Growthpoint Properties Australia (GOZ) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the Growthpoint Properties Australia Full Year Results Conference Call. [Operator Instructions] I would now like to turn the conference over to Mr. Timothy Collyer, Managing Director. Please go ahead.

Welcome to Growthpoint Properties Australia Full Year Results Briefing. As many of you are aware, our head office is in Melbourne and to comply with government regulations, we are doing this call from our respective homes. So this is quite new for us. Hopefully, it will be seamless. But if not, we will tend to get back to you as soon as possible. Joining me this morning is Dion Andrews, Chief Financial Officer; and Michael Green, Chief Investment Officer. And together, we will take you through the presentation. I'll start this morning with a brief overview of our results. I will also provide an update on the impact of COVID-19 on our business and our response. Michael will then provide an update on our key markets, our property portfolio and developments. Dion will then give a more detailed review of our financial results. And finally, I'll provide some commentary on our thinking for the financial year ahead and longer-term outlook for the group. We will then be happy to answer any questions you may have. Turning to Slide 4, our financial year '20 highlights. The group has delivered a strong performance in a challenging year. In March, we withdrew all forward-looking statements due to the uncertainty created by the COVID-19 pandemic. I am pleased to report that we have delivered FFO growth ahead of this guidance and 2% higher than the prior year. The value of our portfolio also increased over the year, driven primarily by the significant leasing success we had in the first half. This includes signing the group's longest lease agreement to date with our single-largest tenant, the New South Wales Police Force in Parramatta. We also reached practical completion of 2 development projects, Botanicca 3, our new A grade office development here in Victoria and the expansion of the Woolworths distribution center in Gepps Cross, South Australia. We made good progress with our debt book, taking advantage of the current low interest rate environment to refinance some of our existing facilities and extend their duration. Turning to Slide 5. To date, our earnings have not been materially impacted by the COVID-19 pandemic. This reflects the resilient nature of our portfolio as a result of our deliberate portfolio construction over a number of years. Our exposure is limited to the office and industrial property sectors. As many of you are aware, we have undertaken reviews of the retail sector over the last 10 years, which all came to the same conclusion. The entry point wasn't right, and we chose not to invest. Given the current environment, this was undoubtedly the right call for our business. Within the office and industrial property sectors, we have invested in well-located, high-quality modern properties. Almost 90% of our office assets are located in metropolitan markets, which we believe may benefit from some of the structural shifts accelerating due to the COVID-19 pandemic. Michael will discuss these further. Our industrial assets are predominantly used for warehousing or logistics, 2 areas, which have seen increased demand due to continued growth in e-commerce. We have carefully selected our tenants favoring large companies and government. Our portfolio is also diversified geographically, which is important to mention at this moment with what's happening here in Melbourne. Only 28% of our assets are located in Victoria. Turning to Slide 6 and the actions we have taken to date in response to the pandemic. Firstly, we followed recommended steps to stop the spread of the virus, including temporarily closing our head office back in mid-March. Protecting the safety and well-being of our team, our tenants and the broader community has been our priority throughout this period. In March, we made a commitment to the Growthpoint team that we would support everyone through this challenging time with no reductions to fixed salary or working hours. Whilst we have certainly missed the office and being together, I'm proud of our team and how we have successfully transitioned to working remotely. We've stayed in close contact with our tenants throughout this period. For a number of small and medium-sized tenants, such as operators of cafes in our office buildings, who we knew would be significantly impacted by the lockdown imposed by state and territory governments, we've reached out to them and offered a rent-free period at the start of April. This was implemented before there was a government code of conduct and state and territory legislation introduced. We wanted to help our tenants when it mattered most. This initiative reduced our earnings by approximately $800,000. We've also received rent relief requests from a number of our larger tenants. We have implemented a Board-approved process to review these requests, which involve collecting detailed financial information to ascertain the impact of the virus on their business. For our larger tenants, our discussions have been much more focused on rent deferments rather than abatements. We have now reviewed the majority of these requests received to date and have agreed to defer approximately $2 million of rent. This rent will begin to be collected from October 2020. Through this period, our rental collections have remained strong, even when rent relief discussions were ongoing. Excluding rent waived, we have now collected 97% of our total billings between April and June. We also implemented another -- a number of corporate measures to protect the long-term value of the group. This included delaying all nonessential capital projects and operating expenses. We have also increased our liquidity and extended debt maturities, which Dion will discuss in further detail. And finally, before I hand over to Michael, I wanted to provide a bit of context for this year's performance, as highlighted on Slide 7. The last 4 months of financial year '20 were challenging for businesses everywhere. And Australian REITs were not immune to the global equity selloff. However, we were pleased that in this environment, Growthpoint continued to outperform the index, as it has done for the past 3, 5 and 10-year time periods. Our return on equity was 10.8% for the year, a good result, which reflects positive property valuations and the resilient income of the group. I'll now hand over to Michael.

Thanks, Tim. Turning to Slide 9. I'll start this morning by running through some current themes, which we see influencing our portfolio and broader business over the medium term. There's been a lot of commentary since the outbreak of COVID-19, about the future of the office. And whether the real-life experiment of everybody working from home remotely will lead to a severe contraction in the demand for office space. Everyone's experience both at an organizational level and individually of working from home has been very different. And while we anticipate employees are likely to desire increased flexibility to work from home with greater frequency than they did pre-coronavirus, we sense that very few organizations and people will want to work from home on a permanent basis. Studies have found that executives with larger homes and dedicated well-resourced home offices are finding working from home easier than their more junior staff, often living in smaller houses with young children or housemates. This cohort of workers are facing a number of challenges that are not sustainable or conducive to a healthy and productive working environment from home. For everyone, it has been difficult to stay connected with colleagues while working from home. It's also harder to develop company culture, innovate collectively, mentor and develop junior team members when all interaction is done over a scheduled video call. We expect over the medium term that while the look, feel and use of the office may change, having a vibrant office will continue to play an important part in a company's ability to attract and retain talent. Turning to Slide 10. One trend which many are predicting to accelerate due to the COVID-19 pandemic is organizations adopting a hub-and-spoke office model, which is likely to increase demand for our portfolio of metropolitan offices. Hub-and-spoke describes an occupier model where an organization has an office in a CBD location and an additional office or offices in another location. A primary benefit of this model is cost saving. By having a secondary office, organizations can reduce the amount of space required for their office in a relatively expensive CBD. As you can see on the slide, the rental spread between CBD and non-CBD rents has been increasing. Today, having an office in the Sydney CBD will cost you double what an office in Parramatta would. In addition, having an office close to where people live can reduce lengthy commute time. Commute times to metropolitan offices are likely to get even shorter as the numerous government infrastructure projects underway are completed. Cost reduction will become increasingly important as Australia entered the recession, making the financial benefits of adopting hub-and-spoke models even more attractive. Metropolitan offices provide a number of benefits compared with their CBD counterparts for employees to operate effectively and safely in the current COVID-19 environment. These include higher car parking ratios, larger floorplates to assist with social distancing and less levels within a building leading to shorter lift wait times. Turning to the industrial market update on Slide 11. For a number of years, industrial logistics has been the favorite property subsector. Strong population growth and sustained growth in online shopping has driven increased demand for industrial assets. This, coupled with constrained supply, has led to higher valuations across the sector. The economic impacts of the COVID-19 pandemic are far-reaching and the industrial sector is certainly not immune. Several industries have seen an uptick in demand as a result of the pandemic. This includes nondiscretionary goods, online retailers and cold storage facilities. Other industries have not fared as well, such as discretionary goods, the construction sector and hire-related businesses. As a result, the performance of the industrial sector going forward is likely to be less uniformed, and an increased importance will be placed on an asset's age and design as well as tenant profile, industry and us. Modern, well-located assets, suited to logistics uses, are likely to outperform, while secondary assets, suited to manufacturing, are likely to underperform. At Growthpoint, we have maintained a disciplined approach when investing in the industrial sector, which is why we are significantly weighted to properties that are used for logistics and warehousing. Furthermore, 41% of our rent from our industrial assets is derived from grocery distribution. Turning to Slide 12, which provides an overview of our property portfolio. As Tim mentioned, our property portfolio had another strong year. In the first half, we saw strong valuation uplift across both our office and industrial portfolios, driven by leasing success and the development project. We are pleased to see no material movement in our portfolio valuation in the second half. Our portfolio occupancy did drop during this year as our new office development in Richmond at Botanicca 3 is vacant upon completion. Unfortunately, leasing this property has been more challenging than we initially expected as businesses' decision-making processes are prolonged in the current environment. We will continue to get positive feedback from our prospective tenants, and we expect to lease the property progressively over the next 18 months. If we exclude Botanicca 3, our portfolio occupancy is 97%. Turning to Slide 13. During the year, we agreed 51 new leases or renewals, representing 19% of the portfolio income, a record year for Growthpoint. Our leasing success drove a significant increase in our weighted average lease expiring from 5 years to 6.2 years. We continue to see a high level of tenant retention, which reflects both our efforts to engage with our tenants to make sure our properties are meeting their needs and also tenants' reluctance to move without a strong impetus during these uncertain times. While we haven't done a significant amount of leasing since the outbreak of COVID-19, what leasing we have been doing has been in our fitted suites in Sydney Olympic Park and 333 Ann Street in Brisbane and also our smaller logistics properties. Typically, the decision-makers for these tenants live locally and makes the process a lot easier. Looking ahead, discussions are already underway regarding most of the significant lease expiries for FY '21 and FY '22. Growthpoint's lease to Woolworths at Larapinta is a significant one for the group. Woolworths has been a key tenant for Growthpoint since our inception, and we have a long-standing mutually beneficial relationship with them. Larapinta remains an important part of Woolworths' grocery supply chain, and they continue to invest their own capital into the site, spending approximately $18 million over recent years. Through our discussions with Woolworths to date, we are confident that we have a good opportunity to renew this lease. Turning to Slide 14 and an update on our development projects. During the year, we completed 2 development projects, both ahead of time and on budget. In February, we achieved practical completion on Botanicca 3, a new A grade office building in Richmond, approximately 5 kilometers from the Melbourne CBD. We are proud of this development, and we believe it is one of the highest quality metropolitan offices in Australia. In June, practical completion of the expansion of our Woolworths' grocery distribution center in Gepps Cross, South Australia was reached. Woolworths now have a 15-year lease at the property. Prior to the COVID-19 pandemic, we were progressing our plans to develop an industrial site in Broadmeadows, Victoria. As part of our response to the crisis, we decided to delay all nonessential CapEx, including this project. We are currently reviewing all options for this site, including divestment. Turning to Slide 15. Across our portfolio, we're looking for opportunities to operate in a more efficient way to reduce our environmental footprint. Key achievements this year include installing 2 substantial solar photovoltaic systems, taking the total number of installations across our portfolio to 6. We also made a commitment to purchase accredited renewable power for a number of our key sites. We are pleased that our efforts and high green credentials were recognized by NABERS this year. They ranked our property portfolio as one of the top 10 most energy-efficient portfolios in Australia. We also saw an increase in our average NABERS Energy rating and GRESB score. I'll now hand over to Dion, who will take you through the financials.

Thanks, Michael. Starting on Slide 17 with an overview of our financial results for the year. As you can see, we've delivered a strong performance in a challenging year. Our net property income increased 5.1%, driven by an increased contribution from recently acquired assets, surrender fees and annual rent increases. Net finance expenses have decreased due to the reduced cost of debt, which I'll provide more detail over on the next few slides and a higher amount of capitalized interest on development projects, which completed in FY '20. The income tax expenses were higher as we reached practical completion on Botanicca 3. Growthpoint was the development manager for this project and earned profits in the company as a result. These profits allowed the payment of a fully franked dividend during the year, clearing accumulated franking credits. As this project is now complete, we do not expect to have any significant tax expense in FY '21. FFO increased by 10.8%. There was a smaller increase in FFO per security due to a higher number of securities on issue. Despite the increase in FFO, the Board decided to reduce our distribution this year to $0.218 per security to retain a higher level of capital within the group during this uncertain period. Our payout ratio in FY '20 was 85% compared to 94% in FY '19. Turning to Slide '18, where we wanted to provide a greater level of detail on the key drivers of FFO per security this year and the impact that COVID-19 pandemic has had on our results. As you can see, the biggest positive drivers of FFO per security were recent acquisitions, the Broadmeadows surrender payment and our lower finance costs. It is important to note that the Broadmeadows surrender payments and capitalized interest are 2 items that will not reoccur in FY '21. COVID-19 had a relatively small impact on our earnings. FFO reduced by $0.01 due to the rental abatements, which we granted. Just over $2 million of deferred rent is included in our FFO results. We expect to begin collecting this rent from October 2020, and the outstanding amounts are simply carried as debtors. We provide further detail on the accounting treatment of COVID-19 and a reconciliation of operating cash flow to FFO in our supplementary information for those who are interested. Turning to Slide 19 and the key drivers of NTA during the year. In the first half of the year, NTA per security increased by 4.6% due to the property revaluation gains on the back of our strong leasing success, particularly in the office portfolio. In the second half of the year, we saw a decrease in the value of some of our office properties, generally those with near-term lease expiries as valuers have changed some of their valuation inputs. We are now assuming longer lease-up periods between vacancies and higher incentives due to the increased economic uncertainty caused by COVID-19. On the other side of this, for our properties with long leases in place, we saw an uptick in their valuation. If we take the police headquarters in Parramatta, for example, a 25-year lease to a government tenant with 3.5% rental escalation per annum, makes this an even more attractive property in the current environment. During the year, our gearing was reduced by 210 basis points to 32.2%, as you can see on Slide '20. The reduction in gearing was driven primarily by the equity raising and increased cash from operating activities. We are currently 260 basis points below our target gearing range. Our target gearing range reflects our business model. Our earnings are derived solely from rental income with no development projects underway and no funds management business. Our portfolio also has a relatively long WALE, and we have a higher proportion of debt fixed for a weighted average 5 years, which gives us good visibility on our cash flows over the medium term. We have significant headroom to our debt covenants also. However, we believe gearing at or below the bottom of this range in the current operating environment to be prudent. Turning now to Slide 21. During the year, we refinanced $400 million of debt on favorable terms. As a result of these transactions, we have reduced Growthpoint's average weighted debt cost by 50 basis points to 3.4% and extended our weighted average maturity to 4.7 years. We now have no debt maturing until FY '22. In May, we entered a new $100 million debt facility with a new banking partner to increase our liquidity. This facility was priced lower than the group's weighted average cost of debt, which was particularly pleasing as we entered into this transaction after the COVID-19 outbreak. We'll continue to look for opportunities to reduce the cost of debt further in FY '21. I'll now hand back to Tim to provide an update on our outlook.

Thanks, Michael and Dion. As we look ahead to financial year '21, there still exists a great deal of uncertainty. Already, we are seeing a significant divergence in experience within Australia, with Queensland almost virus-free and its residents leading life with minimum restrictions compared to Victoria, where we are still navigating a strict lockdown. We won't start to get a true understanding of the impact of the COVID-19 pandemic on businesses and individuals until the government support measures are lifted. As a result, we have not provided FFO guidance for financial year '21. However, we have provided our investors and analysts with some detail around how we are thinking about FFO and key downside and upside risks that could impact our performance on Slide 23. We understand the value our securities -- security holders place on receiving distributions. So we have provided distribution guidance of $0.20 per security for financial year '21, expected to be $0.10 per security per half. At current pricing, this represents a distribution yield of approximately 6.2%, attractive relative to the yield on cash and bonds. Turning to Slide 24. We expect the COVID-19 pandemic will have far-reaching implications for a number of years. For Growthpoint, there are several external factors listed on this slide that we are watching closely as they will have an impact on our business. The government's response to the pandemic could have a significant impact on the group. This includes further lockdowns or restrictions to stop the spread of the virus and extensions to government measures to support tenants, such as the National Cabinet's code of conduct and state legislation. We are keeping a close eye on the property market. Growthpoint has a successful track record of growing through acquisitions. At the moment, we aren't seeing a fully functioning market, but it is opening up and will continue to do so in this half. Prior to this year's property valuations, valuers have not had significant sales evidence to use as part of their analysis. As the market opens up, we will get a better understanding of the impact of COVID-19 on property prices. As a group, we are focused on what we can control. I'm confident we have taken the right steps to date to ensure the group is able to continue to face the challenges presented by the pandemic head on and deliver value to security holders over the long term. The fundamentals of our business remain robust with a long WALE, high-quality tenants and manageable near-term lease expiries. We also have a strong balance sheet, significant liquidity and ongoing access to providers of capital. We will now be happy to answer your questions. Thank you.

[Operator Instructions] Our first question is from Darren Leung with Macquarie Group.

Two quick ones from me. One, Michael, you mentioned in your comments around hub-and-spoke. Is there any evidence, particularly in the last fourth quarter or the last sort of few weeks, of tenants looking to execute on this model, either -- whether they've achieved it or not [ walked for inquiries ]? Just an update here, please?

So, Darren. I mean, I think the themes in our presentation will play out. A lot of businesses at the moment aren't really focused on getting through this next period. We have seen some really good strong leasing within our fitted suites at Sydney Olympic Park. And we do expect that, that trend will continue as businesses become more cost focused. But we haven't seen a big swing in it to date, but it's just a trend that we anticipate will pick up.

Okay. And then the second one was, we saw that your ADI stake ownership has declined by a little bit. Any sort of fresh thoughts around ownership stake here, particularly given where that investment is being priced at the moment versus NTA?

Thanks, Darren. It's Tim here. No, we still hold, obviously, the same amount of units and investment as we did when we first invested. Currently, we're just holding that as an investment and obviously receiving dividends and happy with the investment at this point in time.

Our next question is from Caleb Wheatley with Macquarie Group.

Just a couple of additional ones for me. Just on your dividend guidance of $0.20 per share. So it's -- that's about 8% on this year. I was just wondering if you could give any color on the driver of this. It feels like there might be a lower payout ratio in there. But just wondering if there's anything else in there that were kind of the levers for you going into FY '21?

Yes. It's Dion Andrews here. Yes, look, that distribution is a little lower than FY '20. That really just reflects the cautious environment that we're going into. We're not giving guidance on FFO or payout ratios at this time because of that uncertain environment. So we're trying to give investors a good forecast, and therefore, providing the $0.20 per security but aren't able to give other forecasted information at this stage.

Sure. Would a good interpretation be kind of a ground floor distribution just to give that certainty into '21?

That is our forecast distribution. So we can't provide any other information at this time.

Yes. Sure. And just an additional one. So you mentioned retail for the presentation. Obviously, it'd been difficult to get there to date. We've seen some devaluations coming, and there's probably more to come. Do you foresee a situation where these assets might become attractive? And if so, is there a preference within that?

Thanks for that question. Tim here. At this point, retail property investment isn't under consideration. Sometime in the distant future, it may well, but certainly not at this point in time. We are not considering that.

[Operator Instructions] There are no further questions registered at this time. I'll now hand back the conference over to Mr. Collyer for closing remarks.

Thank you, everyone, for attending the results presentation today. If you have any further questions from -- to the EMT or Virginia, we'd be happy to take those as well. Thank you for the time. We believe that Growthpoint is in a strong position at this point in time. We've produced some good results for the financial year '20, but undoubtedly, like everyone, we're looking forward into '21 with considerable uncertainty in the market. But certainly, our portfolio is in good shape, good properties, good income and a long WALE. So as I said, we are well positioned. So thank you for your time this morning and all the best. Thank you.

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