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

Thank you for standing by, and welcome to the HomeCo Daily Needs REIT Full Year '22 Full Year Results Briefing Conference Call. [Operator Instructions] I would now hand the conference over to Sid. Please go ahead.

Good morning, everyone, and thank you for dialing in. Joining me on today's call is Group CFO, Will McMicking. Before we commence today's presentation, we would like 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 their elders past, present and emerging and extend that respect to all Aboriginal and Torres Strait Islander people today. I'll start today's presentation on Slide 3. It has clearly been a transformational year for the HomeCo Daily Needs REIT. The successful merger with Aventus has given us greater scale, a stronger balance sheet and a platform for growth. There are 3 key takeouts from today's results. First, the portfolio is performing well. We've maintained high occupancy, high cash collection, strong leasing spreads and strong comp NOI growth. Importantly, our tenants have also performed well. Second, we are making strong solid progress on our $500 million development pipeline. We successfully delivered $37 million of developments in FY '22. And we are on track to activate over $75 million of development in FY '23. Thirdly, we proactively manage the balance sheet to protect our capital position and flexibility. Today, we announced the sale of our LFR asset on the Sunshine Coast, Queensland for $140 million. This represents a 6% premium to December 2021 book value. This will see HDN's gearing reduce to 30.6%, which is at the bottom end of our target range. And hedging, post this transaction, increases to 73.5%. Let's now turn to Slide 5 with the key result metrics. FY '22 saw HDN deliver FFO per unit of $0.0885. This represents a 30% increase on FY '21 and also exceeds our February guidance. NTA per unit increased by 12% since June '21, reflecting strong valuation growth in our portfolio. Pleasingly, we are still seeing strong investor demand for quality daily needs assets, notwithstanding these macroeconomic conditions. The sale of our Sunshine Coast LFR asset in the last 2 weeks demonstrate this. As I mentioned earlier, the portfolio is in great shape and we are capitalizing on our enhanced scale post the merger to drive rental growth. We achieved comparable net operating income growth of 5.1% and positive leasing spreads of 5.7% with only 3.9% incentives. This reflects the strong underlying tenant demand for our daily needs assets, which increasingly act as last mile logistics hubs for e-commerce fulfillment and distribution. Our development program secured 26,000 square meters of leasing in line with HDN's accelerated pipeline rollout. The $37 million of development delivered in FY '22 have provided a 10% ungeared cash-on-cash return. We increased the FY '23 development target to $75 million with a 7% ungeared cash-on-cash target return. As stated earlier, we have substantial growth opportunity here through the $500 million pipeline of identified projects. Finally, on this slide, I want to note the progress of our ESG strategy. We remain on track to achieve HDN and HMC Capital's target to be net zero in 2028 for Scope 1 and Scope 2 initiatives. Turning to Slide 6, where we summarize HDN's investment strategy for those that are unfamiliar with it. We target a model portfolio of 50% neighborhood, 30% LFR and 20% health and services. This mix balances the best characteristics of defensive, reliable income streams with sustainable growth. While at this point, our exposure to LFR is higher than target following the Aventus merger, HDN is committed to bringing this back to the model portfolio in the medium term. Importantly, we have over 79% exposure to metropolitan cities with a high skew to the large population growth centers of Sydney, Melbourne, Brisbane to the Gold Coast. We serve over 13 million Australians who live within a 10-kilometer radius, and we have over 80 million visitations through our assets per annum. We have substantial opportunity to unlock and enhance a lot more real estate. HDN owns over 2.5 million square meters of high quality and strategically located land with only a 37% site coverage at present. This gives us a substantial opportunity to leverage the rapidly emerging and essential last mile infrastructure trends and needs of our tenants. Turning to Slide 7. The Aventus merger has been positively transformative for HDN and our expanded unitholder base. Within 4 months of the merger date, we completed the seamless integration of management platforms, systems and teams. This was achieved while maintaining strong operational momentum and making significant progress in unlocking the development pipeline we've spoken about. We would like to thank Darren Holland and the wider management team, along with Bruce Carter and the Board of Aventus for their stewardship, support and assistance with a successful merger and integration of our respective businesses. Aventus is a remarkable collection of real estate assets that was created with the vision of Brett Blundy and Darren. We are proud to have these assets part of the HomeCo and HMC family. This takes me now to Slide 9, where we provide more color on the combined platform and income composition. HDN now owns over $4.65 billion of high-quality real estate with over 1,200 tenants. Average rents are low at $349 per square meter. 73% of our income has a weighted average rent review of 3.6%, and 19% of our income has annual increases linked to CPI. The balance of our income now has 4 supermarkets that are in percentage rent from the 2 that we announced previous half. At this point in the cycle, HDN's affordable rents and customer convenience proposition provide a reliable platform for growth for our tenants. Turning to Slide 10. We maintained high occupancy above 99%. Cash collection was greater than 99% each month throughout FY '22. This reflects the portfolio's weighting for high-quality assets and robust tenant covenants. We continue to grow HDN's property income with over 200 leasing deals completed over the year. These deals were delivered with positive spreads of 5.7% and low incentives of 3.9%. As I mentioned earlier, we have forward secured over 26,000 square meters of development leasing to support the accelerated development pipeline. Despite the continuing impact of COVID-19 over the course of the year, our centers attracted more than 80 million customers. That statistic strongly underscores the portfolio's strategic location and daily needs characteristics. As a result, HDN's retailers continued to perform strongly. Sales grew 3.7% for supermarkets and 1.8% of specialty tenants cycling off already-elevated basis. These outcomes highlight the portfolio's premium positioning as critical last mile infrastructure. Notably, center foot traffic is materially higher than pre-COVID levels. Customers are increasingly now living, working, shopping and dining close to home in the fastest-growing suburbs of Australia, where HomeCo assets reside. On Slide 11, we provide further detail about our top 10 tenants and portfolio weightings, which, as I said, we are rebalancing in line with the target model portfolio over time. Slide 12 shows there are several ways with which we will rebalance the target model portfolio. One, we are actively remixing our tenants. Two, we are undertaking developments of health, wellness and supermarket precincts. Number three, we will continue to enhance the portfolio composition via appropriate acquisitions and disposals. The sale of Sunshine Coast for $140 million, representing a 6% premium to December '21 book valuation, demonstrates our discipline on capital management. Moving to Slide 13. I'd like to spend a moment to highlight the portfolio's increasing role and value in last mile logistic strategies for our tenants. Tenants are increasing their sophistication in finding cost-effective ways to distribute their goods and services to consumers. With increasing input costs in a high inflationary environment, being able to utilize existing store network to fulfill omnichannel orders is critical for tenants. And that's where the HDN portfolio is at a critical advantage. We own a very strategic footprint of 2.5 million square meters of land in the best suburban growth corridors of Australia. Slide 14 discusses in some detail how domestic and international retailers are fastly adapting their last mile solutions and omnichannel offers. Slide 15 importantly shows how our retailers and tenants in our portfolio are beginning to utilize their stores for this critical last mile fulfillment. Whether it's supermarkets or large-format retail tenants, providing frictionless retailing is core for the retail of the future. Increasingly, store footprints, automation and labor inputs are evolving to meet this challenge. The HDN portfolio is ideally suited to providing the best real estate for these retailers and tenants to implement their strategies, and we are working closely with them in this regard. Our centers have big on-grade car parks, accessible loading solutions and are on main roads that service big suburban and catchments, which are growing fast. More than 77% of our tenants are now supporting their last mile logistics strategies through their store network in our portfolio. This shows how quickly our tenants are adapting their strategies and there's more to come. Moving to Slide 17. HMC Capital is committed to the creation of healthy communities and driving long-term value creation across all of our investments that we manage. We continue to make great progress implementing our sustainability commitments across the HDN portfolio. We have previously provided our detailed road map to net zero. This slide provides more color on our journey so far and our commitments into the future. Our energy management system to convert our buildings to smart buildings is progressing well. This is a relatively small investment in dollar terms, but is already delivering an over 20% reduction in our consumption. It is also yielding a return on investment in excess of 15%. So we're very pleased with the early progress. The next phase will see the rollout of our EMS program across the balance of HomeCo sites, followed by our solar rollout, which we are now tendering. These next stages are critical to our commitment to achieve net zero within our asset base. In order to play our part in securing a greener future for future generations, we are pleased to announce today that HomeCo Mackay will be the first large format retail center in Australia to target a Green Star Rating. Slide 19 cuts to the developments that we are focused on, which includes HomeCo Mackay that I've mentioned. Slide 20 provides details of the $37 million of developments, which we delivered over FY '22 and we provided more detail of previously. Moving to Slide 22. Here, we have highlighted some of our FY '23 development opportunities. The $75 million of development program has increased by 25% on our plans as at December 2021. These development projects will add 28,000 meters of GLA and target a 7% blended cash-on-cash yield. We received requisite development approvals for Mackay, Glenmore Park and Nowra and have made excellent progress on the leasing. HomeCo Mackay is set to become the dominant large-format retail, leisure and lifestyle center in the catchment. This project is tenant demand-led, as are all of our projects. Glenmore Park will see an essential government-led health and wellness precinct added to our town center. Nowra will see the introduction of a leisure and lifestyle center that services our network between Sydney and the South Coast of New South Wales. This slide merely highlights the breadth of opportunities within the portfolio to remix post the Aventus merger and to positively leverage HomeCo's huge and strategic land bank as we move back to the target model weightings. Slide 23 gives you a closer understanding of future development opportunities, which we've categorized in some minor and major projects. And over time, we'll provide more color about unlocking these opportunities. I will now hand over to Will to provide some commentary around the financial results.

Thanks, Sid. Turning now to Slide 25 to go through the earnings summary. HDN delivered strong earnings growth with FY '22 FFO of $105.6 million or $0.0885 per unit, which equates to annual growth of 30%. HDN also declared DPU of $0.0828 for FY '22, which represents an 18% increase versus FY '21. The earnings and DPU growth were driven by active portfolio management comprising the execution of developments and acquisitions, including the Aventus transaction, which completed in March. Turning now to the balance sheet on Slide 26. Acquisitions and valuation gains during the period have resulted in a robust balance sheet with June '22 total assets of $4.9 billion, net assets of $3.1 billion and NTA of $1.52 per unit. Underpinning the NTA and its growth are investment properties of $4.7 billion with a weighted average cap rate of 5.3% as of June. This reflects the ongoing strength of the daily needs asset class and is highlighted by the recent sale of Sunshine Coast at a premium to June '22 book value. NTA per unit is now 22% higher since first announcing the Aventus transaction back in October '21. Moving now to Slide 27 to talk to capital management. The $140 million sale of Sunshine Coast puts HDN in a strong capital position with post-sale gearing of 30.6% and liquidity of $380 million. HDN has also undertaken additional hedging since December. And adjusted for the sale of Sunshine Coast, the group's hedge debt is 73.5%. Weighted average debt tenor and hedge book is 3.1 years and 2.8 years, respectively, and a summary of the debt and hedging book is detailed in the appendices. Turning now to Slide 29. We're pleased to provide FY '23 guidance today and are feeling very positive about the outlook for the business. The property portfolio continues to deliver strong underlying NOI growth and is supported by our deep development pipeline, providing attractive reinvestment returns. Our guidance also reflects the proactive capital management steps already taken in FY '23 with the pending sale of Sunshine Coast, which will reduce gearing to the low end of our target range and improve the hedge book. This disciplined approach by the manager puts HDN in a great position to continue its value-accretive development and consider other accretive investments as and when they arise. HDN is pleased to provide FY '23 FFO guidance of $0.086 per unit and DPU guidance of $0.083. I'll now hand back to Sid for closing remarks.

Thanks, Will. As you can see, the group will remain focused on unlocking highly attractive investment opportunities for our investors while also optimizing tenancy mix and performance across our now substantially expanded portfolio. To recap on my opening comments, there are 3 key takeouts from today: first, the portfolio is performing really well; second, we remain focused on unlocking value from our $500 million development pipeline; and thirdly, we have proactively managed the balance sheet and are well positioned to grow into FY '23. Thank you to everyone for your interest today and ongoing support. I would also like to thank our dedicated management team that really drive our asset performance day in and day out. I will now hand back to the operator for questions.

[Operator Instructions] The first question will come from Ronny Cheung from Jefferies.

It's Sholto visiting Ronny's log in from Jefferies. Just a question on a good result. Just a couple of questions on the guidance. The Sunshine probably wasn't in consensus given you didn't announce it today. So that looks to be about on this year about 1.5%, 1.2% dilutive. So that's in the guidance, is it, that you've put out today, that dilution?

Yes, that's right, Sholto. [indiscernible]

Okay. That's great. Pardon?

Yes, about $1.5 million impact when you reduce the debt.

Yes. Okay. And then just on the -- I noticed in the guidance, you increased the payout ratio by 3% to 97% this year. I know that the business has grown. What was the rationale behind that?

Yes. I mean payout ratio is still within the guidance of 90% to 100%. We're conscious of maintaining distribution and we're feeling confident in holding that.

Okay. And then when you sold an LFR, are you looking to sell any more, like sell some half stakes in the larger assets like a Castle Hill to get back to your portfolio weighting? Because pro forma weighting LFR is 47% now, so that's still about 17% off your target. What was your view? I know you'll get there through organic developments. But what's your view on maybe selling down some of the larger assets to reduce that exposure?

Sholto, like we've said, we'll always be proactive in our capital management and disciplined and we're always opportunistic, that given -- you can see that we can get back to our model portfolio weightings through the organic embedded opportunities within the portfolio. That's the #1 focus for the group. We're really happy with our asset base and we can see growth opportunities in front of us. That's what the team is going to focus on unlocking.

And then just on the debt. I noticed you spent $16 million in derivatives. Was that part of the Aventus merger when you [ reviewed ] that or was it post that?

Yes. So that was done post the merger, Sholto. So what we did as part of the transaction was there was a legacy hedge book that was broken and entered into the caps. I mean one of the considerations there was, at the time of announcing the merger in October, we had guidance for the merged group. So this allowed us to improve the hedge book and hold prior guidance.

Great. And then just finally on the cap rate. I noticed the cap rate was firm at [ 5.7%, 5.1% ] Sunshine. It looks like that growth was from income, the 2.4%. The rise in asset value between December and June, looks like it all came from income growth of around 3.6%. Is that a fair comment?

Yes. That's right.

Yes, predominantly income growth there.

Our next question will come from Simon Chan from Morgan Stanley.

Can I just ask Will to clarify his response to Sholto, just before the $16 million payment, exactly what was it for?

Yes. So it was when we put in, as part of the hedging, we entered into caps. As we've outlined in the appendices, when you enter into those as a premium paid. So...

Okay. Okay. So that's for the -- the cap on the $400 million thing?

Yes, that's right.

Okay. That's cool. My next question. Look, I know the Sunshine Coast sale was a little bit dilutive, but notwithstanding that, earnings guidance is still going backwards. Is it fair to assume it's purely down to the increase in the cost of debt that's resulting in the decline in earnings next year? Or is there something else that we should be mindful of?

No, that's it. I guess the other point we'd like to make here is -- we've reduced the gearing to 30.6%. So at the bottom of the range, we've got a good development pipeline in the portfolio already. But just -- it sets us up for strong future growth and that probably adds to the consideration around the distribution holding out at $0.083.

Probably I might add as well, Will. Ultimately, you can see that, that comparable net operating income growth last year and what we forecast moving forward is still very, very, very strong. Leasing spreads are strong. Our house is almost full. Our occupancy is at 99%. And I probably hasten to add, the comparable NOI growth number that we put out on Slide 29 at 3.3%, that excludes development that we've alluded to. So they are not in that basket. They add further growth to the portfolio.

Great. And my final question, just leases you've signed, are you guys sticking to the same structure? Or have you tried to work more CPI linkage into new leases signed? Can you comment on that, please?

Sure. I'll take that one, Simon. So about 12 months ago, we probably saw a bit of inflationary pressure coming, and we were successful in negotiating a lot more CPI-linked leases at that point in time. We will still work with our tenants. What we're really focused on is matching sales growth projections that tenants have with rental growth so that we can match it to have sustainable income growth over the medium term. At this point in the cycle, not many tenants are going to sign a CPI lease with you.

Our next question will come from Richard Jones from JPMorgan.

Just in relation to the development, are you able to talk about the initial yield that you're getting and the time you typically assume for stabilization?

Sure, Richard. So the initial cash-on-cash yield are the numbers that we've put out. So the FY '22 numbers of 10%, that's an initial cash on cash with earnings that will flow through in FY '23. The forecast of $75 million of future developments that we're targeting as a return cash-on-cash of 7%. The stabilization period on that -- on these kind of assets, given the tenancy book and the low exposure to specialty tenants, is quick. Typically, we stabilize these within 3 to 6 months, and you don't really have an earnings gap like you would when you develop one of these big shopping centers that have a lot of specialty tenant risk that takes time to stabilize. So once the projects are complete, they're income generating.

Okay, very clear. And then can you also just touch on, obviously, rise in construction costs are an issue for all. Just our resourcing and raw material price increases, how that's impacting on project feasibility and potentially are there income offsets to maintain returns moving forward beyond obviously strong returns in the projects in FY '22, but imagine the cost increases are more at 23-plus impact.