Goodman Property Trust (GNZ) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the Goodman Property Trust FY '23 Interim Results Webcast. [Operator Instructions] I would now like to hand the conference over to Mr. John Dakin, Chief Executive Officer. Please go ahead.

Thanks very much, and welcome, everybody, to the half year results for FY '23 for Goodman Property Trust. In the room with me today is James Spence, Director of Investment Management and incoming Chief Executive from the 1st of January 2023; and Andy Eakin, our CFO; and Andy also heads up our Sustainability Strategy, and we'll talk to that. So if I can take everybody to Slide 4, maybe hitting there some things up pretty well. The industrial sector does remain extremely resilient amidst what's a very uncertain economic climate that we have today. We've had a very strong first half operating performance that we're very pleased with, consistent with expectations, and our guidance for the year is earnings of at least $0.069 per unit, up 4% on FY '22. GMT is certainly continuing to benefit from a growing digital economy and sustained demand for well-located warehouse and logistics space. The Auckland industrial market, which is our focus, has historically low vacancy, currently at 0.10% for prime industrial, and urban logistics portfolio is at capacity. And this is a common theme that Goodman is seeing around the world. The positive leasing dynamic is contributing to strong income growth with new rental benchmarks having been achieved throughout the 6-month period and also continuing to be achieved up to the state. The highly constrained market means that customers are securing space early and many are committing to longer lease terms. This is also supporting a record level of development activity for the Trust with around 150,000 square meters of warehouse and logistics space currently under development. Capital management is increasingly coming into focus. And in terms of asset values, they are stable as at 30 September with effectively rental growth offsetting expansion in cap rates. Our conservative approach in terms of low gearing and sufficient liquidity provides us with financial flexibility, both to fund current development commitments and selective. We emphasize the word selective acquisition opportunities where we will remain very patient. Finally, over the period, we created our sustainable finance framework and launched our inaugural $150 million green bond of funding new sustainable developments targeting new 5 Green Star Built ratings. I'll move now to Slide 5, the result overview in terms of the portfolio. As I mentioned, it's largely full at 99.6%. Very strong level of leasing activity of 140,000 square meters, again, also evident of the strong demand. And if you went back 3 or 4 years ago, that would probably be in the range of 50,000 to 70,000 square meters. Pleasingly, underlying like-for-like net property income growth of 5.6% was recorded for the period. And as I mentioned earlier, property values, supported by desktop valuation advice, have indicated cap rate expansion of around 40 basis points, but that's been cushioned by market rental growth and leasing outcomes. And that leaves the portfolio as at through September at around 18% under rental. With the demand that we're seeing, that's also resulted in a record level of development work-in-progress at $635 million. The majority of which is from existing customers, including New Zealand Post, with about 35,000 square meters, and also a pretty big workbook for Mainfreight at 59,000 square meters. In terms of the financial outcome of the FY '23 results, we've got an 11% increase in operating earnings after tax, $54.6 million. Cash earnings at $0.0352 per unit, 7% up on the comparable period and distributions consistent at $0.0295, a 7.3% increase. On the capital management front, again, as I mentioned earlier, significant liquidity to fund both our development activities and/or acquisition opportunities should they arise. Gearing, again, very conservative at 23.2% and that will build over the next few years to 27.7% at a committed level, well within any covenant maximum. So that's a summary and introduction. And then I'll hand over to James to take you through the next section.

Thanks, John, and good morning, everyone. Turning over to Page 7 of the presentation. As John mentioned, we continue to see significant upwards pressure on rentals for prime warehouse space in Auckland where the market is effectively at full capacity. The increase in market rents over the last year across the prime Auckland market of around 20%, while significant, is not out of shape with what is happening in other gateway cities around the world that have similar demand and supply dynamics to Auckland. Los Angeles, for example, has seen rental growth in excess of 40% for the last 12 months. Net absorption is outstripping supply as businesses continue to look for ways to offset higher costs and become more productive. This often coming by way of a more efficient warehouse facility in a superior location. If there are extremely limited options, space that is becoming available in the future has also been snapped up. By way of example, in the GMT portfolio, we were notified by a customer at Highbrook that they would be exiting their 6,000 square meter warehouse facility in 2024. The space was leased within short order to a 3PL customer who was focused on e-commerce solutions as they were looking to build capacity into their network. We have leased this space to them for 2 years in advance, providing for a rental increase to GMT of around 50%. This dynamic is also driving the growth in our development work-in-progress as can be seen on Page 8. In the last 6 months, we have announced a further 50,000 square meters of developments across 5 buildings. These developments include the construction of the remaining 3 buildings at Roma Road. One of the buildings is an 18,000 square meter facility for Cotton On for a term of 12 years. The other 2 are to be built on a speculative basis completing in March 2024. We're currently dealing with strong inquiry for these 2 assets, which are well located for access to the central Auckland market. Over to Page 9. Currently, we have close to 150,000 square meters underwear across 10 projects. Approximately 80% of these projects are brownfield developments, which includes the demolition of older existing improvements. These projects provide a weighted average lease term of approximately 14 years and a yield on additional cost of the Trust of around 8%. Our development program continues to produce high-quality irreplicable assets for the Trust and assist their customers in providing essential infrastructure to the Auckland economy. Page 10 provides some further detail on the current development program. Of the 150,000 square meters of developments underway, around 30,000 square meters of this was commenced on a speculative basis with all but 8,700 square meters being leased being the 2 Roma Road developments I mentioned before. Our exposure to speculative development sits at less than 1% of our total portfolio. We do continue to see an elevated level of construction costs and do not foresee this easing until at least the second half of next year. Our in-house development team are very focused on cost and program control and have been able to keep the impact of this challenging environment in this challenging market to within manageable levels. Over to Slide 11. GMT's strategy to invest solely into the best locations in Auckland has not changed. Auckland is a market with high barriers to entry for both occupiers and owners and our footprint provides plenty of options for our existing and new customers across Auckland. The portfolio remains effectively at 100% capacity with the weighted average lease term extending to above 6 years, sorry, largely on the back of development leasing where customers are opting to take longer leases to secure both their position and investment Slide 12 provides an overview of the stabilized leasing completed over the last 6 months. Around 14% of the portfolio was subject to new lease or renewal with an average agreed increase in passing rents for those leases of 23.3%. Incentives remain low at around 2.7%, the equivalent to around 1.5 weeks of rent free per year of lease. While the core average warehouse rental rate agreed for the 6 months was $156 per square meter, rental growth has accelerated. And in the last 3 months of the period, the average warehouse rental rate for our core product was $170 per square meter. With the quality of the portfolio and limited options for relocation, retention has remained high at above 80%, where we have had a vacancy, the time to backfill the space has been slightly less than 2 months. Leasing inquiry following on from the end of September remains significant, and I'm pleased to say that as of today, the stabilized portfolio is now 100% occupied. Over to Slide 13. These leasing results are flowing through to our underlying cash flows with like-for-like NPI growth increasing -- sorry, at 5.6%. Our portfolio has a real mixture of rent review types across its leases with a large majority of our revenue subject to some form of review each year. We have provided further insight into our review profile for the next 18 months, with the portfolio now significantly under-rented, strong growth in underlying cash flows comes through upon a market rent review or lease expiry. Approximately, 22% of our portfolio is subject to either one of these before March 2024. Further to this, a portion of the leasing completed over the last 6 to 12 months will commence over the next 18 months, providing for additional tailwind for NPI. Over to Page 14. We continue to do a higher proportion of our development business with our largest customers with significant developments underway for New Zealand Post and Mainfreight as they look to further expand and improve their networks within New Zealand. In line with trends around the world, we are seeing increased demand from 3PL businesses as many customers look for increased logistics expertise and a difficult supply chain environment. Looking at our current work-in-progress across the development, it's approximately 70% of our customers in that program or in this line of business or the parcel delivery business. SBA requirements line up with our strategy to provide last-mile solutions to the best locations, and we don't see this trend easing. Over to Page 15, and our valuations. Value has completed desktop valuations for the entire portfolio at the end of September. Independent valuations supported the carrying value of our assets with a 10% growth in market rents over the last 6 months and new leasing, offsetting the expansion in the portfolio cap rate to 4.6%. As I mentioned earlier, rental growth remains significant and terms agreed with customers since the end of September have provided for rental rates in excess of those adopted in the September valuations. This, alongside the release of the under-renting position over time, will continue to provide some form of offset should cap rates continue to ease. Over to you, Andy.

Thanks, James, and good morning, everyone. If we turn to Slide 17, first of all, and take a look just at some of the aspects of our sustainability initiatives. As you know, we've committed to 5 Green Star developments for all of our new developments. And in addition to that, brownfield redevelopments of existing sites now account for around 81% of our current work-in-progress. One of the major successes we've seen out of those brownfield redevelopments is the amount of material from demolition that's been diverted from landfill. 90% of the Roma Road demolition diverted and even better than that at Favona Road in the last period, 96% was diverted. We're working with our customers in the Green Building Council and an energy efficiency benchmarking exercise. And ultimately, the aim of that is to help those customers be more efficient, lower the carbon footprint and save money. The 2025 targets across the stabilized portfolio include 100% LED lighting. We're well advanced with procurement for that replacement of all R22 climate damaging refrigerants in the core portfolio and 2 megawatts of solar arrays installed, and I'm confident that we'll exceed that 2-megawatt target. The first 2 completions since commitment around the 5 Green Star targets are well on track and look likely to achieve that without any issue. If we turn over to Slide 19 and take a look at some of the financial highlights. As John and James have said, operationally, this has been a very strong first half, and that's reflected in the results that we've reported today. Operating earnings of $54.6 million, 11% up on the same half last year. Cash earnings of -- sorry, $0.0352 per unit, 7% up on the first half of last year. Statutory profit before tax of $48.8 million, and that is done in the first half of last year. The key driver between the differences being the fair value of the property assets. As James has outlined, the asset portfolio is stable this year, and we're very pleased with that outcome in the current climate. Last year, there was a $505 million positive revaluation. Turning over to Slide 20 and look at net property income. So, NPI first half this year compared to last year, 12% higher. Really good to see that cash flow. At $78.5 million last year up to $88.2 million this year, and underlying like-for-like net property income growth of 5.6%, really pleasing to see. Acquisitions contributed $3.7 million to the NPI growth that was for the OG, Bush Road, Sky TV and Sleepyhead sites. Developments contributing more than $1 million, and you'll see the redevelopment, so that was Roma Road and Favona Road taken offline for redevelopment in the last period, resulting in a small reduction to NPI. In addition to that, included within the other category, the $2.8 million positive, that reflects the COVID support given to customers in the prior period. And in the current period, we didn't see any required. Strong cash flows, as I said, really important and pleased to see the business generating those, and the team remain very close to customers. As a result, at 30th of September, we had no arrears outstanding. Turn over to Slide 21 and have a look at cash earnings. So, first half '23 cash earnings, as I said before, 7% higher on a cents per unit basis. Contributing into that is an effective tax rate of 15%. So that's effective tax lower than it was the same period last year. The leasing that James mentioned before, we've benefited from the deductions associated with that record level of leasing. Moving from operating earnings down to cash earnings, so the adjusting items that we have there, one worth noting capitalized borrowing costs on land, so $1.8 million this period compared to $0.8 million in the last period, and that reflects the acquisition of the Villa Maria site. Total CapEx in the portfolio, the stabilized portfolio was $12.4 million for the first half, within that $2.2 million, which is an adjustment that we include within the cash earnings calculation. We expect similar levels of total CapEx and maintenance CapEx in the second half of this year. The total CapEx reflects greater level of investment this year in the sustainability initiatives. As John mentioned, full year guidance has been firmed. We're now guiding to at least $0.069 per unit. Distribution of the guidance remains at $0.059 per unit for the full year. That's at the midpoint of our 80% to 90% range and represents 7% growth on last year's distributions. Turn over to Slide 23, and have a look at the gearing. So, at 30th of September, we reported gearing of 23.2%, very comfortably in our range -- preferred range of 20% to 30%. The record level of development commitments sees us spend another $300 million out to FY '25 to complete those developments and rolling forward to then, all other things being equal, we see gearing getting to 27.7%. Still within the range, the 20% to 30% range. and importantly, very comfortably in compliance with our covenant maximum of 50% that sits across all of our debt facilities and the trust aid. Slide 24 looks at the debt profile for the Trust, and we do continue to focus on liquidity. The major contributor to that in the period was the Green Bond that John mentioned, we raised $150 million in that first Green Bond for a 5-year term issued back in April. The eligible assets pool. So these are the 5 Star Green Assets -- sorry, the 5 Star that we're targeting for those new developments, that now stands at over $500 million, provides capacity for more green funding. Liquidity at 30th of September, nearly $450 million, and it's been providing us that capacity to complete those developments and, as John said, any further acquisitions or developments that we may choose today. Turn over to Slide 25 and look at the interest rate hedging. So, 12-month roll forward hedging profile, it's at 67%, so still providing us with good protection through this elevated period. Weighted average cost of debt for the half was 3.6%, and our full year forecast weighted average cost of debt sits at around 4%. ICR covenant, so there's a covenant requirement that ICR is greater than 2x. That's at 4.3x at the 30th of September, reflecting the impact of the rising interest rates, but also importantly, noting that income-producing assets taken offline for redevelopment and those developments can start to complete in FY '24 and adding back into the income. Hand you back over to John.

Thanks, Andy. And if I can take everybody to Slide 27, a summary and outlook. We do remain cautious and very patient, given the volatility in geopolitical risks and a rising interest rate environment that we have, an expectation of a slowing global and local economy. We feel that we're in a strong position to withstand the impact of these risks with our low leverage and significant financial flexibility. Importantly, I think the strength and consistency of GMT's underlying operating performance demonstrates the resilience of the business in the prime sector and the benefits, in particular, of our strategy, which is focused on urban logistics properties with A-grade locations and A-grade buildings. Demand, as you've heard throughout the call, is underpinning high occupancy, continued positive rental growth and also by extension development activity as we continue to provide well-located sustainable properties to improve the productivity for our customers. By continuing to be disciplined with investment decisions and closely managing the delivery of the development program, the Trust will continue to benefit from the structural trends that are driving demand for sustainable warehouse and logistics space close to consumers. Finally, as mentioned by Andy, forecast cash earnings of at least $0.09 per unit confirmed for FY '23. So I think at that point, we can go to questions.

[Operator Instructions] Your first phone question comes from Nick Mar with Macquarie.

Just on the underwriting and where sort of market wins. Can you just talk through about how you sort of land on that number for the first half? And James, you mentioned that it has sort of lifted since then, could you provide some kind of order of magnitude? And then, lastly, how does the sort of market rent get sort of, I guess, replacement cost rents across the portfolio at the moment?

Yes. So, you might have noticed we've made a bit of a shift yet. Usually we would provide a management assessment of market rents versus passing rents, but this time we've actually provided the independent valuers assessment. So that's just then looking across the portfolio and going what would it rank for today versus the passing rent, so that's come to 18%. Look, it's sort of early days post the end of September. But I did mention, we've done a couple of leasing deals and agreed terms with customers at rental rates above those rents from September. And in some cases, it's not as significant, it can be 15% to 20%. So really strong dynamics out there for where there's no real optionality, but it is early days, and that's not a significant amount of deals. And the final question is about construction costs versus the portfolio. Look, I think if you look at what's happening with land, industrial land, our expectations, maybe John can comment on it more, but that's probably where that we should be seeing a bit of pain on the outskirts, but there's been land transactions that are still that $1,000 a meter plus mark, we understand, and that would put replacement costs for our portfolio at above what we've got to value that as at today.

Yes. I think that's right. I think, our expectation is that we will see a softening in the land market. I think we'll also see a bifurcation between the sort of the really prime assets and the secondary assets and the same in the land market as well. And so, we are aware of the odd development deal unwinding and also the inability of some people to actually sell lean. So, we're sort in the early stages of a repricing process.

Right. And always a sort of tough question, but how are tenants sort of feeling, obviously, there's not a lot of options out there and market as market, but is it putting any stress on tenants with 20%-plus reversions as they come through?

Yes. Look, I think one of the things we're obviously doing is staying really close to our customers and working with them to create more efficiency. And that's -- I guess that's, in many ways, what's driving the demand right for really, really good locations as the customers are getting savings in other parts of your business, be it around transport or more automation and saving people costs, and that's really our focus. But clearly, we'll continue to stay very close to it. James might want to have comment as well. I think, we said here today, the financial metrics are really, really strong for us. There's no arrears. But we're also not unrealistic about how the next couple of years might look. So, you want to add to that, James?

No, that's exactly what I was looking, yes.

Great. And then, just lastly, just on capital investment. Can you talk about how you look at target returns at the moment, given where interest rates are and sort of expectations of development margins across the pipeline from sort of 5% yield to somewhere it might land on a final cap rate?

Yes. I mean, clearly, as I mentioned before, we're going through a repricing period. I think we're going to be seeing 3.5% cap rates at the moment in time. So, we're going to be receiving our expectations in line with that repricing. No one knows really that's going to shake out at the moment, but I suspect we're going to be targeting certainly higher yields on cost than we've seen in the last few years.

Great. And sort of the development margin expectations across the current pipeline?

In terms of the margins, look, I think we've got some -- we've been through a period where we've had some incredibly strong margins with the cap rate compression that we've seen. But I think depending on the customer and the ASC, I think we're still looking in that 15% to 20% in terms of the margin.

Your next question comes from Bianca Fledderus with UBS.

Just one question for me really. But just with regards to consumer goods warehousing, I guess, first of all, we are seeing a bit of a move back to in-store shopping in New Zealand since we moved away from the COVID traffic lives. Hence, there are, of course, concerns around consumer confidence and spend. Could you just talk a bit about what you have seen in the consumer goods warehousing space sort of over the last few months and what you're expecting there going forward with regards to demand for those kind of assets?

Yes. You made just a couple of high-level comments. I think, yes, through COVID, obviously we saw an extraordinary surge in online activity. And I think as people are allowed to get back out into the shops, we're seeing maybe it's back, but in terms of the volume of sales online. However, I think that structural shift is certainly has happened and still got some way to go. So we still think that's going to be a really important demand driver. But James might be able to talk a bit more specifically about some of the conversations with customers.

Yes. And talking with customers, it's those higher-priced items, the sort of more luxury items that you're definitely seeing a bit of a drop off in demand, whereas we've got a lot of businesses in the portfolio that also deal with cheaper products, replacement products that are cheaper at the other end, which are actually seeing a significant increase in sales. So, it's really patchy and divergent depending on what type of product you're selling.

Yes. Okay. And so, with regards to your industry exposure, so it looks like you have about 16% of your portfolio income coming from that subsector at the moment. Do you expect that to change significantly, I guess, or...

Well, if you look at -- a customer of ours, for instance, that might be in a consumer goods business, and they've got a warehouse with us. A couple of years ago, they might have been running at 85%, 90% capacity. Over the last couple of years, that's moved up to 100% capacity and above. If that drops down to normal levels where they're not going to go and sublease part of their warehouse to a smaller warehouse, I just don't see that really happening. -- but expect them to just run at lower levels. Now there might be some movement and lower demand for new product and new developments, but quite difficult to sublease or assign part of your warehouse. So there's a bit of resilience in the portfolio there.

Your next question comes from Arie Dekker with Jarden.

Just on the development pipeline, obviously you preannounced quite a big extension of the projects, and you've done some big leasing deals with some of your larger customers recently. Can you just sort of talk about the inquiry levels you're sort of seeing still for new space at the moment? And I guess, where the best opportunities potentially sit within that brownfield's main bank that you've got?

Yes, to be honest, we are still seeing very strong inquiry. We've only got 2 available warehouses within the portfolio at the moment. They're a bit smaller. Like I said, we've got strong demand. But that sort of bigger project where our customers come together over the last couple of years and thought we need to rework our distribution network and take advantage of what's happening at e-commerce. It's absolutely still in. Some of the inquiries we're getting through at the moment are for very significant warehouses that will have a big impact on our markets. So that inquiry is absolutely still there. And we do have, within our value-add portfolio, many options for these guys that are medium to long-dated.

Yes. The inquiry, the big space is still there, okay. And just on the desktop valuations, I mean, can you sort of -- I mean, obviously they were supportive of the valuations, but can you talk -- give a little bit of color maybe on the extent to which there was some buffer, whether you sort of just held that to be conservative and wait to sort of see what happens over the next 6 years (sic) [ month ] or full year? Just a bit of color on a bit more granularity on what came out of those desktop valuations?

I think, Arie, the digital valuations, they're done by independent valuers. So, yes, it must be given obviously. But look, I think we don't really want to go into any great detail on it. I think the key point is that the growth in rents over that period has offset the expansion of the cap rates. As James said, that we're continuing to see an increase in rents since that period, which will just give some more cushion to any continuation of expansion. But I mean, that's the key theme and the key takeaway.

Your next question comes from Rohan Koreman-Smit with Forsyth Barr.

Congratulations on a strong start to the year. First, just a couple of housekeeping ones. Just on the tax rate, you mentioned that there was a bit of benefit from the leases. Should we expect a similar kind of 15% effective tax rate for the full year? Or does some of that unwind in the second half?

Yes. For the full year, you should expect around 15%. Yes.

And then, on interest costs, there's no, I guess, color on the hedge rates that you've got in place, just the hedging profile. Are you able to give a bit of color on what that looks like in terms of the weighted average kind of cost of those hedges heading forward?

Yes. Look, we don't disclose that. But as I said before, we expect the weighted average cost of debt for the full year to be around 4%. That's the limit of the guidance that we'll give you on that.

Nothing about next year at all?

6 months' time, we'll give you some guidance on next year.

And then, I guess, James, you mentioned that you've seen inquiry levels, or was it John, for the very large shares still there. Can you just talk about that secondary space? Has there been a change just given the general kind of economic malaise we're kind of feeling out there but maybe not seeing yet?

Yes. As you would have seen here, Rohan, rents are still climbing for secondary space, not at the level of prime warehouse, but they're still climbing. We would expect for that more secondary location that it doesn't keep up with where we're seeing the prime market. But at the moment, with the market largely at capacity, you don't have a lot of optionality you need to take secondary space. So it's kind of coming along for the ride a little bit.

And then, maybe just a broader question about industrial cap rates. John, in your long experience, what do you think an appropriate spread costs are over in a normalized environment for industrial cap rates?

Well, look, I think that's up to you guys to kind of work that out. What I would say is that we're going through a repricing period. Obviously, clearly, we see that first in the financial markets, and it takes some time to come through into the private markets. We're not really seeing any transactional activity at this stage. But I think our view is that in that environment, if you are going to be acquiring anything and it's got to be right being on strategy is the first thing, but you've got to be factoring a lot more profit and risk in today's environment. And clearly, the interest rates are a big driver of it. So, we don't necessarily have a number. But what I would say is, we're very cautious, we're very patient, and we'll be certainly building a more profit and risk given the backdrop of the world. And as you said, Rohan, there's an economic malaise out there that you feel, but you're not seeing yet, and we're acutely aware of that.

There are no further phone questions. We'll now move to the webcast questions.

Sure. So we've got a few, I don't read them out. First one, we have got from Nicholas Hill, the first 2 were covered. I'll read the third one. From Craig; morning, Craig. That's a question about the sustainability. You seem to be installing increasing amounts of solar. All your building structure is strong enough to have solar installed or do they need to be strengthened in order to install solar? Do you supply electricity to your customers and bill them or do they own the solar? If not, how does the arrangement work? And I'll get Andy to answer that question.

Good question. So, the buildings where we've installed solar, it's going both on new developments. So, clearly those are designed with the capability of supporting the solar, but also on some of the stabilized portfolio. And again, given how relatively recently our properties have been developed, they've all been able to support the solar being put on to the roof. Arrangements for customers vary. We don't currently bill any of our customers directly by the amount of electricity that's generated and supplied to them. The arrangements can be something like a small increase in the warehouse and office per square meter rate, which provides us with income to offset the cost of putting the solar on through to situations where customers have chosen to use some of the incentives that they've been given for a lease deal to invest into the solar. They then get that electricity free of charge. So that gives them a long ongoing benefit through lower operating costs. So, a range of different arrangements with the customers, but we don't generate direct income as a retailer of electricity currently.

Are there any further questions?

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

Great. Look, thanks, everybody, for your time this morning, and management are available for one-on-one catch-ups. So I look forward to chatting to a number of you in that forum in the next few days. Thank you very much.

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