, it's fair to say, it definitely outperformed our expectations. We obviously were hopeful that we could capture that income in time. But I think it really comes down to just a great commitment from our leasing team. We've spent a little bit of money at 9 McKechnie in particular, which positioned us to capture that opportunity. The interest for that space was pretty broad based. So it's hard to really read too much in terms of where that's coming from. I do think it ultimately reflects just the value proposition of BTP within the broader Brisbane market where BTP provides a really good value proposition to tenants.

Okay. And then is that leasing being reflected in the WALEs because the asset was down 2.5% over the 6 months.

Yes, some of it will definitely be captured in the WALEs.

Okay. So as that work, you lease up 10% of the building, but the WALEs down.

Well, I mean, some of it's been taken up in prior periods. So it's -- we've been working on 9 McKechnie, for example, for multiple periods. Some of that was reflected in prior period WALEs. So it really is outperforming downtime assumptions. The full whack of that does not necessarily come through in a single period.

Okay, all right. One more, if I may. Just the simple one just did the OpEx for the half and the cost of debt that you expect for the second half.

So OpEx, look, the lion's share of that was probably the landlord works at 9 McKechnie, which is around $700,000 minimal maintenance CapEx through the portfolio this half. In terms of debt cost, we printed a number of 3.9% for the half and would probably expect it to move up marginally from there for the balance of the year. 80% of the debt hedged over 80% of the debt is hedged in the second half. So it should be broadly consistent, although slightly higher.

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

Obviously, still reasonably good income growth coming through from the industrial portfolio. And I appreciate that the leasing activity in the last 6 months probably wasn't numerous enough to get a decent feel for what spreads would be looking like at the moment. But I was wondering whether you might just be able to comment on the under-renting in the industrial portfolio at the moment as far as you can tell? And within the context of that, just how we should be thinking about that income growth figure more medium to long term, please?

Murray, so the portfolio is broadly market rented. The industrial portfolio itself is marginally under rented. And we've got about 11% of leases expiring over the next 30 months or so. Within that category, there is a good rental growth to play for. For that period, we're looking at an under-rented position of around 12% to 15%. A lot of that's back-ended to FY '26. So, yes, we should be encouraged by what we can be looking to target in forthcoming periods. It's probably also worth noting that we've generally outperformed value assumptions consistently in the past. So the under-rented position is just aligned the sand. We'll obviously look to outperform value assumptions going forward.

Sure. So just to be clear, that 12% to 15% is based on the values assumption rather than yours?

Correct.

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

Thank you, everyone. I hope you can all see the progress we've made over the half. If you do have any questions, please feel free to reach out to me and the team. And we'll be happy to take your questions. Thank you very much and have a good day.

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