DEXUS (DXS) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the Dexus 2023 Half Year Results Call. [Operator Instructions] I would now like to hand the conference over to Mr. Darren Steinberg, Chief Executive Officer. Please go ahead.

Good morning, everyone. And thanks for joining us today for our 2023 half year results. As an owner manager and developer of property across the country, I'd like to start today's presentation by acknowledging the traditional custodians of the lands on which we operate, and pay our respects to their elders, past, present and future. Today, you'll hear from Keir on the financials, Deb on our funds business, Kevin on office, Stewart on industrial and Ross on investments and our development pipeline. We'll then take any questions you might have. Despite subdued market conditions, it's been an active 6 months. We've announced nearly $800 million of divestments since the FY '22 result, recycling capital into higher returning opportunities and maintaining a strong balance sheet with low gearing, substantial headroom and 85% of debt hedged. We continue to grow our health care fund and our opportunistic fund, raising equity in both funds. We maintained high occupancy levels across both the office and industrial portfolios with strong leasing activity. We've also progressed city-shaping developments, with Atlassian, Central and Waterfront Brisbane commencing construction. And finally, building on our ESG track record, Dexus was again recognized as a global leader in the S&P Global Sustainability Yearbook. Our vision is to be recognized as the leading real asset investment manager in Australia. We aim to achieve this through providing a superior risk-adjusted returns for investors through investing balance sheet capital and managing investments on behalf of our third-party capital investors. Our balance sheet provides resilient cash earnings from a portfolio of high-quality investments, and our funds business adds capital-efficient, higher-growth exposure while maintaining the overall risk profile of the business. Going forward, we don't anticipate a material change to the size of the balance sheet. Overall, AUM will increase as the funds business grows. Our medium-term target is to expand the proportion of income generated from active earnings to circa 20%, up from 11% in FY '22. Balance sheet capital will increasingly be invested alongside third-party partners. As a result, the balance sheet will become more diversified over time due to the expanded set of investment opportunities available across the funds management platform. Capital will also be selectively utilized to warehouse high conviction opportunities. We updated the market in January on the acquisition of the AMP Capital platform. As a result of completion being delayed, we have renegotiated terms with AMP, and the maximum total consideration payable by Dexus has been reduced to $225 million, which equates to an attractive 1.2% of FUM. An alternative transaction structure is being agreed to provide timing certainty with the transaction to now occur in March. This transaction has the potential to add a further $18 billion to the group portfolio and will underpin our next phase of growth, bringing with it an expanded product offering, new capabilities in infrastructure and an enhanced retail platform, providing a complete offering for third-party investors. We continue to be globally recognized for our leadership across ESG, with DJSI, CPD (sic) [ CDP ] and GRESB reaffirming our status over the half. Our office portfolios' NABERS ratings remained strong as a result of our ongoing investment in energy efficiency. We achieved our first health and safety rating across 45 office properties, giving our customers confidence that their well-being is a focus. And we raised awareness of modern slavery through a comprehensive training program with our people and suppliers. I'll now pass you on to Keir to cover the financials.

Thanks, Darren, and good morning, everyone. Turning to the composition of the result. Our property portfolio delivered AFFO of $300.5 million. Office like-for-like income growth was 3.2%, and industrial like-for-like income growth was 2.4%. Rent collections remained strong at 98.9%. Management operations and trading profits grew significantly, which I'll discuss in more detail shortly. The external independent valuations resulted in a total of $242 million or 1.4% decrease on prior book values for the 6 months to 31 December, with positive rent growth partially offsetting the impact of cap rates expanding by 16 basis points on average across the portfolio. Turning to the results in detail. Office property FFO reduced due to divestments and nonrecurring income on development-impacted properties in the prior half, partially offset by contracted rent increases. Industrial property FFO increased due to a full period contribution from Jandakot, recently completed developments and leasing success. FFO from management operations increased significantly driven predominantly by development-related milestone fees. Net finance costs were up, mainly as a result of higher floating rates, partially offset by a lower average debt balance. Net other expenses increased primarily due to tax expense on the management business. Trading profits of $48.7 million post-tax was secured from the sale of 2 assets, with a further $5 million pretax to be realized across FY '23 and FY '24. Overall, funds from operations per security was down 1.9% on the prior period. AFFO CapEx reduced due to the timing of project commencements, with AFFO per security growing by 2.8%. Distributions per security were $0.28, in line with the prior corresponding period, while NTA reduced to $12.01, primarily driven by property devaluations. Moving to our capital management. Since FY '22, we have secured over $2 billion of new and refinanced facilities and further diversified our sources of debt. We now have substantial headroom with $3 billion of cash and undrawn debt facilities. At 25.6%, our gearing remains below the 30% to 40% target range. Combined with our ongoing approach to strategic asset recycling, this provides capacity to fund growth initiatives in funds management and development. Our percentage of hedged debt averaged 85% in the first half this year, up from 65% in FY '22. The weighted average maturity of our hedge book is 4.8 years, providing material protection against interest rate movements over the medium term, and we remain committed to maintaining prudent hedging positions through economic cycles. Thank you, and I'll now hand over to Deb.

Thanks, Keir, and good morning, everyone. We continue to deliver strong performance for our funds. Our responsibility for performance extends beyond the financial with Dexus' global leadership and sustainability aligned to our capital partners' ambitions, with DHPF being recognized as a global sector leader by GRESB in 2022, as an example. Current market conditions have led to a pivot in some investors' strategies with the crystallization of gains in real estate through reducing allocations. In response, we have been able to provide liquidity to those investors whose strategies have required it, with approximately $5 billion of liquidity facilitated over the past 2 years while growing funds under management by $10 billion over the same time period. This half, we raised $550 million in new equity across the platform, predominantly in support of DREP1 and DHPF as well as executing on developments, divestments and acquisitions in line with individual fund strategies. Having the investor at the center of our business has always been a core focus and understanding their business has never been more important. To this end, we look forward to opening our new office in Singapore and developing our on-the-ground presence in the region, which will enable us to be closer to our Asian-based investors and attract new equity to our platform. We have a demonstrated ability to quickly achieve scale in funds. Our opportunity fund was launched in 2021, the first in a series of closed-ended funds that leverages our integrated platform's capability and trading track record. DREP1 has now closed with $475 million in equity since inception, taking the fund's investment capacity to circa $1 billion. We saw an opportunity to enter into the growing health care sector that is underpinned by long-term demand drivers, and we believe the timing was right. In DHPF, we have built a $1.8 billion high-quality health care portfolio, which is delivering attractive returns to investors, 13.4% per annum since inception. Of the equity raised by DHPF during the half, over 80% came from existing investors, demonstrating confidence in the fund's strategy. Looking more broadly at investor sentiment. Australia remains an attractive destination, although not immune to global investment decision-making factors which are considerations for our investors. Investor support for our pooled funds, DHPF, DWPF and DREP, remains strong and ongoing new business conversations with capital partners are continuing across all sectors. Thank you, and I'll now pass you to Kevin.

Thanks, Deb, and good morning, everyone. Office portfolio occupancy continues to outperform the market, remaining consistently above 95%, demonstrating the resilience of our high-quality assets despite some market uncertainty. Stabilized leasing volumes were up compared to the second half of FY '22, with around 1/3 of vacant space leased despite the challenging operating environment. The average weighted lease expiry was steady at 4.6 years. As Keir mentioned, like-for-like income growth was 3.2% for the period, above the 10-year average of 2.7%. Incentives have increased to 31.8%, largely as a result of leasing in Brisbane. And incentives are expected to remain elevated in the near term, although our premium assets should perform better, particularly in Sydney where the portfolio vacancy rate is around 1%. Moving on to our expiry profile. The space we currently have available is concentrated in both Sydney and Melbourne where we have made progress and are in advanced negotiations with a number of tenants. Expiry levels are below our target threshold maximum of 13% per annum over each of the coming 4 years. Our diversified and high-caliber customer base presents limited concentration risk, with our top customer, Woodside, representing 3.2% of income; and our top 10 customers combined representing 16.3%. I'll now share our market observations from the first half. There is continued evidence of a flight to quality, demonstrating the value of well-located, good-quality workplaces. For example, Sydney Premium had positive 30,000 square meters net absorption, whilst lower-grade buildings recorded negative absorption. We also observed a number of organizations moving into the Sydney CBD from suburban locations and taking circa 20,000 square meters in aggregate. Incentives are, however, likely to remain elevated over the 12 months as the existing supply pipeline completes. Larger inquiries picked up across the market, but deals in general are taking longer to convert as customers remain cautious about the potential impacts of escalating interest rates. Companies are becoming increasingly concerned with negative impacts to organizational productivity and corporate culture because of its significantly dispersed workforce. As labor market pressures subside over the next 6 to 12 months, we expect many more organizations to move from encouraging staff back to the office to mandating minimum days of attendance. The return to the office is becoming more evident in PCA data where, in some cases, physical occupancy is at pre-pandemic levels. There's been a notable uptick in Melbourne with a visible buzz of activity in the Sydney CBD core. Office demand is expected to benefit in the long term from employment growth. Last year, 22,000 white-collar jobs were added to the 4 main CBDs while net absorption was only 48,000 square meters, about 1/3 of the long-term run rate. We expect some of this latent demand to flow through from late 2023 as more normalized office utilization resumes. Thank you. I'll now hand you over to Stewart.

Thanks, K.G., and good morning. Turning to the performance of our industrial portfolio, we leased 154,000 square meters across our stabilized properties, which is well above volumes in HY '22. And combined with the development leasing of 60,000 square meters, our total leasing volumes were more than 214,000 square meters for the period. The quality and national footprint of our properties, along with our national customer base bodes well for future leasing efforts as rising transport costs increasingly favor our well-located industrial assets. Portfolio occupancy reduced slightly to 97.4%, driven mainly by expiries at Axxess Corporate Park and our distribution center in Gillman Adelaide, which has since been substantially leased to an existing major Australian customer. Occupancy, excluding business parks, was 99.9%. Incentives reduced to 10.9%, and our portfolio delivered a 1-year total return of 10.2% to the 31st of December. Approximately 46% of space leased in the half was pleasingly linked to annual CPI increases. Effective like-for-like income growth was 2.4% driven by contracted rental growth, offset by downtime and reversions at 2 of our larger facilities. Thanks to strong market rent growth and our leasing efforts, our portfolio was 9.3% under-rented and is set to benefit from our continued market rent growth. However, there is only limited opportunity for rental reversions or stronger like-for-like growth in the very near term due to our lease expiry profile. But looking a bit further out, there is the opportunity to grow income by resetting the rents on vacancy and upcoming lease expiries across approximately 20% of the portfolio by FY '24. Now taking a closer look at what's driving demand. Industrial take-up remains above long-term averages as businesses invest in extra distribution space to cater for last-mile fulfillment. This demand is really broad-based, including medical, supermarkets and retail, transport and, of course, e-commerce. Onshoring of manufacturing will likely continue following the global supply chain uncertainty caused by the pandemic. Warehouse demand is being supported by growing inventory levels as firms adopt a just-in-case business model as a long-term theme. And Dexus' development capability is supporting our customers' growth requirements across Australia and delivers quality new product to the group portfolio. So importantly, we are seen by our customers as a truly national platform. Thank you. Over to Ross.

Thanks, Stewart, and good morning, everyone. It's been another busy period. We continued with our strategy of capital recycling to improve the balance sheet portfolio quality and provide capacity to fund our growth drivers, being the development and funds businesses. As you can see on the slide, at a group level, we were net sellers for the first half of FY '23. For the balance sheet, we announced nearly $800 million of new sales, bringing total divestments over the past 2 years to over $3 billion. The depth and strength of buyers for assets continued to be weak during the half, with the exception of some of the alternative real estate subsectors like health care. We expect demand for quality assets to marginally improve this year, but we do remain cautious on the prospects for secondary assets and markets. During the half, we reviewed the development book and the underlying assumptions, and circa $1 billion of early-phase concept projects will no longer be pursued. Pleasingly, the remainder of the group's $15 billion pipeline is profitable, with average margins expected in the teens based on current market assumptions. After 6 years of prework, we commenced construction of the first stage of the Waterfront precinct in Brisbane. The project is 45% leased and is expected to complete in 2028. Waterfront takes the balance sheet's development commitments to circa $3.5 billion, of which $2.5 billion remains to be funded over the next 5 years. Beyond Waterfront, the next tranche of projects will focus at derisking and committing our 60 Collins Street in Melbourne and Central Place in Sydney. The group industrial development pipeline sits over 2.5 million square meters of land, of which the balance sheet holds a little under half via a number of funds and JVs. Group development completions for the first half will be marginally lower than we anticipated at the beginning of the year with 250,000 square meters now expected. This is driven by a few factors, including weather and the decision to delay some procurement to improve the competitive tension and project returns. Development leasing has also been slower than anticipated during the first half, with Dexus securing just over 60,000 square meters, but we do expect a second half skew and should finish the year above 150,000 square meters of leasing. Keir has already referenced the trading profit result for the first half. We have a number of opportunities in the existing portfolio, but we're also seeing some interesting deal flow in the market, which we may participate in through the opportunistic fund DREP or via trading depending on the circumstances. Thank you, and I'll now pass you back to Darren.

Thanks, Ross. So to conclude, we have demonstrated resilience in a challenging environment, with our portfolio maintaining strong occupancy and continuing to benefit from the flight to quality. Recycling assets and proactively managing capital has also enabled us to maintain a strong balance sheet. Continued macroeconomic uncertainty and higher interest rates will continue to impact our results for FY '23. Taking all of this into account and barring unforeseen circumstances, guidance has been updated to deliver a distribution of $0.51 to $0.515 per security for the 12 months ended 30th of June 2023, reflecting the higher end of the previously stated guidance range. Thank you, and we'll now open it up for any questions you may have.

[Operator Instructions] Your first question comes from Sholto Maconochie from Jefferies.

Just a quick one on the guidance. It seems you've tightened at the low end. Is that mainly just due to the lower leasing and maintenance CapEx? I know it normalized in the second half a bit. But is that mainly the main driver of that upgrade?

Sholto, it's Keir. CapEx is certainly skewed to the second half. That's pretty consistent with what we've seen in prior periods as well. In terms of guidance, when we originally set guidance, there are a lot of moving parts, including around interest rates, trading profits and potential asset divestments. We now have increased certainty around each of those items, which has given us the confidence to narrow the range. Floating rates are tracking in line with forecast. We've secured trading profits, with the majority realized this half. And we've also made really good progress on asset sales. As Darren mentioned, it's close to $800 million that we've announced so far, $350 million settled in January, which is a bit earlier than we had expected. And outside of those things, our results are tracking slightly better than expected across the business.

That makes sense. And then just an update on the bid-ask spread. You still got quite a few assets in the market. What sort of vendor versus buyer expectations? How far apart are you guys? And where do you think they land?

Yes. Well, look, we've just recently revalued the portfolio. So you'd hope that we'd be very close, if not on valuations, at this point in time. So I think what we saw at the end of last year, there was a lot of uncertainty in the market. There's still a lot of capital out there looking for product. And we certainly -- if you think about the first few weeks of this year, we've had a lot of investors coming in from offshore to review market and to look at assets. So we'll see how it plays out during the course of the next 6 to 12 months. But I think you'll see more capital being deployed this year, hopefully, at valuations. And I'd anticipate a lot of that will happen around the mid- to the back half of the year so, say, Q3.

But you wouldn't -- if say, you have an asset you want to sell, you wouldn't take a 10% discount to the latest book?

We look at all offers that come in, and we have more insight than most in the market. And we look at the alternative -- the returns from the alternative use of that capital at that point in time.

Okay. And then just one for K.G.. It looks like the office leasing went up quite a lot in the period. If you look at it, it was up quite materially on the half and sequentially. And if you look at it in the second quarter, like 63,000 was done and the deals look like a bit bigger. Can you talk about the leasing market and what was driving that increase in the leasing volumes in office?

Sure. A lot of the leasing in the period was forward leasing. So not directly impacting this period, about 60-odd-thousand square meters was forward leasing, Sholto. But we are -- the volume was down, I think, on the corresponding half by about 5%. The previous half was up 20-odd percent on the half before, so it was a busy period. But generally, inquiry volumes now, since the end of the calendar year, have picked up again substantially. And so I think it reflects broader business conditions that are still quite solid, quite positive. And so we're seeing that in general inquiry levels, businesses having confidence to commit to their workplace, their workspace. And we're seeing it across the board, too. Last year, there was probably a little bit of a tick down in some of the larger businesses, more of those in the market now, thinking about future requirements. Small business continues to be active. So we remain cautious because the impact of interest rates will have an effect on some. And we've seen a slowing in transaction volumes. Downtime is pushed out a little bit. But at the moment, it doesn't -- the outlook doesn't look too bad from an occupancy point of view.

Yes. And I guess, that's why the leasing maintenance CapEx probably ticks up second half for that strong leasing in the first period where you potentially pay it out.

That's right. We've got about a 9% skewed to the second half on the CapEx.

Okay. And then, can you talk about any redemptions in across the portfolio from the gross equity flows or any redemptions you had in the fund management business?

Sholto, Deb here. We do have -- we talked at sort of high level about the redemptions we've been fulfilling over the past couple of years. There certainly has been a quite large project involving ADPF, the AMP funds that we bought across sort of 18 months ago. And that redemption facility is just completing now, we're probably 10 days away from finishing that off and stapling that to DWPF. So that has been a very purposeful divestment of assets specifically for that strategy and for those investors. DWPF does have redemptions within its core DWPF investor base at the moment, and we're working through that. Some of that will be facilitated in the next couple of weeks as a result of some divestments that fund has already undertaken. But they're all manageable, and we have certainly a large time period in which to facilitate those, so sort of at least 12, if not 18 months, depending on the fund and its terms and conditions.

And the quantum of the ADPF and DWPF redemptions, do you have a number?

Yes. I think it's probably worthwhile just reiterating that DWPF is a $15 billion fund. So the redemption number, I'd have to say at the moment is entirely manageable. It's not excessive. I don't -- it's a matter for that fund, but just remembering it's a $15 billion fund.

And DWPF?

That is DWPF, the $15 million fund.

We don't disclose third-party capital.

The AMP one, sorry.

The AMP fund was circa $3.5 billion when we acquired it. There was a -- we publicly noted redemptions in that fund and that will be -- it will be clear once that fund staples, what its end value is.

Okay. And then just finally on -- can you talk about the leasing spreads that you got in industrial and office, what they were in the passing rents?

In Industrial -- sorry, Sholto, it's Stewart here, and thanks for the question. The spreads in the renewals and industrial, around 17%; and on expires, around 14%.

And Sholto, overall in office, we were negative 19.1%, but that was substantially impacted by Brisbane and leasing. Sydney was negative 10%; Melbourne, negative 11%. Melbourne, pleasingly, sort of moved from the last period negative 15% to negative 11%. And the Brisbane, Perth numbers, they're a little bit skewed because we had some first-generation leasing from developments rolling off at both Alluvion and 480 Queen Street. And our methodology, the original incentives in those developments don't wash through in the amorts through the cash flow. So you have this impact of re-leasing off a clean cash flow. So that's why the number looks light, but...

Negative spreads, what were they again?

Sydney, negative 10%; and Melbourne, negative 11%. So coming in...

And the Perth and Brisbane ones, were they negative and how much?

About negative 40%.

Okay. And that's clearly effective on that number.

Correct.

Your next question comes from Stuart McLean at Macquarie.

First question was just at a high level, just regarding the slight shift in that vision from being Australia's leading real estate company to being recognized as Australia's leading real asset investment manager. I was just wondering, what does that mean in terms of proportion of balance sheet asset, portion of FUM and going into infrastructure and other subsectors? What does that shift from real estate to real asset mean in practice?

Yes. Good question, Stuart. We'll be giving further details in the market after we've closed AMP at the back end of the year. But I think if you think at a high level, think about 80% of income coming off fixed assets and 20% more active earnings. And what you will see over time, we've seen a lot of merging of these real assets and things like the hospitals, are they infrastructure or are they real estate; student accommodation, a similar question. With some of the airports, for example, there's a very large industrial land banks around them. So we are seeing a bit of emerging of the asset classes there. So I think you can expect over time that potentially, we'll be taking some of those assets into that coinvestment income. And the returns of those are looking very favorable compared to some of the real estate assets as well.

Should we expect a reduction of real estate assets on balance sheet as a result and maybe holding some more of these infrastructure-type assets on balance sheet? Or is it mainly by coinvestment in real asset funds that's housing that? Just wanted to get the capital opportunity.

I think assume coinvestments, but there may be periods from time to time where we do warehouse really good assets on the balance sheet and then sell them down later on.

Okay. And just a follow-up regarding Collimate. When the deal was originally penned, you provided some guidance on earnings saying they'll be broadly earnings neutral in FY '23 and accretive in FY '24. Just given you've had a bit more time to look at where the fund is going to land, et cetera, I'm just wondering if you can provide a bit more of an update in regards to the earnings impact coming through from that $18 billion of FUM coming onboard.

Yes. Look, obviously, there's been delays now. So assume broadly neutral to this year, no impact. There'll be some accretion coming through in '24, but because of the delay, there will also be some more upside coming through in '25 now, and it's purely because of timing.

Okay. And you also said that, that bridge from 10% to 20% of more active earnings in the funds management book, how far does AMP gets used there from that 10% to 20%? Do they get you halfway there, do you think? Do they get you the majority of the way there?

No. Look, we'll give more detail on that at the full year.

Okay. Great. And then just another one, just regarding -- maybe a question for Keir, just around the convertible that occurred in the first half and just around the reasons for needing to go to a convertible and with conditions that are [ essentially struck ] in the CB holders' favor with the dividend protection. Just why was there a need to go to the market for that facility?

Stuart, look, exchangeable notes have been a part of our capital management strategy for a number of years. If you look at the environment last year, there's a lot of volatility. There's only one rate issuance in the domestic MTN market last year. And we're seeing elevated credit spreads in offshore debt capital markets. So we didn't think it was the right time to lock in long-dated debt at those rates. What the exchangeable does provide is diversification of our funding sources. It provides 5-year fixed rate debt, and it also gives us optionality around how we choose to deal with it ahead of its maturity in 2027. So with the benefit of that, we're now sitting with a very strong balance sheet to support the business. Now gearing is 25.6%, well below our target range. We've got a lot of headroom, and we're 85% hedged with a term of close to 5 years now.

Okay. And how do you think about the cost of that facility as it maybe starts to mature to more than just the 3.5% coupon? How does that compare to the [ maturing ] and maybe compared to what you're seeing in offshore markets?

I'd said it's meaningful cost savings versus what we're seeing in alternate sources of debt available at the moment. I think in terms of what it looks like going forward, really, it's going to be a factor of timing and the price at conversion. And naturally, we'll give you more of an update as we get closer to that date.

Yes. Stuart, I think if you go back in time, there's been a lot of uncertainty this year. There was talk of capital markets freezing over. One thing we were very, very focused on is making sure there was never going to be a massive dilutive equity raising from Dexus. That's something we do not want to see on the watch of this management team. And you've seen overnight, in other markets, that kind of thing happening. So rest assured, we are very focused on the balance sheet. It's part of our normal funding package, and we think it was a sensible move at the time, and we still do today.