Growthpoint Properties Australia (GOZ) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to Growthpoint's Financial Year '21 Results Conference Call. [Operator Instructions] I would now like to hand the conference over to Mr. Timothy Collyer, Managing Director. Please go ahead.

Good morning and welcome to Growthpoint Properties Australia full year results briefing. I'm Tim Collyer, Managing Director of Growthpoint. Thank you for joining us today. Once again, we are doing this webcast from our respective homes due to the lockdown in Melbourne, and I'm sure many of you listening are also in lockdown. We recognize that this is a very difficult time and we hope you are doing okay. 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 will start this morning with a brief overview of our results and sustainability highlights. Michael will then provide an update on our property portfolio, followed by Dion, who will give a more detailed review of our financials. And finally, I'll provide a summary. We'll then be happy to answer your -- any questions you may have. Turning to Slide 4 and our full year highlights. Growthpoint has had another successful year. Our FFO for financial year '21 is $0.257 per security, which is at the upper end of our upgraded guidance range and 0.4% above last year. We are pleased that we were able to deliver growth, as we started the year with a $10.4 million headwind to our earnings as Woolworths vacated a large industrial asset in the financial year '20. We increased our portfolio's occupancy to 97%, driven by our leasing success. We also maintained our weighted average lease expiry at 6.2 years. As a result of these leasing success and cap rate compression, the value of the group's portfolio increased by 10.2% or $416.8 million over the year on a like-for-like basis. We remain committed to operating in a sustainable way and reducing our environmental footprint. We've made some great progress this year, which is summarized on the following slide. I'm pleased to announce we have significantly accelerated our net 0 target to 2025, 25 years earlier than our previous target which we set in 2017 to align with the Paris Agreement. This target supports our strategy to create value by maintaining a portfolio of modern, high-quality, resilient assets which meet our tenants' needs now and into the future. We also progressed our sustainability reporting to further align with the recommendations made by the Task Force on Climate-Related Financial Disclosures and have released our inaugural ECFD -- sorry, TCFD statement alongside our sustainability report today. Both documents can be accessed on our website. We continue to perform well in external benchmark surveys. The portfolio's average NABERS rating is 5.1 stars. And GRESB awarded us with a score of 74 points, which is 6% higher than the peer average score. We recognize that our people are critical to our success, and the leadership team is committed to ensure Growthpoint is a great place to work. We maintained our high alignment and engagement scores this year and our position in the top quartile of our benchmark group. I am also pleased to announce that we have joined forces with a number of our significant tenants to improve the well-being and mental health of workers in the road transport and logistics industries by becoming a sponsor of Healthy Heads in Trucks & Sheds. Across our industrial portfolio, there are thousands of workers who could benefit from these important services and the information on offer. And we look forward to working with our tenants to support this important initiative. On Slide 6, we have highlighted our total securityholder returns compared to the ASX-S&P 200 A-REIT index. In the second half of the year, we saw a strong appreciation in our security price as it made up the majority of the ground that was lost at the outset of the pandemic. This drove the substantial increase in our total securityholder return over the year, and once again, our returns were above the index. As you can see, the group has now outperformed the index over the last 1- and 3-, 5- and 10-year time periods. Our return on equity was 19.7% for the year. This strong result reflects the significant valuation gains across the group's office and industrial portfolio. I'll now hand over to Michael.

Thanks, Tim. And good morning, everyone. I'll start with a brief overview of our property portfolio on Slide 8. As you can see, our occupancy significantly increased over the year to 97% from 93%, and we maintained our long weighted average lease expiry of 6.2 years. Our team's leasing experience has certainly been beneficial for Growthpoint this year. We signed 33 leases, representing 12.4% of the portfolio's income. Securing Bunnings as a key tenant at Botanicca 3 was a great result. We also signed a new 10.5-year lease with the Australia Post in February at Adelaide Airport, a site which Cheap as Chips had recently vacated. This lease builds on our existing partnership with Australia Post, who also occupy one of our large distribution facilities at Melbourne Airport. And we agreed a 10-year lease extension for that site with them during the year. We were also pleased to see strong tenant retention with key tenants the South Australian government, Monash University and Laminex, among others, all renewing their leases. Driven by leasing success, yield compression and the quality of our portfolio, we saw the largest like-for-like 12-month valuation increase in the group's history. During the year, there has been ongoing speculation about whether a permanent shift to more flexible working arrangements will lead to a sustained decline in office demand. While it remains too early to call long-term trends, we are seeing encouraging signs that, while a degree of flexibility is expected to remain, it is unlikely to drive a long-term reduction in office space requirements. Before the latest COVID-19 lockdowns, analysis undertaken by the Property Council of Australia had shown that increasingly workers were returning to the office. And in some capital cities, physical occupancy was just below that of pre-pandemic levels. While the same analysis does not exist for metro offices across our portfolio, we are generally seeing higher physical occupancy [ than recorded ] by the PCA for CBDs. Across Australia, we have seen a decline in net effective rents primarily driven by higher incentives. In Sydney, the decline in CBD rents has been much more pronounced than in key metro markets. Despite this substantial reduction, Sydney CBD rents remain at least 2 to 3x higher than most metro markets. Historically, some commentators have speculated that, when CBD rents decline, tenants based in metropolitan locations will choose to reallocate to the CBD as it has become relatively more affordable. To date, this trend has not been observed. In Sydney and Melbourne, we have seen a number of high-quality tenants commit to metropolitan locations over the financial year. In Sydney, many of these tenants' offices were already located in metropolitan locations, and their decision to move appears to be motivated by a desire to upgrade their accommodation. There's been a similar story in Melbourne, where we've observed a flight to quality. Across our office portfolio, we have seen sustained demand for our assets from our existing high-quality tenants as well as potential new tenants. We signed 26 leases during the year. The weighted average lease term was 8.6 years. As a result, our office portfolio now has one of the longest WALEs as well as highest occupancy -- as well as one of the highest occupancy levels in Australia. The increase in occupancy was primarily driven by our leasing success at Botanicca 3. In securing Bunnings, we have signed a further 4 lease agreements at Botanicca 3, including 1 that occurred after the end of the financial year. We also recently agreed a heads of agreement for a further full floor. Together, this takes the building's occupancy to 92%. Reflecting the strength of our assets, the value of the group's office portfolio increased by 7.6% on a like-for-like basis to $3 billion over the year. We saw significant gains at 3 assets, which we have listed on the slide. Excluding these 3 assets, the remainder of the office portfolio increased in value by 2.7%. At the start of the pandemic, there was a lot of speculation about a substantial decrease in office valuations. This has not come to fruition. In fact, we are seeing the opposite with investors taking a long-term through-the-cycle view and continuing to invest in high-quality assets with strong tenant covenants. We remain positive on the outlook for metro offices and are continuing to look for opportunities to grow our portfolio. Turning now to the industrial market. Over the last decade, the penetration of online shopping has been steadily increasing in Australia. This trend accelerated during the COVID-19 pandemic. As restrictions eased, many individuals who tried online shopping for the first time have continued to shop online. As a result of the rise of e-commerce, alongside other trends, occupier demand for industrial space reached record high of 2.9 million square meters in 2020. The first half of 2021, gross take-up has already exceeded the average annual rate over the last decade. This strong occupier demand underpins the sector's fundamentals, and as a result, the Australian industrial property market continues to be one of the most highly sought-after sectors by both domestic and offshore investors. JLL estimates that there is currently $45 billion of capital earmarked for investment in Australian industrial assets. This is more than 3x the value of total industrial transactions in financial year '21. As a result of this strong investor appetite, yields significantly tightened over FY '21. Prime yields are now consistently in the low-4% range, and super prime yields for modern assets with long weighted average lease expiries are now approximately 3.5%. As a result of this substantial re-rating across the sector, we saw significant yield compression, with the weighted average capitalization rate of our industrial portfolio tightening 86 basis points to 5.2% over the financial year. On the left of Slide 12, we've highlighted the 3 assets with the most significant valuation movements. 2 of these assets are fully leased to Woolworths and used as key distribution centers. The third asset is a relatively new logistics warehouse that we acquired in September 2019. This property is located in Truganina in Melbourne's west, one of the fastest-growing distribution locations in Australia. Since acquiring the asset, market rents have increased by 5.5%. The current tenant is due to vacate [ in a year's ] time, and we are confident that we will be able to quickly re-lease this asset as we have already received a number of inbound inquiries. In addition to cap rate compression, we had good leasing success, most notably signing new leases with Australia Post, as I mentioned earlier. We also extended Laminex' lease for 3 years. As I've highlighted throughout my slides, we are really pleased with the amount of leasing we completed over financial year '21. We've built on this momentum since year-end, signing several leasing deals, representing 3% of portfolio income. This includes agreeing a 5-year lease extension with Samsung for their office at Sydney Olympic Park. Together, these leases reduced our FY '22 expiries [ to under 10% ]. The group's key expiry in financial year '22 is a distribution center located in Larapinta, Queensland which is fully leased to Woolworths. This lease represents 5.5% of the group's total portfolio income. Woolworths have indicated to the group that they plan to exercise a 5-year option, and a market rent review process is currently underway. At Growthpoint, we regularly review our property portfolio to ensure our assets continue to fit within our strategy. During the year, we successfully disposed 3 assets. Firstly, we sold a vacant industrial property located in Broadmeadows during Melbourne's second lockdown, as we decided that pursuing a lengthy development project in an uncertain operating environment is outside of the group's risk and return appetite. There were also costs associated with holding these non-income-producing assets. Secondly, we sold 2 assets located in Sydney Olympic Park, as the properties no longer fit within the group's portfolio of defensive assets. As I highlighted earlier, we are seeing a flight to quality in office markets around Australia, and the quality of these assets was below the remainder of our portfolio. Keeping these assets, which were principally tenanted by smaller businesses, presented a significant near-term leasing risk for the group. Although we divested the Quads, we remain confident in the long-term outlook for Sydney Olympic Park. And we were pleased that we were able to relatively quickly reinvest the sales proceeds from the Quads into an A-grade modern office asset located nearby. The new property, situated at 11 Murray Rose Avenue opposite the train station, is fully leased to high-quality tenants with a 4.8-year weighted average lease expiry. Pleasingly, we settled the acquisition yesterday. I will now hand over to Dion to take you through the group's financials.

Thanks, Michael. Starting on Slide 16 with an overview of our financial results for the year. We've had another successful year, delivering FFO of $0.257 per security. In February, we provided FY '21 FFO guidance for the first time in the financial year, which we subsequently upgraded in April. And we are pleased that our final results is at the top end of our upgraded guidance. I'll provide some more insight into the key drivers of this result on our next slide. While our financial performance exceeded our expectations, the Board decided to maintain our FY '21 distribution at the level we guided to at the outset of FY '21, being $0.20 per security. This represents a payout ratio of 78%, which is in line with our new target payout ratio of between 75% and 85% of FFO. If we had decided to increase our payout ratio to 85%, the top of our range and the same as FY '20, our distribution would have been $0.219 per security, slightly above FY '20. However, we expect incentives to remain elevated in the near term and believe it was prudent to maintain a lower payout ratio towards the bottom of this target range for FY '21. This will also assist us to grow distributions moving forward. On Slide 14 (sic) [ 17 ], we've highlighted the key movements in FFO and NTA per security. As expected, we faced a significant headwind to our earnings this year, as we no longer received any contribution from a large industrial site in Broadmeadows which we are subsequently divesting. In FY '20, we received $10.4 million from this asset, including rent and a surrender fee. There was a further reduction to FFO due to increased interest expense. Although our average cost of debt reduced in FY '21 and borrowings were lower, FY '20 saw interest capitalized on development projects. However, this was partially offset by a reduction in the group's tax expense, as there were no taxable development management fees in FY '21. FFO growth drivers were an increase to net property income due to fixed bumps in leases as well as higher income from our recently expanded Woolworths distribution center in Gepps Cross and from Botanicca 3 and a higher add-back of amortized incentives. NTA per security increased 14.2% over the year. This was largely driven by the strong valuation uplifts across both our office and industrial portfolios, which Michael highlighted earlier. The ADI share price also increased and is now trading above its pre-pandemic level. Over the past 5 years, we've significantly reduced the group's gearing. In FY '14, when we first introduced our target gearing range, the group's gearing was 40.3%. At the end of FY '21, the group's gearing was 12.4 percentage points lower and well below our target range of 35% to 45%. The current gearing level is below what we consider the optimal level for the group, and we are actively looking to deploy debt to support our growth ambitions. We are currently able to deploy approximately $387 million of undrawn debt at a cost of around 1% and still remain below our target gearing range. This will be accretive to FFO. As I mentioned earlier, the Board has decided to maintain a more conservative payout ratio going forward; and introduced a new target range, 75% to 85% of FFO. This distribution policy will be reviewed annually. I'll now hand back to Tim.

Thanks, Michael and Dion. On Slide 20, we've provided an overview of our 4 strategic pillars. The first 3 have been key priorities for the group over a number of years. By focusing on investing in high-quality assets, maximizing value and maintaining high occupancy, the group has been able to deliver a consistently strong performance even in a challenging economic environment as demonstrated over the past 15 months. We first flagged to our securityholders that we were considering diversifying our income streams just before the onset of the COVID-19 pandemic. In the immediate aftermath, we put this project on hold to focus on our core business. Since the beginning of the calendar year, this has been firmly back on the agenda. And we believe that, by entering funds management, we can generate higher returns on capital employed for our securityholders. Our target is to generate between 10% and 20% of FFO over the medium term, with the remaining amount to come from assets we hold on our balance sheet. Entry to funds management is best achieved via acquisition of an existing fund manager to achieve scale, and our concentration has been on this. Alternatively, Growthpoint could purchase some warehouse assets on balance sheet prior to launching [ a fund ] or using existing balance sheet assets to form a fund. Looking ahead. The future of our operating environment in the near term and the broader Australian economy has become less clear when compared with a few months ago, as many parts of Australia remain under lockdown due to the spread of the Delta variant of COVID-19. Unfortunately, we expect that lockdowns of varying length and severity are likely to remain a part of our lives until a higher proportion of the population is vaccinated. This could impact Australia's economic recovery and the speed at which employees return to working in an office environment, as we have seen after previous lockdowns. Despite this uncertainty, Growthpoint is in a good position to continue to deliver a strong performance. Throughout this unprecedented period, our business has highlighted its resilience underpinned by our portfolio of modern, well-located assets leased predominantly to large organizations and government tenants. We have delivered a robust set of financial results in financial year '21 which have exceeded our expectations. We delivered FFO growth per security. We increased our occupancy to 97% and we maintained our long WALE. We also achieved the largest 12 months like-for-like valuation uplift in the group's history. As Dion highlighted, the group's gearing and payout ratio are both at record lows, and we're in a strong position to pursue growth opportunities. Reflecting our confidence in the group's position, I'm pleased to announce that -- our financial year '22 FFO guidance of at least $0.263 per security, which represents at a minimum 2.3% growth on financial year '21. We are also providing distribution guidance of $0.206 per security, up 3% on financial year '21. That wraps up our prepared remarks. Thank you very much for your attendance today. And thank you to those who work for, with; and support Growthpoint. We will now open up the lines and are happy to take your questions.

[Operator Instructions] Our first question comes from Caleb Wheatley with Macquarie Group.

Just a couple for me. First, just on the components of guidance. Can you provide any color around your expectations on rental income, particularly occupancy given the current COVID situation; and potentially around some other expense lines, interest and corporate expenses, into FY '22?

Thanks, Caleb. I'll hand that question over to Dion.

Yes. Caleb, look, starting with COVID: Obviously it's very difficult to predict the impact of COVID. There are the new codes -- or the reintroduction of codes both in Sydney and Melbourne, but really what we saw as an impact in FY '21 was immaterial impact from COVID. We have -- less than 3% of our tenants are SMEs, so we're again expecting an immaterial impact on our guidance, although we haven't really factored in any COVID impact as it's impossible to determine. As far as rental and property expenses go, I might hand over to Michael just to comment on that.

Thanks, Dion. So I mean we've got 97% occupancy. So we've got fixed rent reviews throughout our leases and which averaged 3.4% across the portfolio. So they're all being factored in. And we're not expecting to not collect our rentals. And likewise, property expenses, they get budgeted in minute detail on a year-by-year basis. So we've gone through a very thorough process, which starts back in sort of February time, and results in the Board approving the budget prior to the commencement of the financial year. So that process is being as thorough as always, and we don't expect any deviation from what we typically budget.

Yes, okay. So there's no sort of conservatism around. I know there's some progress on those lease-ups as mentioned, but across the rest of the book there's no sort of any reason to think that leases won't get done given the current situation. It sounds like you're pretty confident on those.

Yes, we are. I think we've got good momentum with the FY '22 lease expiries. We recently agreed Samsung's lease, so that's now done with a 5-year lease extension there. So that was 2.5% of potential expiry this financial year, so that's a really good success. And again they took the same amount of space they were in. And rents are at market levels. Incentives, we're pretty happy with, so yes, we're confident in the outlook for the group. We've got a really good tenant base. And we've seen through the last 12 months that the leasing that we've undertaken, which has been substantial, has actually been for the longer term sort of what our average weighted average lease expiry is across the group, so that's been a good trend and we hope to continue that.

Sure. And just a final one on guidance for me, the -- at the "at least" comment. So it looks like there could be some upside to that $0.263 per share FFO. Is this just in relation to the balance sheet? Or are there other things that you think might surprise to the upside as well on that number?

Yes, thanks, Caleb. Dion here again, yes. Look, I think we're not alone in sort of giving that "at least" guidance. The -- that does indicate what we see our business as today, as how it's going to perform. It does include the acquisition of 11 Murray Rose, which settled yesterday, but as we said, our gearing is now at its lowest. And we are looking to deploy that debt capital. If we were to acquire other assets during the year, that would be accretive.

Sure. And just one final one on me, just the funds management opportunity being flagged again. I know you spoke to that maybe 10% to 20% of FFO into the medium term, but it's one that's been mentioned before. How do we think about when this might start to become a material opportunity -- or become material to earnings, I should say, for Growthpoint? And what sort of discussions are you having potentially on the capital partner side? Or is there a particular subsector or any thoughts around that as we move into FY '22 on that front?

Thanks, Caleb. It's Tim here, yes. So I mean, since the beginning of the calendar year, we've evaluated a number of options, which for one reason or another we haven't pursued. We've been primarily focused on the market. Is there fund managers? There has -- that's the quickest way to obtain scale for the business, so we continue to look at the market there but also looking more actively to consider the possibility of warehousing assets on balance sheet and launching a fund and/or some of our existing assets on balance sheet as well.

Sure. I guess I'm just thinking about when it might become material. Is that sort of opportunities that might be able to get launched in the next 6 to 12 months? Or is this more of a sort of 4- to 5-year-type story?