HomeCo Daily Needs REIT (HDN.XA) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the HomeCo Daily Needs REIT FY '25 Full Year Results Briefing. [Operator Instructions] I would now like to hand the conference over to Mr. Sid Sharma, HMC Capital Managing Director, Real Estate and HDN CEO. Please go ahead.

Thank you, and good morning, everyone, and thanks for making time to attend today's call on HDN. Joining me today is HMC Group CFO, Will McMicking; and HDN Fund Manager, Paul Doughty. Before we commence today's presentation, we want to acknowledge the traditional custodians of country throughout Australia. We celebrate their diverse culture and connections to land, sea and community. We pay our respects to elders past, present and emerging and extend that respect to all Aboriginal and Torres Strait Islander people. We'll begin the presentation on Slide 5. FY '25 was another disciplined year for HDN, where we continue to grow our earnings. We continue to create new developments. We continue to recycle assets, and we continue to work within our existing balance sheet. We've delivered on our guidance of $0.088 per unit FFO, and we've delivered our guidance of $0.085 DPU. In FY '26, we're guiding to $0.09 per unit of FFO per unit, and our distributions are growing to $0.086, albeit our payout ratio is reducing as we rightsize our distributions to AFFO over time. Our gearing remains at the midpoint of our target range, and we are positioned well for the year coming up. Proudly, since our IPO, we have delivered 6.7% compound average growth rate in FFO per unit. This is despite a challenging interest rate environment, which has seen a material increase in interest costs for HDN over the last 3 years. On Page 6, we outlined the strong operational performance at HDN. This result is driven by an exceptional group of over 100 people that work on HDN assets day in, day out. The key team we have assembled have been with us since day 1 and continue to deliver market-leading metrics of comp NOI growth of 4%, leasing spreads of 6% while sustaining high occupancy and rent collection rates that continue to be market-leading for retail real estate in Australia. The property income growth at the top line is a pleasing result despite being a net seller for the last 3 years. And what it demonstrates is the strong embedded income growth in the portfolio driven by this operational focus and asset management intensity. As we approach our 5-year anniversary as a listed entity, we thought it would be good to reflect for a moment on the journey since IPO, which commenced during the so-called COVID year of 2020. On Page 7, we've highlighted some of the key achievements the Board and management of HDN are proud of, which also then provide a foundation for us for our future growth. Our cash collection of 99% since IPO is outstanding and demonstrative of the quality of our tenancy mix and tenant counterparty performance. Our FFO per unit CAGR of 6.7% shows our discipline in growing earnings while preserving value. And notably, we have paid out over $0.376 in dividends since IPO. Our development CapEx program, which accelerated 3 years ago, has delivered $327 million of projects since inception. These have been delivered with a yield on cost of over 8.5% at completion. That's been well over our 7% stated target. Notably, what sometimes gets forgotten is the value creation in these developments. The $327 million invested over the course of the last 5 years is now valued at approximately $500 million, effectively $170 million development profit over that period. The gross value uplift in the portfolio and the income growth is a function of how HDN has grown approximately $4.1 billion of assets since creation. This has provided benefits of scale that cannot be underestimated. We proudly manage today what I genuinely believe is one of the best convenience retail portfolios in Australia. Our investment strategy on Page 8 sums up who we are and what we do. HomeCo Daily Needs REIT creates daily needs community hubs, supporting the growth strategies of Australia's leading retailers. On that note, I will hand over to Paul to talk through the portfolio update and key growth opportunities.

Thanks, Sid. Turning now to Slide 8. On this slide, we summarize our investment strategy. Our target model portfolio is 50% neighborhood, 30% LFR and 20% health and services. This mix balances the best characteristics of defensive, reliable income streams with sustainable growth. HDN's strong investment fundamentals are underpinned by competitive rents, which are at the bottom end of the landlord cost curve. As a result, HDN continues to achieve sector-leading leasing spreads and low incentives. We have always said we would have sustained continued leasing spreads to ensure long-term sustainable rental growth for our tenants, and we're pleased to have delivered those yet again throughout the year. And we have started 2026 just as strong. HDN owns 2.4 million square meters of high-quality and strategically located property with 36% site coverage, providing in-built growth through our $650 million development pipeline. This gives us a substantial opportunity to leverage the rapidly emerging the rapidly emerging essential last mile infrastructure trends to unlock additional embedded value. Our portfolio is differentiated with approximately 86% exposure to metro locations and a high skew to the large growth centers of Sydney, Melbourne, Brisbane to the Gold Coast. We serve 12 million Australians who live within a 10-kilometer radius of our centers, and they visit us 93 million times throughout the year. The population in and around our centers is forecast to grow by 21% over the next 10 years. As a result, HDN's portfolio is perfectly placed to play a critical role in our tenants omnichannel retailing strategies. So in summary, HDN has continued to deliver on all key strategic and operating metrics this year. On Slide 10, we provide our portfolio summary and the key takeouts for the year on the page are: firstly, our portfolio valuation, which has improved to $4.92 billion despite being a net seller of assets. This valuation growth reflects income upside and moderate cap rate compression. Our assets are always in demand and have always traded well throughout up and down cycles. The market pricing of convenience retail and investor demand is now increasing at pace, which should provide future valuation growth if current conditions continue. Secondly, our WALE has improved through our proactive leasing and we smoothed our lease expiry profile. Our portfolio mix continues to trend towards the model portfolio. A unique characteristic of our rent composition compared to our peers is that 87% of income increases every year by a weighted average of 3.5%. Because of the unique tenancy composition, our fixed escalations and outgoing recoveries provide better organic growth compared to our peers. Now we also get asked frequently about tenant sales. And as we say every half, retailer sales movements are not always directly correlated with rental spreads or cash collection. That given, HDN's retailers continue to perform strongly. Total MAT growth is 1.6%. And what's curious for the half, however, is a tick up in the non-supermarket sales categories, which are now performing at 2.6% MAT. Supermarkets for the year have been impacted with goods deflation, industrial actions and increased competition. On Slide 10, we provide further detail about our top tenants and the quality and diversity that underpins the portfolio and HDN's performance for investors. 35% of gross income is derived from our top 10 tenants and 7 of those are ASX listed. Some of our major retailers have reported to the market and outlined strong growth outlooks, which is encouraging. On Slide 12, we highlight the location of our assets. This details HDN's key metropolitan markets. The majority of centers are located in the key Eastern Seaboard capital cities, and these include 40% of the portfolio being in Sydney, 19% of the portfolio in Melbourne and 17% of the portfolio in Greater Brisbane to the Gold Coast. These 3 cities are the fastest growing in Australia, giving our portfolio exposure to the increasing population as demonstrated by the 10-year population projections we have included. Our sustainability commitments, which we outlined on Slide 13, are designed around our objectives to create healthy communities. I'm pleased to report on the following initiatives delivered. On environmental, we've delivered solar to 70% of feasible sites against the target of 65% and achieved a 32% reduction in Scope 1 and Scope 2 emissions versus an FY '22 baseline. This has been through a combination of our energy management system and solar installations. On social, HDN has targeted our social needs program to support youth under 18 as demonstrated by the support of national partnerships with organizations such as ETA. And on governance, HDN was awarded ESG regional top-rated company with Morningstar Sustainalytics for the third straight year, and HDN has lodged its third modern slavery statement and continues its GRESB submissions. Moving now to our growth opportunities that commence on Slide 15. Since IPO, HDN has differentiated itself from other REITs through its ability to actively develop assets. Since IPO, we have invested more than $327 million across 25 projects, delivering an average yield on cost of 8.5%. The development of the portfolio continues. Today, we have $170 million of projects under construction, and we're aiming to commence a further $80 million to $100 million of projects in FY '26. All of the projects are targeting at least a 7% return on cost. The value creation in our growth through our asset management and development teams is a key point of difference. And I'd now like to take the opportunity to update you on our active development projects. On Slide 16, we outline our progress at Tuggerah, where we have an 11,200 square meter leisure and lifestyle expansion under construction. The development is 96% leased to ASX and leading national retailers, including Officeworks, Nick Scali and Anaconda, and we have multiple offers to choose from on the remaining space. The development is targeting a more than 7% return on cost and a 10% net valuation gain. On completion of the development, 10,000 square meters of land remains available for future development. We have a development consent in place for an additional 7,000 square meters of GLA on which we have interest from ASX-listed retailers. On Slide 17, we provide an update on our Castle Hill development. Castle Hill is one of the leading LFR centers in the Sydney metropolitan area, and it's the largest asset in the HDN portfolio. The prime center is in high demand from retailers who are attracted to its strong population growth, high quality of the center and the tenancy mix. The strong demand has allowed us to develop additional GLA in underutilized car parks. Stage 1 of the development completed 100% leased to leading retailers, including BCF, Total Tools and Petstock and has delivered a valuation gain of $14.5 million. Stage 2 of the development is 100% leased to retailers such as Bingle, Plus Fitness and Beacon Lighting, and we're targeting a noncompletion value for the asset of $450 million. And on Slide 18, we provide an update on Lutwyche. In August '24, we acquired Lutwyche, which is located just 5 kilometers from the Brisbane CBD and contains all 3 major supermarkets, Coles, Woolworths and Aldi. We're well advanced with the implementation of an accretive remixing strategy we identified on acquisition. The strategy proposes to replace the existing underperforming food court with a 700-square meter mini major we've leased to a leading national retailer. The remix has also allowed us to lease up other long-term vacancies in the center, including the introduction of new food operators. On completion, we're targeting a 21% valuation gain. And on Slide 19, we provide some information on our other active developments. These include a new Woolworths anchored daily needs asset at Armstrong Creek, a childcare center at Upper Coomera and an urgent care medical center and childcare center at Caringbah. Again, all of the developments are tenant-led and target a minimum 7% return on cost. Turning now to Slide 20. Over the last 2 years, HMC real estate platform has established 3 unlisted retail property funds, which we have articulated on this slide. HDN has invested in aggregate $94 million. This is a relatively small investment in the context of the balance sheet, but a strategically important investment that allows us to, one, invest in complementary strategies in adaptive reuse and greenfield developments that HDN would not normally invest, but had outsized IRR returns that we should benefit from. Access -- number two, access to high-quality assets once complete, that are of the type and quality that HDN would be proud to own and which we will have a right of first offer. And three, gives us the benefit from cost and income synergies that come with the scale of the HMC real estate platform, which now has approximately $10 million of real estate under management. I'll now hand over to Will to take us through the FY '25 results in more detail.

Thanks, Paul. Turning now to Slide 22 to go through the earnings summary. Strong underlying revenue growth saw property net income grow 6% to $288 million in FY '25. FY '25 FFO increased to $182.5 million or $0.088 per unit despite offsetting a 17% increase in net interest expense. Turning now to Slide 23 to go through the balance sheet. June '25 net tangible assets was $1.47 per unit, recording a 1% gain versus December. The portfolio cap rate as at June remained steady at 5.6%. Asset recycling continued within the balance sheet with proceeds being reinvested into neighborhood centers and developments. Turning now to Slide 24. June gearing of 35.2% remains at the midpoint of the target gearing range of 30% to 40%. Liquidity as at June was $108 million with no debt expiries until FY '27. During the second half of FY '25, HDN increased its hedge book to 50% of current drawn debt for the 3 years to June 2028. I'll now hand it back to Paul to discuss outlook and guidance.

Thanks, Will. Turning now to Page 26. We're really proud of the team and the results. We continue to grow our earnings per unit and remain focused on long-term value creation for our unitholders. In the last 3 years, we were able to navigate through a rising interest rate environment without dropping earnings, distributions or undertaking capital raises. We recycled assets, we reinvested back into our assets and focused very simply on operational excellence at our assets. We're pleased to provide our FFO guidance of $0.09 per unit and distributions of $0.086 for FY '26. We have a balance sheet, gearing and hedging profile that positions us for growth should market conditions improve and the interest rate environment become more benign. I'll now hand back to the operator for questions.

Your first question comes from Cody Shield from UBS.

Just firstly, on that Warilla Grove asset. Are you able to provide some details on yield settlement and what you're seeing there in terms of opportunities to add value?

Yes. Thanks, Cody. I think firstly, just a quick little bit of information around the asset. It's a great asset, really strong supermarket sales, just under $100 million of sales. Buying the asset from an owner that probably just -- where there's an opportunity there for us to really, I think, make some changes as we've demonstrated both in our pack through developments and asset management on the asset. We're looking at getting that asset at initial 5.5% and growing it to 7% plus in a pretty short period of time. And I think we're planning to get some more information in our next press for you once we've got our hands on it. But we'll settle it in the next couple of weeks is the plan there, Cody.

So Cody, if you recall what we did at Southlands recently at Marsden Park, what we've outlined in Lutwyche, Wheel is going to be another one of those opportunities where it's got a few too many vacancies at the moment. We see immense upside because the bones of the asset are fantastic. It's in a growing catchment with wonderful fundamentals. And we'll -- we think we'll make some outsized returns on that, both from a yield and a value uplift perspective. So we're really excited about it.

Okay. That's clear. Just second one on maybe the run rate of disposals. I mean you probably expect valuation gains into FY '26. So how should we think about the run rate there? Is it maybe $40 million or so in second half '25? Or are you going to marry it up with CapEx? How should we be thinking about it?

We're going to marry it up with CapEx.

Okay. Great. And then maybe just lastly, could you give us a read on how your tenants will be trading into July and August?

Yes. Certainly, I think we tried to articulate in the press, we're seeing some strong growth. June was probably one of our strongest month-on-month in the mid-single-digit growth throughout the portfolio. And anecdotal evidence from the retailers is that's continued into July and August as well. And I think as I articulated in the presentation, we're actually seeing that coming through from some of those categories that have been under pressure in the last couple of years. So the furniture, homewares, the leisure and lifestyle guys are really seeing some good momentum there.

First time for a long time, consumer sentiment, certainly at our assets is really positive off the back of anticipated interest rate cuts. So there's a buoyancy amongst the retailers, which is really encouraging. And probably to add to Paul's remarks because I know we'll get asked the question, we've started the year really strongly on leasing spreads. So we will probably end up the year similar to this year, around 6%, but we've started with leasing spreads that are double digit on the deals done to date during July and the first little part of August.

Your next question comes from Lou Pirenc and Jarden.

Sid. Quick question on your guidance. It seems a little conservative with 4% NOI growth targeted to the upside from asset recycling. Are you expecting another jump in interest expense? And what -- or maybe another way of saying it is what do you expect your [ WACC ] to be in '26?

Yes, Lou, I'll touch on the interest assumption. So we're assuming 3.4% for the unhedged portion of the debt. And then on the property NOI, I'll probably pass to suit on that one.

Yes. So the comp NOI growth will be pretty similar to last year. We -- look, again, the outlook from where we sit today is optimistic. Retailers are performing well. Our leasing activity is really strong. The downtime between our remixing is reducing. OpEx management, we've been incredible at our OpEx management for the last 3, 4 years while inflation has been running. And one of the great things we have in our book is property expenses are capped at 3% of gross rent. So look, the guidance is what it is, but I think there's some tailwinds now that are emerging that used to be headwinds in previous years. So I think to your point, Lou, I think cost of debt, as we sit here today, is a marginal headwind, which is affecting the guidance today. But the market is turning, interest rates potentially are coming down, and it could turn into a tailwind really fast.

Great. And maybe -- and apologies for asking too many questions about debt and stuff, but it's the interest expense in '25 went up by 17%. The cost of debt only went up by 10 basis points and your average debt balance hasn't really changed that much either. So how should we think about that? Is that just fluctuations in debt balance throughout the year that is higher than the period end?

Yes. It was just a function of the hedge book rolling off and stepping up. So yes...

Is that captured in your average cost of debt?

Yes. So I mean, as Sid said, yes, I mean, this is the last year where we've got that sort of step-up and roll off of the hedge book. Our current hedge rates are pretty in line with the unhedged market. So it's setting us up for good future growth.

Your next question comes from David Pobucky at Macquarie Group.

Just wanted to follow up on Lou's question around the weighted average cost of debt and interest expense into next year. I mean with that hedge debt reducing to 50% at July, would you say you've got relatively less visibility on interest expense than usual? Is that hedge debt lower than prior years? And Sid, I think you mentioned, it sounds like interest rates or interest expense is a marginal headwind but could turn into a tailwind through the year potentially depending on kind of where interest rates come in. So potentially some conservatism in guidance. Is that the way to read it?

Yes. I think what we're saying is, I mean, the assumption for unhedged debt is 3.4%. I think if we went and locked it in today, we'd get around 3.2%, 3.3%. So I mean, there is a bit of upside there today, but maybe that comes back down. But I think the key point to sort of take away is we've HDN's absorbed sustained increases in cost of debt over the last 3 financial years. right here right now, we're not going to be seeing that for future periods.

Second question is on development commencements. So $100 million to $120 million last year. This year, you're guiding to $80 million to $120 million. So a slightly wider range than last year. Could you talk to that, please?

Look, there's a various number of projects around the portfolio, David, some of different size and scale. So I think it's probably just more a matter of the mix of projects that are there. We don't want to be, I suppose, overshooting what we think is achievable and be presenting in that $80 million to $100 million target of what we see in FY '25. The pipeline at $650 million is there. There's a couple of larger projects that will probably come online in future years that we'll see it smooth out.

And just the final question on the payout ratio. I think the opening remarks mentioned that the payout ratio is reducing as you rightsize the distributions to AFFO over time. Will you start providing an AFFO per share number going forward? Or what payout ratio are you targeting medium term relative to AFFO, please?

Yes. So yes, over time, I think we'll start as the portfolio matures and there is maintenance and leasing CapEx in a more stabilized environment, we will provide AFFO per unit. And then with an intention over time, whether it's next financial year or after that our payout ratio will be at 100% of AFFO. Now that's based on a lot of feedback we've had from our investors. The one thing is unlike other REIT peers, our development book creates incremental income and value and earnings that otherwise aren't there. So just a data point for everyone on the call, that might be helpful. Since our inception, interest expense has grown from $17 million to $81 million last year. yet we've grown our earnings every year. We've grown our distributions every year. And we've sized our distributions historically to where we think the earnings will get to, including the developments as they come online. So look, I've been pretty comfortable with where we've been at historically. But I think that's probably -- our view is the right way to go moving forward is to just size the DPU to AFFO and then to keep reinvesting in this development pipeline, which is creating some outsized performance.

Just one follow-up. What was [ MCNTI ] in FY '25, please?

Sorry, David, I just -- it was a bit muffled. Could I trouble you...

[ MCNTI ] in FY '25, what was it, please?

Sorry, I'm missing the acronym. Are you asking for leasing incentives and tenancy incentives?

Yes. What was maintenance CapEx and tenant incentives in FY '25?

Yes, it was $20 million. We had $5 million in maintenance CapEx and $15 million in incentives.

Your next question comes from Richard Jones with JPMorgan.