Dexus Industria REIT (DXI) Earnings Call Transcript & Summary

Good morning. I'm Jason Weate, Fund Manager of Dexus Industrial REIT, and I'm pleased to present DXI's FY '26 result. I would like to begin by acknowledging the traditional custodians of the many lands on which we operate and pay our respects to elders, past and present. Today, I will cover the highlights, financial results, portfolio performance and growth drivers before moving to Q&A. DXI provides investors with access to a diversified portfolio of 90 assets valued at $1.5 billion with 80% of the population within 60 minutes of our asset base, 77% located in infill markets and a significant $217 million development pipeline at ASCEND at Jandakot. DXI's investment proposition is to generate strong risk-adjusted returns built on three core pillars of secure and growing income, active portfolio management and prudent capital structure. Occupancy has consistently remained above 98%, supported by proactive management of forward leasing risk. We have successfully transitioned to a 100% industrial portfolio, setting a stronger foundation for future performance. Our development pipeline is a key differentiator that drives FFO growth, and our balance sheet discipline has allowed us to pursue acquisitions, fund development and execute a meaningful buyback, all in parallel. Over the period, the fund delivered $0.176 per security, above upgraded guidance, supported by strong leasing outcomes, while distributions totaled $0.166 per security. Like-for-like income growth of 5.3% was underpinned by strong rent reviews and positive rent reversion with re-leasing spreads of 21.4%, providing a further tailwind to future earnings. 45,200 square meters of Jandakot completions achieved a strong yield on cost of 7%. Our balance sheet strength was maintained with look-through gearing of 31.2% at the lower end of our target range. Capital was recycled into acquisitions at Glendenning, Dandenong South and Moorebank, and our securities buyback program is being executed at pace and has been upsized to 5%. Post balance date, a zero-cost hedge book restructure was completed, and I'll cover this in further detail later in the presentation. DXI offers a differentiated combination of secure income, embedded growth and a development pipeline of scale. Income security is supported by high occupancy of 98.8% and a proven track record of de-risking near-term expiries through forward leasing. Approximately 87% of income is subject to contracted rental increases of at least 3% and our development pipeline provides a clear pathway to FFO accretion over the medium term. DXI remains committed to delivering sustainability outcomes that generate both environmental and financial benefits. Our sustainability initiatives include incorporating renewable energy solutions such as solar and battery storage into new developments, which not only reduce environmental impact, but also enhance asset appeal and long-term value. Turning to our financial results. DXI delivered FFO of $55.7 million or $0.176 per security, ahead of upgraded guidance. Distributions were $0.166, reflecting a payout ratio of 94.4%. The divestment of BTP drove a net reduction in overall property income, which understates the strength of underlying like-for-like property income growth of 5.3%. Notwithstanding that strength, the combined impact of a 60 basis point rise in our cost of debt and the sale of BTP were the key drivers of year-on-year reduction in FFO per security. Ultimately, FY '26 was a transition year, one in which the underlying industrial portfolio performed strongly. A key differentiator for DXI is its balance sheet strength with look-through gearing of 31.2% at the lower end of our target range. During the year, we executed $358 million of new and extended facilities at competitive pricing and entered into $550 million of new hedging, including interest rate caps to benefit should rates decline. Post balance date, we undertook a zero-cost hedge book restructure. This brings forward higher rates to reflect mark-to-market debt costs. Interest costs in FY '27 will be approximately $1.4 million or $0.005 per security higher following the restructure. From FY '27, the flatter profile allows property income growth to translate more clearly into the bottom line. DXI reported a valuation uplift of $19.1 million or 1.3% over the year, supported by rental growth and development activity. ASCEND at Jandakot remains a key driver of valuation growth potential, underpinned by tight Perth market fundamentals. Turning to our portfolio performance. The portfolio delivered strong operating performance across a period of high activity. 170,000 square meters of leasing was secured across the stabilized and development portfolio, while re-leasing spreads of 21.4% reflect under-renting in the existing portfolio with key outcomes at 89 West Park Drive, Derrimut, 50 Jayco Drive, Dandenong South, and Jandakot. Spreads achieved this year predominantly relate to FY '27 to FY '29 expiries, making them an additive driver of FFO growth over the medium term. On the four acquisitions completed during the year, we have made a strong start to executing against underwrite assumptions. At 32 Cox Place, Glendenning, we completed the repositioning of the asset, which was acquired with vacant possession. We secured a 5-year pre-lease across the site, completely de-risking the investment while retaining future larger-scale value-add upside potential. In Dandenong South, the positive re-leasing spreads of 20.8% were above underwrite. And at 12 Church Road, Moorebank, we leased an additional unit and saw the capitalization rate tighten by 12.5 basis points, contributing to a $3.1 million revaluation uplift. Collectively, these acquisitions demonstrate the fund's ability to drive value through active asset management. Turning to our development pipeline at Jandakot. During FY '26, four projects across 45,000 (sic) [ 45,200 ] square meters were completed at a total cost of $43 million. Importantly, these completions are 100% leased compared to average pre-leases of 47% at the time of commencement and achieved a yield on cost of 7%, above our 6.25% plus development target. These completions demonstrate consistent execution with momentum continuing across the pipeline. Since acquisition, South Perth rents have grown at over 16% per annum, well ahead of construction costs, a spread that directly underpins our returns. Yields on costs have improved from approximately 5% at commencement to 7% in FY '26, reflecting the improving return profile over time. Looking ahead, the committed pipeline spans five sites with the majority expected to complete over FY '27 into the first half of FY '28. These projects are approximately 68% pre-leased and are estimated to deliver a yield on cost of 6.6%, above our target at 6.25% plus. Post balance date, two additional pre-leases will see the activation of a further $20 million of development at a yield on cost of 7.0%, which will increase overall pre-leases from 68% to 76%. In the context of impact to FFO, it is important to reiterate that every dollar spent at Jandakot going forward translates into a P&L incremental yield on cost of above 8%. This is because the land has already been acquired and fully reflected in our cost base. Through to FY '30, we expect $30 million to $40 million of completions per annum, providing a material driver of FFO accretion over that period. The industrial market backdrop is improving. Across capital cities, rents required to justify new development sit materially above prevailing market rents, making new supply difficult to justify. Developers are responding rationally and speculative starts are down materially from the peak. Construction costs are forecast to compound well ahead of inflation through to 2028 as data centers, infrastructure and Olympics-related work compete for land, labor and specialist trades. This supports tightening vacancy, a pullback in incentives and ultimately, rental growth. The investment case for DXI remains clear. We offer an attractive distribution yield of 6.8% paid quarterly, compelling in both absolute and sector relative terms. Underpinning that yield are multiple drivers of growth, our development pipeline, embedded rental escalations, aided by our restructured hedge book. With DXI trading at a 29% discount to NTA, investors can access that income and growth at a compelling price entry point backed by high-quality industrial portfolio. Looking ahead, we are well positioned to continue delivering long-term value. Our focus remains on disciplined execution of the buyback program, continued build-out of the development pipeline and preserving balance sheet flexibility. The hedge book restructure reflects a deliberate resetting of FY '27, allowing future property income growth to translate more clearly into the bottom line. Barring unforeseen circumstances, DXI expects to deliver FY '27 FFO of $0.17 per security and distributions of $0.166, which remains in line with FY '26. I'll now hand back over to the moderator for broker analyst Q&A.

[Operator Instructions] The first question today comes from Andy MacFarlane from Bell Potter.

You talked about -- you spoke about the hedge book restructure. Can you just walk through the rationale and what it means for FY '27 and for FY '28 onwards?

Thanks, Andy. I think as I mentioned in some of my final remarks in the speech there, I mean what we've done is quite deliberate. We've brought forward rates to mark-to-market levels to establish a flatter hedge cost profile from FY '27. And we think that allows underlying property income growth to translate much more clearly into the bottom line earnings of that reset base. And it does make it clear, we think, for market participants like yourself to evaluate the FFO trajectory from here. A couple of points to note. The restructure that we've mentioned that does reduce FY '27 FFO by $1.4 million or $0.005 per security does account for the majority of the decline versus FY '26. And I'd reiterate that the restructure was an NPV-neutral one with zero upfront cost.

Just looking at the payout ratio, it's about 94% in FY '26. The guidance for '27 reflects a step-up to about 98%. How should we be thinking about the payout ratio going forward from here?

Thanks, Andy. Look, a good question and no doubt a topical one at the moment. I'll start by talking to the fact that our FFO settings that we've provided obviously set like a new platform from which we can grow earnings. And so naturally, that provides us with greater options in terms of where we want to peg distributions going forward. Strategically, we do think about distribution settings from a couple of different lenses. The first one being the underlying cash flow coverage you have to support distributions. That's a clear one. But the other one is your balance sheet settings. And we know that if you run gearing lower, you naturally have greater ICR coverage, and that provides you with more flexibility in terms of how you want to run a particular distribution setting. And so I think they are the mix of things that we look at. They're definitely the mix of things that we'll take into account when we're looking at setting distributions in 12 months' time from now for FY '28.

Final one, if I may. Just the re-leasing spreads at 21%. Can you just talk about what's driving that level?

Yes, sure. I mean, obviously, it was a great result for us. The significant components really relate to forward leasing that was achieved at Derrimut, which was an FY '28 expiry. Dandenong South, as we mentioned, which also was a '28 expiry and Epping, which was an FY '29 expiry. So reducing risk well ahead of expiry in the process. The standout was really Derrimut. It delivered the largest uplift at about 52% above passing. And pleasingly, the rental spread at 50 Jayco Drive in Dandenong South, that's our recent acquisition, achieved a 21% positive reversion, which outperformed our acquisition underwrite. And I should also mention Jandakot in that process. I mean, across the estate more generally, we've achieved 15% positive spreads across the stabilized segment of that estate, supported by strong renewal and new tenant outcomes. So, these deals ultimately reduce expiry risk and provide contracted income growth across FY '27 to FY '29.

The next question comes from David Pobucky from Macquarie Group.

Just a follow-up on FY '27 guidance and some of the key drivers there. So if you exclude the hedge restructure, expected FFO in '27 would have been roughly in line with FY '26, despite strong leasing momentum and development completion. So if you wouldn't mind just walking through some of those other moving pieces between FY '26 and '27, please?

Sure thing, David. Thanks for the question. So the way to think about the compositional drivers and starting with the positives, we are assuming like-for-like growth in there of approximately 3%. That's obviously supported by the contracted rental increases and positive leasing outcomes. But we have allowed for some prudent downtime in there, in particular, at a final unit that we're looking to lease up at Moorebank, and an asset called 5 Compass Drive at Jandakot. And so we're assuming some pretty prudent lease-up timing expectations across those couple of sites, that's probably pulling down like-for-like growth a little bit. We obviously will have continued positive contributions from completed and active developments. We are also assuming that we complete the full extent of the 5% buyback by around, let's call it, March next year. They are the positives. In terms of the offsetting drivers, there will be some ongoing full period dilution associated with the sale of BTP. And excluding the post balance date of restructure, we naturally would have been stepping up our interest rate cost as well. And so that's sort of how to think about arriving back to that sort of flat outcome. Also, sorry, floating rates are obviously expected to increase into next year. And I guess, finally, we are assuming an all-in interest expense of 6% in FY '27, like that is our marginal cost of debt in the market today and really speaks to the growth potential in underlying earnings from here with that in our base in '27.

That's really comprehensive. I appreciate that. If I could just follow up on the comment you made around completing the full 5% buyback. Obviously, the stock is trading at a substantial discount to NTA still. I mean, do you view the buyback as a superior use of capital to acquisitions and development activity? Or do you believe that you've got the balance sheet capacity to pursue all of those levers?

Yes. So I'll start with like the opportunity set in front of us. I mean, obviously, we have acquisitions in the market. We have the buyback. We have continued deployment into Jandakot. Of those three, the latter two, the buyback and Jandakot development deployment screen obviously much more attractive. And so they, in combination, are our two key areas that we'll look to continue deploying. And so that's why we're sort of confident in including that within guidance. If we -- assuming that current share price levels remain depressed, we will keep buying. In terms of our funding position, look, we're starting off a point of what? Around about 31%. And so we have plenty of -- we're fully funded to continue full development of Jandakot and full execution of the buyback program.

Just the last one from me. Just in terms of that funding position being at the lower end of your target gearing range. I mean, how do you think about where you want that level to sit medium term or even kind of in the next 12 months as well?

Yes, good question. I mean I think we've displayed like an appetite to generally run it a little more conservative than not. I did mention in my answer to Andy earlier before around distribution settings and the additional flexibility that running a lower gearing level does provide you with. And so we run the fund with an eye to the value in optionality, and we think running balance sheet gearing, or look-through gearing rather, at a level that's under 35% will always give you that -- always give you deployment optionality, and that's what we value. So I think you can expect us to continue to manage that at below that level.

The next question comes from Leanne Truong from CLSA.